rule of law in china

International Law Section

THE STATE

BAR OF

TEXAS

The opinions or views expressed in the Texas Transnational Law Quarterly do not necessarily represent the opinions or views of the State Bar of Texas, the International Section of the State Bar or the Council, unless specific approbative action has been taken by the relevant body.

Section Membership: If you are aware of attorneys who are not members of the International Law Section of the State Bar of Texas or who may have failed to renew their membership, please give them the membership information that is included in the back of the TTLQ.

Submission of Articles: We welcome the submission of articles and recent developments for publication. Authors may wish to check with the Editor about pre-emption of their topic. Articles should be approximately three to ten double-spaced pages inclusive of endnotes. Generally, citations should conform to the Bluebook form of citations. All articles should be submitted by e-mail [email protected].

IN THIS ISSUE:

Announcements: 20th Annual International Law Institute ................................................................... 1

ILS 2007 Law Student Writing Contest Winners .................................................... 2

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Articles: Through a Glass Darkly: English Contract Law for the Texas Lawyer .............. 3 The Rule of Law Caught in the Net of Administrative Rules in China ................. 8 2007 China Tax Reforms Update .......................................................................... 16 The U.S.-Chile Free Trade Agreement: Current Results and Future Possibilities ............................................................................................................ 22

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ILS Membership Information ................................................................................. 26

Texas Transnational Law Quarterly

VOL. 21 DECEMBER 2007 NO. 1

Texas Transnational Law Quarterly – December 2007

STATE BAR OF TEXAS ANNOUNCEMENT

Sylvia J. Kerrigan Chair Marathon Oil Company 5555 San Felipe, Suite 2528 Houston, Texas 77056 Tel.: (713) 296-2526 Fax: (713) 499-8401 E-mail: [email protected] Joe Rudberg Vice Chair Thompson & Knight LLP 1700 Pacific Avenue, Suite 3300 Dallas, Texas 75201 Tel.: (214) 969-1479 Fax: (214) 880-3194 E-Mail: [email protected] Stephen D. Davis Secretary/Treasurer Vinson & Elkins LLP 1001 Fannin, Suite 2500 Houston, Texas 77002-6760 Tel.: (713) 758-3862 Fax: (713) 615-5597E-mail: [email protected] Lori A. Feathers Immediate Past Chair Pioneer Natural Resources USA, Inc. 5205 N. O’Connor Blvd., Suite 900 Irving, Texas 75039-3746 Tel.: (972) 969-4041 Fax: (972) 969-3577 E-Mail: [email protected] James L. Loftis Past Chair Vinson & Elkins LLP 1001 Fannin, Suite 2300 Houston, Texas 77002-6760 Tel.: (713) 758-1024 Fax: (713) 615-5122E-mail: [email protected]

COUNCIL MEMBERS Term Expires 2008 Steven L. Dickerson, Exxon Mobil Corp. George Humphrey, Andrews & Kurth Alejandro Ortiz, Gardere, Wynne Sewell Betty Ellsworth Ungerman, Hunt Oil Co. Term Expires 2009 David K. Bargainer, Chevron Phillips Alexandre P. Bourgeois, Schlumberger Alejandro Cestero, Pride International Timothy J. Tyler, Mayer Brown Rowe & Maw Term Expires 2010 Sergio Garza, USA Apache Corporation George Goolsby, Baker Botts, LLP Alamdar Hamdani, BHS, LLP Carlo Romero, Wartsila North America, Inc.

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2007 Law Student Legal Writing Contest

The International Law Section of the State Bar of Texas has the privilege of announcing the following winners of its 2006-2007 Law Student Writing Contest:

First Place Farrah Rajabi South Texas College of Law The U.S.-Chile Free Trade Agreement: Current Results and Future Possibilities

Second Place Ikrakli G. Mirzashvili University of Houston Law Center Cross-Border Insolvency Issues in U.S. Bankruptcy Courts: The Yukos Oil Case Study

Third Place Edward Bopp Southern Methodist University Dedman School of Law Arbitration Clauses in International Commercial Aviation

Honorable Mention Andy Peter Mielnik Southern Methodist University Dedman School of Law The Dispute Settlement Regimes of NAFTA and the WTO – Friends or Foes?

We are also pleased to announce that The U.S.-Chile Free Trade Agreement: Current Results and Future Possibilities has been selected for publication as a student submission in this December 2007 issue of the Texas Transnational Law Quarterly.

We sincerely thank all of the law students who participated in our writing contest and congratulate the winners! The judging this year was again made very difficult due to the high level of the submissions from entrants from various law schools. We encourage continuing law students to participate in our 2007-2008 Law Student Writing Contest and wish everyone much success.

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Through a Glass Darkly: English Contract Law for the Texas Lawyer

By Mark Beeley

It’s 5 o’clock on a Friday afternoon. The phone rings. One of my Texan colleagues is urgently seeking an English solicitor to bless what he describes as a "UK law agreement" (more on that later), which he has drafted on the assumption that Texan and "UK" contract law are substantively identical and the only changes will be cosmetic. So somebody can just have a quick look and the client can sign in half an hour, right?

Sadly, things aren't so simple. As was once remarked, America and the UK remain two countries separated by a common language, and the same is true of our respective contract law regimes. We use the same jargon, in similar circumstances, but there remain a number of important differences which are perhaps less than obvious on their face. And therein, as the Bard would say, lies the rub.1

For reasons that are likely to become obvious it is impossible to provide a complete summary of all the differences between the two systems, but this article hopes to flag at least some of the pitfalls of which to be aware.

Fundamental Principles

To start with the underlying principles of English law, it should be noted that, unlike the developments in the United States, English contract law remains largely un-codified, relying solely on a few statutes. For the most part, the source of both contractual and commercial law remains case law. And again, unlike his American counterpart, the English lawyer feels more comfortable the older his authority is (cases dating back to the 1600s are perfectly fair game). In terms of statutes, the three most commonly invoked are the Contracts (Rights of Third Parties) Act 1999, the Sale of Goods Act 1979 and the Unfair Contract Terms Act 1977. Beyond that and outside certain specialist areas (such as insurance) there is no convenient restatement or codification of laws in this area. Speaking of such codifications, it should be noted that the United Kingdom is not a signatory to the Convention on the International Sale of

Goods, and accordingly, unless specifically contracted for, this treaty will not be applicable to an English law-governed contract.

It is convenient to pause here for a moment and explore a common misconception. While England forms part of the United Kingdom of Great Britain and Northern Ireland, the United Kingdom does not (for these purposes at least) benefit from a single legal system. A contract may be governed by the laws of England and Wales or the laws of Scotland. A choice of law clause calling for the application of the laws of the United Kingdom, or submitting disputes for resolution before the UK courts will lead to uncertainty and perhaps some quite unexpected results, as a court will seek either to determine what jurisdiction the parties really meant, or to attempt to divine such "common" principles as may be found between these legal systems.

