Stricter regulatory enforcement - recent cases and suggestions

Recently, our practical observations indicated a growing trend of more frequent and stringent law enforcement inspections conducted by regulatory authorities across various sectors. These sectors cover foreign exchange management, labor supervision, customs, market regulations and so on. This trend can be attributed to the stricter implementation of the 'Double Random and Public Disclosure' mechanism (“双随机、一公开”).

The 'Double Random and Public Disclosure' mechanism entails regulatory authorities conducting inspections and checks randomly, with the results being made public through the social credit system. While this initiative aims at enhancing transparency and fairness in regulatory inspections, it presents big challenges for companies in China.

Under this mechanism, companies face heightened uncertainty, as they are less likely to predict when an inspection will take place. The potential consequences of a negative inspection finding, especially when made public, can harm a company's reputation significantly. Furthermore, this trend underscores the delicate balance between stringent regulatory enforcement and the desire to establish a business-friendly environment for enterprises. Companies must put more attention and resources in the fields of compliance to ensure they can effectively respond to unexpected inspections and any subsequent legal actions.

In this newsletter, we will introduce several typical administrative enforcement cases from four different areas and provide you with suggestions and recommendations for corporate compliance.

1.    Labor Supervision

Compliance with labor law has consistently been a significant area of focus for FIEs. Labor inspections are frequently initiated due to complaints from competitors or the own employees of the company, but they can also be instigated by enforcement authorities themselves.

1.1    Regulations

In the field of labor supervision the provincial and local Human Resources and Social Security Departments (HRSSDs) issued specific rules on the implementation of "Double Random and Public Disclosure", and thereby strengthening the supervision of enterprises' compliance with labor laws.

1.2    Cases

As disclosed on the government official website , Suzhou City in Jiangsu Province conducted in 2023 a special supervision and inspection of labor protection for female employees. The inspection included the following aspects:

• Special regulations regarding working hours, rest, and leave for female employees during pregnancy, childbirth, and lactation periods.
• Payment of wages during legally mandated leaves such as marriage leave, family planning surgery leave, prenatal examinations for female employees, maternity leave, lactation periods, and male caregiver leave.
• Cases of termination or dissolution of labor contracts for female employees during pregnancy, childbirth, and lactation periods.
• Labor contracts for female employees and their participation in social insurance system.
• Currently, the relevant authority has not yet released the results of this special supervision and inspection.

1.3    WZR Comment

For enterprises, it is crucial to examine the substance beneath the form and diligently ensure compliance with labor laws in their daily operations. FIEs in China may face distinct labor law risks compared to domestic ones. For example, from the labor supervision perspective, compliance issues for FIEs may generally arise in the following areas:

• Working hours/overtime, leaves and holidays;
• Special labor protection of female workers
• Wage payment and minimum wage standards;
• Social insurance,
• Labor dispatch and labor outsourcing
• Engagement of foreign employees, etc. 

2.    SAFE: Foreign exchange inspection

Recently, China’s State Administration of Foreign Exchange (SAFE) has intensified its scrutiny of the foreign exchange receipts, expenditures and relevant business activities of market entities.

2.1    Regulations

Foreign exchange control in China is a dynamic and evolving area of regulation, with changes occurring periodically to adapt to economic conditions and government priorities. Key aspects of foreign exchange control in China include capital control (investment, dividend, etc.), foreign currency related transactions, foreign debt control, etc. 

2.2    Administrative penalty for unauthorized foreign borrowing

In November 2022, Omega Integration (Nantong) Ltd (a wholly owned subsidiary of Singapore's Omega Integration Pte Ltd.) was fined RMB 156,000 by the Nantong Branch of the State Administration of Foreign Exchange for its unapproved foreign borrowing. 

2.3    WZR comment

 "Foreign debts" refers to debts owed by domestic institutions to non-residents in foreign currency. In practice, it is quite common for FIEs to acquire loans from their parent companies, which are typical instances of foreign debts. These debts are subject to specific quotas. Furthermore, when it comes to foreign debts, companies are required to complete registration with the foreign exchange authority and establish a special bank account for handling loan deposits and repayments. The utilization of shareholder loans is subject to rigorous oversight by both the foreign exchange authority and the bank. For each withdraw of use of the funds in the foreign debt bank account, supporting documents must be presented to the bank.

3.    Customs: Royalty inspection

In recent years, customs authorities have been conducting comprehensive nationwide inspections on royalties paid by companies in various industries to overseas entities. From a customs oversight perspective, the legislation concerning the taxation of licensing royalty fees is relatively principle-based, making it difficult to arrive at specific determinations that necessitate specialized expertise. This complexity poses greater challenges for companies when responding to customs inquiries. Consequently, ensuring compliance with the taxation of licensing royalty fees has emerged as a central concern for businesses engaged in import and export activities.

