China startups

Five mistakes

According to Mark Schaub, a reflective and patient approach will help international partner schools avoid five common mistakes that often affect school start-ups in China.

 

Veni, vidi, vici . . . .

I came, I saw, I conquered.  Julius Caesar

I came, I got excited, I lost a lot of money. China investor

Whose fault?

The China market and ‘China opportunity’ have not gone unnoticed by international educational entities. Although there are many success stories, many come, many fail to proceed and then many blame China for such failure. This is not always fair . . . in many cases the blame lies with the international educational entity and not China. So what tends to go wrong?

1. Underestimating how competitive the market is

International education entities assessing the Chinese market should be aware of the real challenges they may face. Although the opportunity is great, so is the competition. Accordingly, it is important to consider how feasible your plans are. If you are a school it should be noted that Chinese partners place great emphasis on fame and school rankings.

If you are not a highly ranked school you may face more difficulty in securing the right partner and may need to look further afield to establish schools in third or lower tier cities. If you are an Edtech company it is important to consider whether what you have to offer is world standard. The days of China salivating over any old Western technology are long gone. If you have cutting edge tech then China may be a highly lucrative market – if not it is unlikely you will be able to break in.

2. Not empathising with your Chinese partner

Most UK educational entities will work with some form of Chinese partner – be it a joint venture partner or a cooperation partner or a delivery partner. Joint ventures can be notoriously difficult to navigate. The Chinese saying “same bed, different dreams” can often sum up the situation.

 

Same bed, different dreams

 

Education can bring cultural differences to the fore with disagreements over admissions standards, curriculum, physical facilities, teaching materials, tuition, marketing, teachers etc. Accordingly, it is important to choose your partner wisely and then work at the relationship.

3. Failing to protect your reputation

As a dynamic market with fast changing regulation and fierce competition there is a risk to your reputation. Will a Chinese partner engage in behavior that reflects badly upon your institution? Will the Chinese authorities introduce policies that do not conform with your values or beliefs? Is it likely that trustees, governors or parents have concerns about the relationship the school has with China? Although it is easy to overstate the likelihood of such risk its severity is clear. It is important to be closely involved with the operation of the project; have a clear contract and keep aware of the climate in China.

4. Failing to get money out

The bane of many an international company is obtaining payment from its Chinese partner. Part of the problem is that China’s currency, the renminbi (“RMB”) is not fully convertible and not easily transferred. Over the years the situation has improved.

A major improvement has been that designated banks have been authorized to convert RMB into foreign exchange for current account items to allow for easier transfers. The State Administration of Foreign Exchange (“SAFE”) approval can, however be needed for payments exceeding US$100,000. Such payments need to have documentary evidence (i.e. contract; proof of withholding tax being paid). Current account receipts and payments must have a genuine and lawful basis. This normally means a need to present a contract and proof of tax being paid. In our experience parties that have the paperwork in place and a sensible bank to work with do not often encounter major issues in making remittances. The most common problems are that your contract does not specify how to deal with withholding tax (generally 10%) and dealing with expenses. Although not insuperable, another issue is charging for expenses (i.e. flights; per diem for teaching staff; accommodation etc.). Ideally such payments should be made by the Chinese partner or calculated as part of the overall remuneration. Reimbursement of expenses can be difficult due to the lack of documentary evidence.

In our experience many difficulties with remittance are due to misunderstandings between parties on withholding tax or reimbursements. However, many other remittance issues are due to the Chinese partner not wishing to pay. The authorities can be a useful scapegoat for recalcitrant Chinese partners in such regard.

5. Failing to Understand PRC Tax

In practice UK education bodies generally obtain their remuneration for Chinese activities by way of licensing fee or service fees paid by the Chinese partner. In general, the licensing fee is subject to PRC withholding tax at a rate of 10% as well as value-added tax at 6%. On the other hand the service fee would only be subject to value-added tax at 6% (i.e. not 10% PRC withholding tax).

 

If the tax issue is not clearly understood between the parties and spelled out in the contract, disputes or at least hard feelings are very likely.

 

This is provided the UK body does not create a taxable presence – i.e. a permanent establishment (“PE”) in China. It is important to note that these taxes are for the account of the UK body and is payable within China. The Chinese partner has a withholding obligation. If the tax issue is not clearly understood between the parties and spelled out in the contract, disputes or at least hard feelings are very likely.

More importantly, it should be noted that China tax authority has been increasingly taking a more stringent approach in respect of examining the outbound payment of license and service fees. This is particularly so for the service fee. If the UK body regularly assigns its teachers or other staff members to perform onshore activities in China there is a risk of creating a PE in China. If PE in China is established, then the PRC tax authority may require the UK bodies to pay PRC enterprise income tax at the rate of 25% for the net income (e.g., license fee and service fee income) attributable to the PE rather than the withholding tax of 10%.

Further, UK bodies should bear in mind that teachers and other staff members assigned to work in China may also be subject to individual income tax in China, although there are some exemption rules available for the applicable teachers under the relevant tax treaty.

Patience is rewarded

As with all other aspects of working with a partner to establish a school in China, it takes time and patience to understand the environment in which a newly-established sister school is operating. Building the kind of relationship that will accommodate and overcome the tensions that arise from misunderstandings will generally be rewarded.

Regulatory and legal requirements are complex, but not impossible to understand, and with the right approach, empathy on the part of both partners and sound advice, most, if not all difficulties can be overcome.

 

Mark Schaub

China veteran and lawyer Mark Schaub is an international partner and global co-head of Consumer Practice at King & Wood Mallesons. He has advised on foreign investment projects in all major sectors in China with a cumulative value exceeding USD 20 billion. He is familiar with China issues faced by companies and education institutions of all sizes. He speaks English, German, and Mandarin. King and Wood Mallesons offer a variety of legal services to UK schools in the process of finding and working with an educational partner in China.

 

International Partner, King & Wood Mallesons

London/Shanghai

T +44 2075501564

mark.schaub@eu.kwm.com

 

FEATURE IMAGE: Xiamen, China,  Aeter – Pixabay

Support Images: Geralt, moerschy &  TheDigitalArtist – Pixabay

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