One final wrinkle exists: the pervasive and oft-times controversial presence of the law of the European Union, which is increasing overlaid with English domestic law and cannot be ignored, particularly in certain areas of “social concern.” EU legislation comes in three flavors.2 (i) regulations, which are directly applicable without the need for any corresponding national legislation; (ii) directives, which do not by themselves form part of national laws and which member states have a duty to enact by a certain specified date; and (iii) directives gone bad, being what happens when enacting legislation is not passed at a domestic level by the specified date and therefore, arguably, becomes effective in the same manner as a regulation.

Given the non-consolidated nature of such laws, the lawyer dealing with English law must at all times keep a weather-eye on the European dimension to ensure that there are no over-riding provisions which may not otherwise be obvious. Areas to exercise particular caution in include: anti-trust,3 consumer rights, employment, commercial agency, export control, distance selling, information protection and tele-/E-marketing.

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Doing the Deal Contracts under English law take two forms, deriving from the manner into which they are entered. The first species, which will be familiar to any Texas practioner, includes “contracts under hand.” These contracts have simply been executed by the signature of each party. The second species, “contracts under deed,” are more arcane devices, historically executed with great formality (and a certain amount of ribbon and sealing wax), and which have certain unique properties. The principal reason4 for the two different forms is the requirement under English law for a contract signed under hand to benefit from "good consideration." As Lord Coke remarked in the 1602 Pinnel's Case, “[T]he gift of a horse, hawk, or robe, etc., in satisfaction is good [consideration].”5 While it is no longer necessary to provide beasts, birds, or clothing in order to complete a contract, the law does require that some identifiable consideration “move” from the beneficiary of the contract in return for the obligations which are being assumed in his favor. Admittedly, however, the court will no longer inquire too closely into the sufficiency of the consideration on offer.6 Should consideration not be present, the course of wisdom is to enter into your contract as a deed, which will avoid the danger of the court finding that, in the absence of consideration, your contract is simply not enforceable (in essence, that your contract is not a contract). The rules governing the execution of deeds are somewhat arcane, but in brief, the principal requirements are: (i) the instrument must say on its face that it is a deed; (ii) it must be expressed to be “executed and delivered”; and (iii) the instrument must be executed in an appropriate manner, which typically involves, in the case of companies, the execution by two duly-authorized officers of the company and, in the case of a private individual, the signature being witnessed. One additional consequence of choosing this form of contract is that the period of limitations for the obligations created thereunder are lengthened from the normal six-year period to twelve years.7 (As an aside, it is worth noting that the majority of deeds the average commercial practitioner will come across take the form of security documents and, in particular, parent company guarantees.)

If You Prick Us, Do We Not Bleed? Liquidated damages clauses are allowed under English law, but they are enforceable only to the extent that they represent a genuine pre-estimate of loss. While this does not have to reflect the loss actually suffered, a clause judged to be in terrorem8 will be unenforceable and the wronged party will be left trying to prove his damages in the normal fashion. Two areas that might raise some concern in this regard (which the oil & gas lawyer can expect to encounter regularly) include take-or-pay clauses and forfeiture in the event of payment dispute. With a take-or-pay clause, questions might arise as to whether the provision constitutes a conditional payment obligation or a liquidated damage. With a forfeiture clauses, there may be a dispute as to whether the forced loss of an entire investment is a genuine pre-estimate of loss suffered. The Milk of Human Kindness Despite the famed English sense of fair play, there is no duty of “good faith and fair dealing” in the performance of a contract governed by English law. Indeed, the English courts have gone so far as to recognize that there may come a time when it makes the best commercial sense for a party to actually deliberately act in bad faith in the performance of a contract, provided of course that the price for any actual breach of contract is paid in damages. It may not be cricket, but it is how the law operates. The rare exception to this rule may be found where a fiduciary duty can be determined to have arisen (e.g., between partners) and in the case of insurance contracts. More Than Kin, and Less Than Kind Under English law, the assignment of a contract is distinguished from the novation of the same. An assignment (without dwelling here on the mysteries of the differences between a legal and equitable assignment) will transfer only the benefit of a contract; an assignment will not by itself remove the assignor’s obligations to its original counterparty. In order to excuse itself from the contract entirely, a party must enter into a novation, which requires the active consent and participation of the original counterparty. Effectively, a novation operates to remake the contract anew, but the novator will not be excused (without express language to the

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contrary) from liabilities it incurred prior to the novation taking place. Another vexing issue in relation to third parties is the doctrine of privity of contract. Under such doctrine, only a party to a contract may enforce that contract, even if the contract grants benefits to a third party. Recognizing that this exception of third-party beneficiaries may on occasion produce an unfair result, the law changed in 1999 with the introduction of the Contracts (Rights of Third Parties) Act. Section 1 of the Act sets out its principle effect:

(1) Subject to the provisions of this Act, a person who is not a party to a contract (a “third party”) may in his own right enforce a term of the contract if—

(a) the contract expressly provides that he may, or (b) subject to subsection (2), the term purports to confer a benefit on him.

(2) Subsection (1)(b) does not apply if on a proper construction of the contract it appears that the parties did not intend the term to be enforceable by the third party. (3) The third party must be expressly identified in the contract by name, as a member of a class or as answering a particular description but need not be in existence when the contract is entered into.

The Act is limited in that it requires a manifest intent by the parties to a contract that a specified third party has the right to enforce the contract. Another significant restriction is that the Act is not retrospective. The Act may not be invoked in relation to contracts entered into before May 11, 2000, when the act came into force. Where the Act does bite, it has the effect of ensuring that a third party’s rights under a contract may not be varied or terminated without that party’s permission. On the flip side, if a third party wishes to enforce his rights under such a contract then he is bound by the forum selection (or arbitral consent) contained therein. Given the relative infancy of this act, there remains little in the way of case law explaining its operation to date. While the sensible drafter would explicitly deal with the Act and its application (or lack thereof), questions remain as

to the application of the Act in unexpected circumstances, for instance where a pre-2000 contract is novated (or amended and restated) today. When a Contract Does Not Mean What It Says While normally the English courts will enforce the terms of a contract on the assumption that the parties intended to be bound by what they signed up to, with the arrival of European law into the United Kingdom, the Unfair Contract Terms Act (UCTA) came to protect the unwary. Under the UCTA, liability for death or personal injury cannot be excluded; and liability for tort and breach of contract and/or misrepresentation can be excluded only to the extent it is reasonable to do so in the case of consumers and all parties contracting on another’s standard form. A reasonable term is one “reasonable to be included having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made.” That being said, the courts are fairly robust in judging what is reasonable and, where parties are judged to be of equal bargaining power or are operating on a business-to-business level, the general presumption is one of reasonableness. One notable exception comes in the form of clauses excluding liability for misrepresentations (so-called “entire agreement” clauses). Under such a clause it will not be deemed reasonable to exclude liability for fraudulent misrepresentations.9 A Few Drafting Tips As discussed above, one should be precise in drafting choice of law clauses. The election should be to either “English law” or “the laws of England and Wales” as references to the “laws of the United Kingdom” will produce murky results.10 Conversely, less precision is more desirable in a forum selection clause, where a simple selection of the English courts is sufficient. An election for a particular court (either location, level or division) will make little impact on which English court you or your client may one day end up in, since that outcome is governed not by election but by the fundamental jurisdiction of each court. On another note, the English courts will take the same notice of a clause irrespective of the