3.1    Rules: Taxable Conditions of Royalties for Customs Duty

In cases where the customs value of imported goods is determined based on the transaction value, any royalties that the buyer must directly or indirectly pay to the seller or related parties for the imported goods shall be incorporated (*1). Such royalties must also simultaneously meet the following two conditions (*2): a. they are related to the goods; b. the payment of royalties is a precondition for the sale of the goods for export to China.

3.2    Case: Wuhan LangBo Co. v. Wuhan Tianhe Airport Customs

In the classic case Wuhan LangBo v. Wuhan Tianhe Airport Customs (“the Customs”) (*3), the customs authority determined that the payment of USD 50,000 made by the subsidiary of LangBo to the overseas company was not a regular advance payment, but rather a royalty. The dispute in this case is whether the USD 50,000 upfront fee is a royalty that shall be included in the customs value. The customs imposed a fine of RMB 25,000 on LangBo because it held that LangBo should have included the fee in the value when it imported Paclitaxel APIs but did not truthfully declare it. By contrast, LangBo argued that the USD 50,000 was a kind of deposit instead of a royalty. 

In the judgment of the People’s Court found that based on the Agreement, the purpose of the USD 50,000 was to obtain the exclusive distribution right, so it was part of the royalty which allows LangBo to import Paclitaxel APIs to China for sale. Therefore, the People’s Court held that the USD 50,000 shall be included in the customs price. 

3.3    WZR comment

Royalties means fees paid by the buyer of imported goods for obtaining the permission or transfer of patents, trademarks, know-how, copyrights, distribution rights or selling rights from the owners of IP right or the duly authorized representatives thereof. In the determination of the customs value (also called “dutiable value”) of imported goods by Chinese customs, it is not always clear whether a fee is royalty or not, and whether a royalty shall be included in the customs value or not, sometimes resulting in disputes between the customs and enterprises. Thus, we suggest enterprises to familiarize themselves with Chinese customs rules and engage the professional agency to provide legal advice when designing agreements related to license fees and in declaration to the customs.

4.    AMR: Law Enforcement Inspection in the Field of Marketing

Nowadays, advertisement is everywhere! We could be the target audience of such advertisement, or we could be the advertisers. “We have the best product”, “our product is integrated with the most advanced technology”, “our product is the most popular ones in the market”. Are you familiar with those words? Do you see any problems with those words?

4.1    Case: Using “Forbidden Word”

In 2023, several clients have received notices from the local Administration for Market Regulation (the “AMR”) stating that they have violated the PRC Advertising Law and hence companies shall rectify its violation behavior and could be imposed a fine ranging from RMB 200,000 to RMB 1 million because they used the forbidden words for product introduction on their website such as the “using the most advanced technology”, “the No. 1 product”, “the Top 1 brand”. 

4.2     WZR comment

This case could happen to any companies especially for SMEs, where the official website is controlled by the overseas headquarters. Once the product information including the common English terms, for instance “the most outstanding product” is published on the global website, it will be automatically translated into Chinese and shown on the local website. Such Chinese terms will become solid evidence against PRC Advertising Law. Therefore, to avoid such risks, companies should improve the awareness in this regard and check its websites, social media accounts, promotion documents and material on a regular basis. 

Moreover, in the event of receiving a notice from local AMR, the possibility of pleading for leniencies and avoiding the penalty still exists, especially for the first-time violation according to our experience. We summarized some takeaways that companies could adopt:

• Cooperating with the local AMR regarding the investigation 
• Promptly removing the relevant wordings from the advertisement
• Conducting legal research if there are any local regulations or policies for leniencies 
• Gathering the evidence to support the advertisement 
• Making explanation to the AMR emphasizing the evidence and highlighting that the violation was not willful, minor, promptly corrected, and did not result in any detrimental consequences.
   

In the context of authorities intensifying their oversight and inspections, it becomes even more important for companies to strengthen compliance management. We will continue to closely monitor the latest developments in advertising regulations and provide support to our clients.

Please do not hesitate to contact us if you are interested in any of these topics and we are excited to discuss it with you!

Beijing, September 12th, 2023

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*1  Regulations of the People's Republic of China on Import and Export Duties Article 19(5): Royalties related to the imports which are payable by the buyer as a condition of the sale of such imports.
*2  Measures of the PRC Customs on Determination of Dutiable Value for Imports and Exports Article 11(3): Royalties to be paid by the buyer directly or indirectly to the seller or related parties, except for those paid under any of the following circumstances:(a) the royalties are not related to such goods, or(b) payment of royalties shall not constitute a criterion for sale of such goods within the People's Republic of China.
*3  Wuhan Intermediate People's Court of Hubei Province (2018) E01 Xingchu 438 Judgment.