Besides being core-assets for any business, intellectual property rights – as well as non-patented know how – can be used by foreign investors as capital contribution in their PRC subsidiaries.
As a matter of fact, while in the past the main alternative to cash contribution was contribution by means of industrial equipment and land use rights, we see now foreign investors more and more oriented to contribute intangible assets into their subsidiaries’ registered capital.
According to the PRC Company Law and the relevant PRC regulations concerning capital contribution, up to 70% of the registered capital of a PRC foreign-invested enterprise (“FIE”) can be contributed as intangible assets.
Intangible assets include IP rights (trademarks, patents, domain name) as well as non-patented know how. Even if intangible contributions normally account for around 20-30% of the registered capital, there are cases of 70% of the registered capital being contributed by domain name assignment.
One of the main reasons why such in-kind contribution is becoming more and more frequent is that it has little impact on the cash flow of the investor such assets indeed have already been developed by the investor at the time of the contribution. On the other hand, equipment and land use rights need to be purchased on the market while innovation is developed internally much often.
Having a high registered capital can be very important in order to have a higher rating with banks, or to have a stronger position in bids, or higher commercial power with some business partners. Intangible assets contribution can help reaching a higher registered capital with less disbursement of cash.
Other reasons may be related to the so-called “PRC indigenous innovation policy”, through which PRC government pressures multinational companies to transfer more of their technology to their PRC entities. Favorable tax policy are set to favor the import of technology or the development.
Whatever the reason may be, capital contribution through intangible assets requires a complex procedure involving (i) a qualified evaluation company - that will need to assess the IP rights or the know-how to be transferred, both through documents review and on-site inspection, (ii) a certified accountant that will need to issue the capital verification report, and finally (iii) the local authorities that will have to approve the contribution by issuing the new business license of the subsidiary.
Key issues in this procedure are:
- choosing the right evaluation company. In every province of China, there is only a bunch of companies authorized to issue official evaluation reports. In order to obtain a correct evaluation, it is important to choose one with a real, sound understanding of both the intangible assets that they are going to evaluate and of the specific industry that the investor is engaged in;
- choosing the right intangible asset to contribute. The main criterion that the evaluator will refer to is: how the contribution of that intangible asset will enhance the business of the subsidiary? On the same time, the investor needs to keep an eye on its worldwide operations and make sure that there is no negative impact in other markets because of such contribution in China (e.g. it shall avoid contributing secret know-how if there are fears that it could leak from the PRC subsidiary). Therefore, it is important to map all the investor’s intangible assets, to tailor the choice exactly on the business to be carried out by the subsidiary (i.e. a high-valued patent which has no impact on the business of the subsidiary could reach a very low evaluation or even be refused) and to prove that the contribution will actually account for the specific targeted amount to the business of the subsidiary;
- choosing the right kind of transfer. Investors, of course, prefer licensing to their subsidiary rather than transferring the full ownership of the intangible asset: in this way it is easier for them to regain full control of the licensed asset if things change in the future. PRC authorities, however, prefer full transfer of ownership. It is very important to understand previously the approach of local authorities and to integrate this in the strategy of the whole operation;
- in case of transfer of know-how, it is critical understanding how much disclosure the local authorities will require on its content. For this kind of asset, it is in fact critical keeping the maximum possible level of secrecy.
If such procedure is not carefully planned and handled correctly in all of its legal and procedural complexity, foreign companies could face ugly surprises: the evaluation could turn out to be different from the expected value, or, even worst, the contribution could even be rejected.
In both cases the investor should make up the difference (likely in cash, if the deadline for the contribution is about to expire).