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typeface or font size employed. Thus there is no need to draft certain clause (e.g., jury waiver) in upper case characters, as may be common practice in Texas. For that matter, there is no need to include a jury waiver at all. Juries no longer sit in English civil courts, except for cases of libel and other forms of slander. One common error in drafting contracts under English law is to make reference to “gross negligence.” This concept is not recognized under English law (either an act is negligent or it’s not), and will lead to much judicial head-scratching and uncertainty in application. If the concept must be employed, then a defined term should be included. You Say Potato . . . The interpretation of contracts under English law is governed in the main by the so called “Hoffman Principles,” which are derived from the speech of Lord Hoffman in the case of Investors Compensation Scheme Ltd v. West Bromwich Building Society.11 In short, these canons of interpretation instruct the interpreter of a contract that: (i) meaning must be ascertained by taking into account the “factual matrix” at the time of contracting; (ii) evidence of negotiation and subjective intent is admissible only for the purposes of rectification; (iii) the meaning of words is not a matter just of dictionary definitions, but terms must be read in the context of trade usage, etc.; and (iv) there is a presumption that a document was intended to make business sense. In summary, first look at the context in which the contract was executed; then read the terms in light of that context. In addition, there is a presumption that every clause is there for a reason. Cry "Havoc!" and Let Slip the Dogs of War Arbitrations seated in England and Wales are governed by the Arbitration Act 1996, which was intended to be a modern and comprehensive arbitration statute. The Act was drafted with the aims of maximizing the parties’ ability to control their own process, minimizing the courts’ interference, and placing an overriding objective upon tribunals to ensure that impartial, quick, and cost-effective procedures are adopted. For the most part the purposes of the Act have been achieved. The Act was based loosely on the UNCITRAL

Model Law, though the Act contains a number of important deviations. While it was intended to be relatively comprehensive (and was deliberately drafted in a manner so as to make it accessible to the business user and not just his lawyers) there remain a number of important gaps that are filled only by the common law. The most significant lacuna is likely to be the principle of confidentiality. All arbitrations seated in England and Wales are innately confidential and private affairs. Accordingly, the resulting award, as well as the contents of the proceedings which generated it, can be disclosed to third parties only in certain limited circumstances. The general theme of the Act can be deduced from the overriding objective contained at section 1:

The provisions of this Part are founded on the following principles, and shall be construed accordingly— (a) the object of arbitration is to obtain the fair resolution of disputes by an impartial tribunal without unnecessary delay or expense; (b) the parties should be free to agree how their disputes are resolved, subject only to such safeguards as are necessary in the public interest; and (c) in matters governed by this Part the court should not intervene except as provided by this Part.

As general propositions, the English courts will enforce submissions to arbitration, party autonomy, and awards qualifying under the New York and Washington arbitral conventions. They will also support arbitrations by assisting with the appointments of tribunals, by granting anti-suit injunctions against litigation brought in breach of an arbitration agreement, and by taking measures to aid in the preservation or production of evidence, such as compelling the attendance of witnesses. The grounds for challenging arbitral awards are relatively narrow. They include: (i) excess of jurisdiction, (ii) procedural irregularity, and (iii) to the extent it is not excluded by the parties and only in cases involving English law, error of law. In the eleven years since the passage of the Act,

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the courts have demonstrated repeatedly that the spirit of non-interference intended by the Act will be honored in practice. The instances of successful challenges of arbitration awards are few and far between. In terms of drafting an arbitration clause providing for English arbitration, one should be aware of two major points. First, consider waiver of sections 45 and 69 of the Act, which concern the power to approach the courts on preliminary points of law and to challenge an award on grounds of error of law. Second, remember that the general rule requiring the losing party to pay costs in English litigation will be applied equally in arbitration. Parties can draft around this general rule, but such agreement is valid only when it is entered into after a dispute has arisen. Concluding Thoughts This article mentions only a few red flags to keep in the back of your mind the next time you or your client is considering selecting English law to govern a contract. There is no substitute for having an English-qualified lawyer review the agreement before it is signed and, of course, it helps if you give him sufficient time to actually read it! Author: Mark Beeley is an English Barrister and Solicitor-Advocate and a member of Vinson & Elkins’ International Dispute Resolution Group. He may be contacted at [email protected]. 1 See HAMLET. 2 In deference to the predominately American reader of this publication, I have adopted American vernacular throughout this article. Arguably, an American lawyer should not adopt the same approach in drafting English-law contracts. 3 Known in both English law and in the European Union as “competition law.” 4 Certain specified contracts, such as those dealing with real property, are required by statute to be transacted as deeds. 5 (1602) 5 Co Rep 117 Court of Appeal. 6 See Chappell v. Nestle [1959] 3 WLR 168 as to “peppercorn” considerations. 7 S. 8 Limitation Act 1980. 8 Dunlop Pneumatic Tyre Co Ltd v. Selfridge & Co Ltd [1915] AC 847.

9 Thomas Witter v. TBP Industries Ltd [1996] 2 All ER 573. 10 Equally, references to “Scottish law” will invoke a contractual regime very different from the one described herein. 11 [1998] 1 WLR 896.

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The Rule of Law Caught in the Net of Administrative Rules in China

By Janis J. Chang

Lately there has been much debate on whether China will be able to develop a rule of law society. The push for the rule of law in China has been spearheaded by several organizations, including the U.S. Department of State, the American Bar Association, and various INGOs. Generally, the idea of “rule of law” is a political concept whereby a system of law imposes “meaningful restraints on the state and individual members of the ruling elite, as captured in the rhetorically powerful – if overly simplistic – notions of a government of law, the supremacy of the law, and equality of all before the law.”1 The central idea of all rule of law conceptions is that the government is meaningfully restrained by the law. A rule of law government then “operates according to the law: openly, transparently, and efficiently”2 and thus promotes predictability in the law.

The Chinese legal system has traditionally been categorized as rule by law: one that is purely instrumental in carrying out the will of the ruler or ruling class. “If the law comes from the will of the leadership without any effective mechanism to restrain the potential arbitrariness and to achieve rationality and legitimacy and nevertheless is backed upon by coercive force, rule of law is no different from rule of person. Besides, this conceptually contradicts rule of law…. In the rule of law society … law itself needs to be legitimatized.”3

Recently, China has made many substantive reforms and considerable steps towards a rule of law regime. Deng Xiaoping “and other leaders have said that it is necessary to establish the authority of law.”4 In fact, the “Constitution in 1999 was amended to expressly provide for the establishment of a socialistic rule of law state.”5 However, the “dominant view is that efforts to export rule of law [to China] have been unsuccessful,”6 which is no surprise as “Western legal ideas themselves are in flux”7 and many of “[t]he challenges in the modernization of Chinese law have also emerged from problems with the Western model itself.”8

One possible problem is that too much emphasis has been placed on the literal meaning of what is “law” in China. It is essential that, when examining China’s legal framework, one must look beyond what is labeled “laws”: namely at administrative rules created by administrative organs (xingzheng jiguan). In China, administrative rules are as important as laws in a “rule of law”9 context. Administrative rules “completely dwarf laws enacted by the legislature”10 and are avenues “through which individual life is regulated and government power is exercised.”11 In fact, “agencies as a practical matter use rules to regulate society more often than laws in administrative process.”12 Thus, because agency rules affect the rights, duties, and freedoms of individuals and the way the ruling class may exert its power, “the success of rule of law to a large extent depends upon whether and to what degree”13 agency rules and their application can be applied in a way that promotes equality and fairness before the law. As “the essence of the rule of law is to impose meaningful limits on the state and individual members of the ruling elite, an effective administrative law regime that limits the arbitrary acts of government is essential to rule of law.”14 Indeed, “‘law’ as mentioned in the 15th amendment of the [Chinese] constitution “undoubtedly includes administrative rules.”15

Because of the unique structure of the Chinese administrative rule regime, administrative rules may pose a greater threat to the rule of law idea than the laws do themselves. Historically, China viewed the purpose of administrative law as facilitating “efficient government and ensure[ing] that government officials and citizens alike obey central policies.”16 Because China was, and still is, very large, the ruling class needed an instrument to efficiently keep the various satrapies in check. One way to do this was through bureaucratic routinization where each level of the governmental bureaucracy had to follow, without discretion, certain administrative decrees.17 In essence, these administrative decrees were nothing more than instruments for the ruling class to flex its muscles all the way

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down the chain to local satrapies without regard to promoting fairness or individual rights.

Under the Communist Party, the administrative rules (xing zheng guizhang) are no longer propounded directly by the ruling class, but made by the constitutionally authorized ministries and local governments. Administra-tive regulations (xing zhong fa gui) are made by the State Council, and local regulations (di fang xing fa gui) are made by some local People’s Congresses. Additionally, there are normative documents (gui fang xing wen jian) created by agencies other than ministries or local governments, which are neither rules nor regulations but still substantively affect the rights and duties of individuals. These normative documents are rarely open to the public yet are curiously binding upon the public in practice.

Recently, China has attempted to shift the purpose of its administrative rule regime from one of instrumentation to one that balances “government efficiency with the need to protect individual rights and interests.”18 However, this shift in purpose has caused the administrative regime to intertwine and interface with the laws. Ironically, this causes more problems for the rule of law initiative in China because of the complications created by the following two main deficiencies of the Chinese Administrative system: 1) one of form (the structure of the system itself that leads to conflict of rules and lack of judicial review, i.e., problems arise from the relationship between agencies and their rules); and 2) one of substance (too much discretion, lack of clear legal procedure and meaningful public participation, no clear scope to agency’s authority, i.e., problems occur during the rulemaking process of an agency).

A. Deficiency in Form

To clearly understand several problems with the current Administrative law regime, one needs to understand the power structure of the administrative system. China currently has a two-level system: central and local. Each level then is divided into rank, and within each rank, there may be several agencies with the same authority. This is called a kuai: a horizontal line of authority. In the local level, in descending order, there are the provincial, municipal, county, township, and village ranks. The central level has corresponding office in each of these ranks. Additionally, there are agencies in

different levels but the same rank. For example, the Ministry (central level) and the Provincial (local level) government are in different levels but the same horizontal rank. Under the Ministry, there is an agency that is in the same rank as the Municipal government, and one in the same rank as the County government, etc. Agencies in the same rank cannot issue binding orders to each other. There is also a vertical line of authority, called a tiao, where an agency is subservient to another agency in the rank above it. Each agency is also categorized within a functional system. Thus, for example, there is a Ministry of Education and a Ministry of Finance and their respective offices below them at lower ranks and a corresponding agency in the local level with the same function.

This multi-tiered, multi-leveled system leads to obvious conflicts between agencies. There are two main problematic and unresolved conflicts between agency rules: 1) conflict within a kuai; and 2) conflict within agencies of the same rank but different level. Because agencies within the same kuai cannot enact rules that bind one another, the agencies and their rules often compete with each other. This becomes a problem when local governments try to protect local businesses and discriminate against outsiders.19 Additionally, because local and central governments of the same rank can promulgate rules without regard to one another (as one is not binding upon the other), “local rules are in serious conflict with central ones, resulting in what had been called the ‘local protectionism.’”20 Thus, not only are conflicting local regulations caused by a possible failure in the internal review procedure, or poor draftsmanship, but conflicts also arise because “[l]ocal legislative organs or administrative agencies promulgate local or departmental legislation to protect or advance the interests of the localities or the agencies, even though the legislation contravenes national legislation.”21 “This results in a need for consensus building between equally ranked government institutions at various territorial levels and functional systems in order to operate effectively. Furthermore, it means that each specialized institution is subject to orders from at least two potential authorities: 1) the government at the institution’s own territorial level … 2) the office in the same functional system one level up the territorial hierarchy.”22 This also affects the efficiency of the administrative rule system, breeds public distrust of the rules, and

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undermines the principles of a rule of law society. If a local government can contravene a central regulation and national law, then there is no unity of law, no stability of law. While some courts have entered into “cooperative agreements (similar to treaties) … to assist each other in cross-jurisdictional investigation and enforcement”23 to combat local protectionism, a national solution to this problem should be built into the system and not from a bottom-up approach.24

There is also a major conflict between agency rules and national laws (national laws being different from central and local rules as they are promulgated by the Standing Committee of the National People’s Congress), which also poses a great problem for China mainly because China does not have an effective judicial review process. As mentioned previously, all administrative rules must be enacted in accordance with the law (yifa xingzheng).

Chapter IV Section 1 Article 63 of the Legislation Law of the People’s Republic of China regarding local regulations seems to provide for an internal verification procedure to ensure that the local regulations do not conflict with the Constitution, laws, and administrative regulations before they are enacted. However, in practice, because this internal procedure is done with almost no transparency (if at all), it is unclear how effectively or efficiently the procedure works. Empirical evidence suggests that this internal review mechanism is not as effective is it ought to be “[a]s more new laws and regulations are being promulgated in China by governments at all levels, the amount of conflict and inconsistencies between local and national legislation have also increased considerably, ‘causing confusion and new difficulties’ in the application of laws. As a result, more administrative adjudication suits are being brought by citizens seeking to reverse government actions based on local regulations that conflict with national laws.”25

Additionally, the mechanism for resolving a conflict between a regulation and a law after the enactment of the regulation also is not effective. The procedure with dealing with such a conflict is for a court to report the conflict to the Supreme People’s Court, which then refers the matter to the Standing Committee for final adjudication. However “[i]n reality, the Standing Committee, which convenes every two months

for five to seven days each time, rarely fulfills its review function.”26 In fact, “the Standing Committee [has] never revoked any conflicting local regulations; nor were there any detailed procedures in place for reviewing conflicting local laws.”27

Further compounding the problem of an inefficient review mechanism is that most courts do not refer the conflict to the Standing Committee but instead merely “apply the law with the higher legal authority while keeping silent on the reasons of their rulings, thereby sidestepping the issue of improper judicial review.”28 This has two main consequences. The first is that this is a sort of “backdoor” justice being used, which makes it almost impossible to review the propriety, legality, and fairness of the decision. The real motivations for the decisions are not stated in the published opinions (anli), threatening the legitimacy of the judicial system. The second consequence is that secretly applying the higher law does not demand attention to the fact that an efficient and effective review process is sorely needed.

An example of the confusion created by the administrative system is the Luoyang City “Seed Case.” There, a dispute arose between two local seed companies “over how to calculate compensation over the alleged failure to honour a corn seed contract.”29 The legal issue presented to the court was over whether to apply the PRC Seed Law or the government-set price under the local seed pricing regulations set by Henan Province People’s Congress. Which authority the court applied resulted in a difference of 600,000 yuan (US$72,500). Presiding Judge Li Huijuan, instead of submitting the conflict of laws to the Standing Committee, ruled that the National Seed Law prevails, citing Article 63 of China’s Law on Legislation, which states that any local decree is invalid if it contradicts national law. However, the “Henan People’s Congress Standing Committee issued a notice claiming Li’s ruling was an illegal review of the local regulation in nature and encroachment on the functions of the legislative body.”30 Judge Li and the other judges on the panel were later removed from their post by the Henan Province People’s Congress (though they were eventually reinstated after media outcry).

In light of this case, many academics push for judicial review, and with China’s accession to

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the WTO, judicial review for WTO-related administrative actions is needed: “Given that the Constitution has set forth the principle of judicial unity and that the Law on Legislation has stipulated the hierarchy of our laws, regulations and rules, when a court faces two conflicting laws on the same issue during the adjudication process, it should be allowed to choose the applicable law of the higher legal authority….”31 However, given the limited autonomy and freedom from influence the courts enjoy, judicial review may not be the correct avenue.

While it makes sense on paper that the courts should be allowed to simply choose what law to apply, in practice it may be difficult to ensure proper judicial review for several reasons. First, the court system in China is anything but independent. Local courts are under the supervision of the local People’s Congresses and judges are paid by, and can be removed by, the People’s Congresses. Additionally, “at each level ultimate control over the courts is exercised by political-legal committees (zhengfa weiyuanhui) of local party organizations.”32 Thus, judges are under tremendous pressure and local government and Chinese Communist Party (CCP) interference. Moreover, interference from administrative officials and by the CCP especially occurs before the case is even accepted by the court.33 It is not only the judges that feel pressure: often “aggrieved parties are pressured to have the case withdrawn.”34 Furthermore, the stature of courts “in the political hierarchy, combined with their dependence on local government for funding and personnel decisions, does not augur well for an aggressive court.”35 Additionally, many judges currently lack training, legal knowledge, and strong analytic abilities. Thus, if China were to allow for judicial review, “too much discretion [would be] left to judges, who arguably are not the appropriate candidate to perform this duty, provided the striking facts that the judiciary in [China] is not well qualified and does not have professional integrity.”36

China has attempted to implement a quasi-judicial review of certain administrative rules through its Administrative Litigation Law (ALL), but this system is plagued with problems. For example, judicial review is limited to concrete administrative action and not to conflicts of law or the legality of the rules enacted. Rulemaking has been defined as an “abstract administrative act” (chouxiang xingzheng xingwei) and is

immune from judicial review. Therefore, the ALL doesn’t really solve any of the major roadblocks to developing rule of law. While courts are theoretically given the authority to refuse to apply agency rules if they believe the rules are unlawful, courts are unable to do so because “if courts do not have authority to review rules, how can they hold a rule ‘lawful’ or ‘unlawful’”?37 The lack of an effective review procedure between conflicting administrative rules and laws is a crisis that China must deal with quickly.

B. Deficiency in Substance

The Chinese administrative agencies enjoy great discretion without any definite scope to their power. While in and of itself discretion is not necessarily a negative aspect of a legal system: “[e]very government and legal system in world history has involved both rules and discretion. No government has ever been a government of law and not of men in the sense of eliminating all discretionary power…. Discretion is a tool, indispensable for individualization of justice…. Rules alone, untempered by discretion, cannot cope with the complexities of modern government and modern justice.”38 It is “necessary in handling the gap between rhetoric and reality in the legal system.”39 Admittedly, “administrative law regimes will differ in the degree of discretion afforded government officials and the mechanisms for preventing abuse of discretion.”40 However, “wide-open discretion tends to make law not only unpredictable but oppressive.”41

In China, the discretionary power exercised by the rulemaking agencies have led to inconsistent judgments, rendering the legal system unpredictable and the idea of equality before the law a mere form of words. Adding the history of China’s rule by law society, prevalence of corruption42 and lack of transparency, and the Chinese attitude tending towards mistrust of the legal system, discretion should be given conservatively to the administrative agencies. Moreover, because rules are made behind closed doors, with only a small opportunity of public participation, the legitimacy of the rules that are promulgated to implement, interpret, and supplement the laws become questionable.

One main problem is that there is no clear scope to an agency’s power. In China, if an agency desires “to make rules that will substantially create new law, rights, and obligations and thus

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virtually exercises a law-making power, expressly delegated power to the agency is a prerequisite.”43 However, this concept, when examined closely, has no teeth because of the lack of an express definition of an agency’s power in any of China’s laws or in the constitution. Moreover, the scope of an agency’s power changes from time to time along with CCP policy. Thus, there is virtually no limit to the scope of the rulemaking powers conferred. One vague limitation exists: the administrative rule or regulation must not infringe upon ‘the spirit of’ applicable law and the Constitution.”44 The uncertainty in the scope of an agency’s power casts doubts upon the legitimacy of the agency’s rules, especially if they are controversial or a limitation on individual freedom. Thus, the incredible amount of discretionary power given to the agency only compounds the suspicion of the legitimacy of administrative rules it emits.

For China to balance the need for discretion with the need to prevent corruption, arbitrary decisions, and at the same time promote predictability, and thus, legitimacy to the agency rules, China must first clearly circumscribe the authority of the agencies and set out a detailed definition of “scope of authority.” China should also put in place procedural safeguards to ensure that the agencies do not abuse their discretion or transcend their prescribed authority, such as an internal review mechanism before a proposed rule is enacted, for example.

Another threat to the rule of law is the lack of meaningful public participation in the making of administrative rules. While public participation is part of China’s rulemaking procedure and is a positive step towards a rule of law society, there is much room for improvement in this area. Public participation is a leading option in rule of law because it legitimizes the resulting rule in two ways: 1) the public feels that the end rule is somewhat reflective on how it feels; and 2) the public is able to give the agency information and perspective on the proposed legislation that the agency may not have otherwise had. The result is enhanced public confidence in government rulemaking. Without it, there will be a “crisis of government legitimacy.”45

A form of public participation exists in China. In the rulemaking process (Notice of Making Administrative Regulation or xingzheng fagui zhidiang zangxing banfa), after the planning stage (guihua), the drafting stage (qichao), and

the consultation (xieshang) stage, public participation is solicited (zhengqiuyijian). The Law on Legislation (2000) and Party policy requires public participation for legislative hearings and notice-comments.

However, there are some deficiencies in the form of public participation, namely, there is no detailed procedure on how to solicit public participation. Moreover, once comment is solicited, there is no procedure for what to do with the comments, except that the LAO needs only “consider” the comments, rendering public participation not as meaningful as it could be. Because of the multi-level, multi-tier structure of the administrative system, “many central and local agencies have formulated rules to implement the hearing requirements…. [which] has led to lack of uniformity.” Conflicts between central rules and local rules and conflicts among different local areas with respect to procedural requirements of public hearing have proved to be very a serious problem increasing the situation of ‘fragmentation’ of … enforcement46 and thus further questioning the legitimacy of the rule enacted and undermining the rule of law.

Effective comment procedures may only solve the legitimacy problem of published administrative rules. In China, there are also “normative documents” (guifangxing wenjian) which seem to be the most troubling to the rule of law and are “administrative norms that fall outside those prescribed by the Constitution.”47 These documents “are not drafted pursuant to any specific entrustment of power in the manner of a statutory authorization of relatively high-level regulatory enactments such as implementing regulations (shishi xize)….”48 Normative documents are documents made by agencies with no rulemaking authority and outside the rulemaking procedures and whose sole purpose is to set forth an agency’s internal procedures. These documents are rarely open to the public, in fact, they are usually “secret.”

In practice, however, these documents are puzzlingly binding upon the public. In fact, the documents can affect an individual’s rights and responsibilities. The Administrative Reconsider- ation Regulation (1991) held that an agency, in an administrative hearing, “shall use laws, regulations, administrative rules, and normative documents as legal bases.”49 Thus, normative documents are a real threat to an individual’s freedom and right to be free from unreasonable

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interference from the government. While a court may not judicially review laws, it may review the legality of administrative normative documents after a person is convicted of one under Article 7 of the Administrative Reconsideration Law.50 Therefore, a convicted litigant may appeal the normative document to the courts. However, this is of little solace to the individual because she must first undergo an administrative hearing, be convicted of the normative document at such hearing, and then appeal her case to a law court that arguably is not independent. In fact, a few courts have judicially reviewed normative documents.51

Thus, because of the red tape that one has to go through before being able to challenge a normative document and because the courts are anything but independent, the public has little, if any, safeguards with respect to normative documents. Thus, China’s continued use of normative rules undermines the ideas of government transparency and accountability, fairness, predictability, and the rule of law52 in a troubling manner. The NPC has only two choices: require that normative documents follow all the procedures that other rules and regulations must follow especially including making the normative documents open to the public, or require that normative documents cannot be binding on the public. Since the ARR already states that normative documents can be used as a legal basis, then instead of revising this piece of legislation, the NPC ought to require that normative documents follow other rulemaking procedures.

C. Conclusion

Despite the difficulties presented by China’s administrative law regime, China has take several positive steps towards a rule of law system. Enacted in 1989, the ALL, despite all of its difficulties, was “aimed at restraining government action through judicial review”53 and has at least “provided one of the few state sanctioned means for private citizens to challenge the actions of government officials on many regulatory and administrative issues.”54 While judicial review is not perfect in China, the ALL has at least opened the door for its application in abstract administrative actions and has allowed review of some government action. Although public participation is a relatively new process in China, it is a step in the right direction. Additionally, administrative reconsid-

eration “is a common means for controlling administrative discretion and making administrative agencies act in accordance with the law.”55 While administrative reconsideration also has its difficulties, such as the fact that some agencies have not even established reconsideration organs, it is a positive step, even if a minor one.

China also has also enacted mechanisms for limiting the power of agencies such as “legislative oversight committees, [and] supervision committees that are functional equivalent of ombudsmen….”56 There is also a letter and petition system, which remains a popular method of objecting to rulings.57 Although these mechanisms are riddled with problems, at least there are the beginnings of procedures to impose meaningful restraints on the government.

Therefore, despite all of the problems navigating the field of administrative rules and regulations, China is at least willing to move towards a rule of law society. All of the legislation aimed at reigning in the government is “a significant step forward in the philosophy of public administration.

However, China still needs a more authoritative position for its legal system to function as a rule of law one. Only when “government offices … observe the legal boundaries of their powers can common citizens enjoy their legitimate rights to the full.”58

Many perceive China to be a country that lacks laws, but in reality the problem seems to be the web of conflicting rules and laws. Thus arguably China has too many laws. A functioning system of review for rules and regulations would aid avoiding the conflicts and resulting confusion without having to widen the scope of judicial review. Moreover, if a detailed procedure for public participation were promulgated, further legitimacy would be given to the administrative law regime. This would encourage transparency and accountability, and promote civil society as people begin to form interest-based groups to participate more effectively. Finally, with increased accountability of the government, especially in light of whistle blowing reports, administrative official positions are no longer an iron rice bowl.59

With these steps, as China moves towards a

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rule of law society, the administrative law regime in China will begin to place meaningful restraints on the government while balancing individual rights with the need for government efficiency. However, one should be cautiously optimistic. While China has indeed made good steps, if the problems with China’s administrative rulemaking are not resolved quickly and satisfactorily, the legislation law may be just a “new invitation to [a] ‘power struggle’”60 between the fragmented legal authorities in China. Thus, to achieve a rule of law system, China should proceed cautiously, yet quickly and systematically, to smooth over the many wrinkles in the new legal dress she is sporting. Author: Janis J. Chang is an associate in the Houston office of Vinson & Elkins LLP and may be contacted at [email protected]. 1 Randall Peerenboom, CHINA’S LONG MARCH TOWARDS RULE OF LAW (Cambridge University Press, 2002), at 2 [hereinafter LONG MARCH]. 2 Dingjian Cai, The Development of Constitutionalism in the Transition of Chinese Society, 19 COLUM. J. ASIAN L. 1, 19 (2005). 3 Wang XiXin, Rule of Rules: An Inquiry into Administrative Rules in China’s Rule of Law Context, at 6, available at http://www.mansfieldfdn.org/programs/rol/rol_ perspectives.htm [hereinafter Rule of Rules]. 4 Yuanyuan Shen, Conceptions of Legality, at 30 (citing A.V. Dicey, INTRODUCTION TO THE STUDY OF THE LAW OF THE CONSTITUTION (London: Macmillan, 1885)). 5 LONG MARCH, supra note 1, at 1. 6 Randall Peerenboom, Law and Development of Constitutional Democracy in China: Problem or Paradigm?, 19 COLUM. J. ASIAN L. 185, 229 (2005). 7 Shen, supra note 4, at 36 (“The dissatisfaction with the traditional rule-of-law model and formal rationality is evident in certain transitions in legal life in many Western countries, especially in the United States. As laissez-faire capitalism has become more state regulated, Western law has changed to create types of regulations that are no longer easily captured in Weberian terms.”) While this certainly sounds forceful, Yuanyuan Shen offers no empirical evidence to support this. 8 Id. at 35. 9 Or, as Professor Wang XiXin states, a “rule of rules” system. 10 Rule of Rules, supra note 3, at 7. 11 Id., at 6. 12 Id. 13 Id. at 7.

14 LONG MARCH, supra note 1, at 394. 15 Rule of Rules, supra note 3, at 1. 16 LONG MARCH, supra note 1, at 16. 17 See generally Max Weber. 18 Id. 19 Rule of Rules, supra note 3, at 7. 20 Id. 21 Veron Mei-ying Hung, China’s WTO Commitment on Independent Judicial Review: Impact on Legal and Political Reform, 52 AM. J. COMP. L. 77 (2004) at 103. 22 E.J.W. van Sambeek, Institutional Framework of the Chinese Power Sector, Energy Research Centre of The Netherlands, October 2001, at 7, available at http://www. energie.nl/index2.html?nel/nl01e1995.html. 23 Margaret Y.K. Woo, Law and Discretion in the Contemporary Chinese Courts, Pacific Rim L. & Policy J., Vol. 8, No. 3 (U. of Wash.) at 170, available at http://www.law.washington.edu/pacrim/abstract/8.3.htm. 24 While many of China’s legal policies and systems stem from bottom-up approaches, China needs to start taking an affirmative action to deal with these problems instead of waiting for local courts to band together. The problem of local protectionism is a great risk to national legal stability and predictability, and thus, in turn, a threat to China’s quest for rule of law. 25 Luoyang City “Seed” Case Highlights Chinese Courts’ Lack of Authority to Declare Laws Invalid, China Law & Governance Review, June 2004, Issue No. 2, at 3 (citing www.china.org.cn, February 5, 2004), available at http://www.chinareview.info/issue2/pages/case.htm [hereinafter Luoyang Seed Case]. 26 Id. 27 Id. 28 Judge sows seeds of lawmaking dispute, People’s Daily Online, available at http://english.people.com.cn/200311/24/ eng20031124_128871.shtml. 29 Id. 30 Id. 31 Luoyang Seed Case, supra note 25 (Professor Jiang Ming). 32 Hung, supra note 21, at 96. 33 Id. at 91, 93. 34 Veron M Mei-ying Hung, Protection of Human Rights in the Context of Punishment of Minor Crimes in China, testimony before the Congressional-Executive Committee on China, Washington, D.C., July 26, 2002, available at http://www.carnegieendowment.org/publications/index.cfm?fa=view&id=1031. 35 LONG MARCH, supra note 1, at 424. 36 Rule of Rules, supra note 3, at 7. 37 Id.

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38 LONG MARCH, supra note 1, at 410, quoting Kenneth Culp David. 39 Woo, supra note 23, at 165. 40 Id. at 5. 41 Shen, supra note 4, at 39. 42 LONG MARCH, supra note 1, at 406 (“Corruption is a serious and growing problem in China”). 43 Id. 44 Peter Howard Corne, Creation and Application of Law in the PRC, AM. J. COMP. L., Vol. 50, No. 2, at 369-443 (Spring 2002), available at http://links.jstor.org/sici?sici=0002-919X%2820021%2950%3A2%3C369%3ACAAOLI%3E2.0.CO%3B2-9, at 4. 45 Xixin Wang, Administrative Procedure Reforms in China’s Rule of Law, COLUMBIA J. OF ASIAN L., Vol. 12, No. 2, at 261 [hereinafter Administrative Procedure]. 46 Wang XiXin, Public Participation and Its Limits: An Observation and Evaluation on Public Hearings Experimented in China’s Administrative Process, China Legal Science, at 58, available at http://article.chinalawinfo. com/article/user/article_display.asp?ArticleID=23685. Id. At the time of the writing of this article, China has enacted a new review process; however, very little is known about the process and of the little data available, it appears that the review process is not effective. 47 Douglas Grob, et al., Mechanisms for Administrative Review of Provisions that Authorize Specific Administrative Acts under the Administrative Reconsideration Law, available at http://www.lawinfochina.com/dispecontent.asp? ID=70&DB=4. 48 Corne, supra note 44, at 4. 49 Id. (emphasis added). 50 Grob, supra note 47. 51 Id. 52 Id. at 8 (In a “Rule of Law State, individuals should not be required to obey rules that are secret”). 53 Administrative Procedure, supra note 45, at 267. 54 Minxin Pei, Citizens v. Mandarins: Administrative Litigation in China, THE CHINA QUARTERLY, No. 152, at 832, 839 (Cambridge University , Dec. 1997), at http://journals. cambridge.org/action/displayJournal?jid=CQY. 55 Peerenboom, Globalization, Path Dependency and the Limits of Law: Administrative Law Reform and Rule of Law in the People’s Republic of China, 19 BERKELEY J. INT’L L. 161, 231 (2001) at 231 (updated and revised version in CHINA’S DEEP REFORM: DOMESTIC POLITICS IN TRANSITION (Lowell Dittmer and Guoli Liu, eds., Rowman & Littlefield, 2006)). 56 LONG MARCH, supra note 1, at 395. 57 Id. at 420–21. 58 City to Better Protect Civil Rights, China Daily (March 17, 2003), available at http://unpan1.un.org/intradoc/groups/ public/documents /apcity/unpan014301.htm. 59 Cai, supra note 2, at 21–24.

60 Rule of Rules, supra note 3, at 8.

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2007 China Tax Reforms Update

By Cheng Wang and Libby Hugetz

By all accounts, China’s track record in attracting foreign investment has been successful. One oft-cited factor underpinning that success is a system of preferential tax treatments. However, reforms are under way in China’s tax system. The preferential tax system, evolving since the late 1970s and codified in the early 1990s,1 ended on March 16, 2007,2 when China adopted a new 2007 Income Tax Law. Taking effect on January 1, 2008,3 the new law will do away with key preferential tax treatments that have been available to foreign investors for close to two decades. To minimize disruptions to foreign investors, the new law has also provided for a five-year transitional period.4 To be sure, only a general contour of the new tax law is emerging. Exact details and effects will likely become more transparent as regulations are implemented. Thus, in a broad stroke this article attempts to summarize key tax reform items of the 2007 Income Tax Law. A. Genesis of Tax Reforms Equalization of the effective corporate income tax (“CIT”) rates of foreign invested enterprises (“FIEs”) and domestic Chinese enterprises (“DCEs”) was a significant factor prompting the current round of tax reforms. By way of background, foreign investors have enjoyed “super-national” tax treatment in China, even after it has acceded to the WTO. While both FIEs and DCEs were subject to a nominal CIT rate of 33%, due to various preferential tax treatments which were not available to DCEs, effectively the rate for FIEs was 15%,5 10% lower than the rate for DCEs.6 That difference was widely perceived as unfair to DCEs.7 Calls for leveling the playing field have grown more pronounced recently as China’s nationalistic sentiments have arisen. It is not surprising that the centerpiece of China’s tax reforms is the unification of China’s bifurcated tax system with more favorable treatment accorded to foreign investors.

Fairness aside, tax unification has a dual aim of closing a legal loophole commonly referred to as “round-tripping.”8 Many DCEs have been known to use this loophole to avail themselves of preferential tax treatments otherwise unavailable to them. In “round-tripping,” DCEs would set up offshore vehicles and use them to make China investments. Given that such investments nominally came from overseas, they were considered “foreign investments” and thus eligible for preferential tax treatments.

Aside from tax equalization, other items of tax reform have generally been viewed as overdue.9 While China’s economic conditions have undergone profound changes over the last 15 years, many for the better, China’s mounting challenges10 resulting from heavy emphasis on growth and manufacturing have necessitated a reassessment of China’s development model. There has also been growing recognition of tax law as an attendant policy tool to achieve China’s many goals, including reorientation of its industry structure and modernization of the tax system so that it is simpler, fairer, and more transparent.

B. Controversy and Timing of Tax Reforms

Tax equalization has not been without controversy in China. The foreign investment community, a strong influence in China’s economy, took the view that CIT rates are but one of many factors of a leveled playing field. They pointed out that, while the tax cost base may be much higher for DCEs, the compliance cost base has been much higher for FIEs. Compared to DCEs, FIEs are generally known to have been more compliant with China’s laws and regulations (including those relating to tax and employee benefits), have encountered more selective enforcement actions on compliance, and have faced many more investment restrictions. In addition, FIEs face many challenges11 that DCEs do not, such as the difficulties of navigating China’s licensing and regulatory approval procedures, the use of unique Chinese domestic standards that disadvantage foreign investors, and China’s lack

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of national treatment of foreign investors generally. In the last several years, the foreign investment community has lobbied the Chinese government to reassess the timing of implementing tax equalization reform. In addition to tax equalization, they have also encouraged the government to address challenges foreign investors face in order to level the playing field. The views among China’s governmental ministries on tax unification have been by no means monolithic. China’s foreign investment approval authority, i.e., the Ministry of Commerce (and its predecessor) (“MOC”) favored a go-slow approach for fear of tampering with a time-tested mechanism of attracting foreign investments. On the other hand, China’s Ministry of Finance (and its subordinate State Administration of Taxation) (“MOF”) favored a more expeditious approach of leveling the playing field. Both sides were able to point to evidence in favor their respective views. Proponents of fast-track reform pointed out that, even in the absence of preferential tax treatments, China would likely remain an attractive place to invest. That view seems supported by surveys and foreign direct investment statistics of recent years. For example, in 2006, 81% of the member companies of the U.S. China Business Council (“USCBC”), a major trade group, were reported to be profitable and 50% reported their profitability rates met or exceeded their global profit margins.12. Since the 1990s, FIEs have recorded over US$200 billion in post-tax profits.13 In addition, 19014 countries are conducting trade with China and 45015 of the world Fortune 500 companies have Chinese investments. The proponents argued that, when viewed together, these macro trends hardly supported the fear that tax unification would lead to a massive exodus of foreign investments. According to advocates of cautious reform, given the ever-expanding importance and reach of foreign investment in China’s economy, at a minimum there were uncertainties about the ramifications of tax unification on foreign investments. Thus, the pace of reform must be judicious. The importance of the extent of foreign investment cannot be over-emphasized. By the end of 2006, 594,00016 FIEs were approved. By the end of 2005 they employed 24

million17 Chinese citizens. In 2006 they accounted for close to US$100 billion,18 or 21.12%19 of China’s total corporate income tax, and represented 58%20 of China’s foreign trade. China’s eastern seaboard has been developed and become prosperous due in no small part to the pivotal and catalytic role played by sustained foreign investment over the last two decades. China’s interior regions, i.e., the Central and Western Areas (“CWAs”), and the Rust Belt in northeastern China, are struggling. In order for them to catch up in development, foreign investments must be allowed to play a similar role. That, so the argument went, meant only incremental changes should be introduced to a tax system that has otherwise worked well to attract foreign investments.

2005 and 2006 were confidence-boosting years for China. In both years, its economic growth was spectacular,21 with its trade surplus hitting new highs22 and its foreign-exchange reserve swelling.23 While foreign direct investment in 2006 was 4% less than in 2005, the total amount for 2006 was still an impressive US$69.5 billion.24 Measured on purchasing power parity, this made China the world’s fourth largest economy.

Viewed against this background, the MOF’s reform view seems to have prevailed in the end, although the MOC’s go-slow approach also seems reflected in the new law.25

C. Previous Preferential Tax Treatments

Preferential tax treatments under the pre-reform system developed over the years. They were manufacturing and export-oriented, coupled with a geographically-based, special-zone focus. If qualified, FIEs were generally accorded one or more of the following preferential tax treatments:

• the “2+3 policy,” from the first profitable year, a two-year CIT exemption and a three-year 50% reduction of CIT for manufacturing FIEs with a term of 10 years or more;26

• the “export incentive,” an additional one-year 50% CIT reduction for export-oriented FIEs in each year in which an FIE exported no less than 70% of its production;27

• the “high-tech incentive,” a two-year CIT

exemption and a three-year 50% CIT reduction for FIEs classified as “high-tech enterprises;”28

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• the “CWAs incentive,” a flat 15% CIT rate for an additional three-year for FIEs established in the CWAs and engaged in activities in certain “encouraged” sectors;29

• the “reinvestment rebate” of 40%30 to

100%31 of CIT paid on profits if FIEs reinvested the profits in China to establish new FIEs with a term of at least 5 years;32

• “loss carryovers” incurred by FIEs for up to 5

years;33 • the “dividend exemption” from CIT on

dividends derived by foreign investors from FIEs;34 and

• the “local incentive,” reductions or

exemptions from local income tax if FIEs were engaged in activities in encouraged sectors35 or operated in various locally established special zones (rather than those established by the national government).

The myriad of special zones established by China’s central government36 provided additional incentives and benefits to foreign investors, such as flat CIT rates of 10%,37 15%,38 or 24%,39 a “5+5 policy”40 (modeled after the “2+3 policy”), or even a “1+2 policy” (also modeled after the “2+3 policy”) for FIEs in the service sectors.41 The availability of these rates and policies depended on a variety of considerations, such as location, industry sectors, industry classification of being a FIE engaged in activities in encouraged sectors, being a manufacturing FIE, or being a knowledge/technology-intensive FIE, and total investment amount.

D. Summary of the Tax Reforms

Key items of the tax reforms enshrined in the 2007 Income Tax Law include:

• Phase-out of Preferential Tax Treatments. Key preferential tax treatments formerly accorded only to FIEs (such as the “2+3 policy” and the “export incentive”) will be phased-out during a five-year transition period.42

• Equalization. With the phasing out of

preferential tax treatments, CIT rates of FIEs and DCEs will be equalized. In addition, application of the remaining preferential tax treatments will generally disregard whether an otherwise eligible enterprise has foreign

investors. • Lower CIT Rate. With limited exceptions,

the new CIT rate for both FIEs and DCEs will be 25%,43 8% lower than the rate of 33%44 under the pre-reform system.

• Preferential CIT Rates. CIT rate for qualified

small-scale and thinly-profitable enterprises will be 20%.45 CIT rate for new and high-tech enterprises supported by the State will be 15%.46

• Favored Industry Sectors. The remaining

preferential tax treatments will move away from manufacturing and export-oriented FIEs and, with limited exceptions, from a geographical focus. Instead, they will shift to technologically progressive,47 environmentally friendly,48 water and energy conserving,49 and safe-production friendly50 qualified venture capital investments51 projects or enterprises.

• Retention. With some variations, preferen-

tial treatments have been retained for the following entities:

– high-tech enterprises generally;52

– new and high-tech enterprises newly

established in the Special Economic Zones (“SEZs”) and the Shanghai Pudong New Area (“Pudong”);53

– enterprises in encouraged sectors

established in the CWAs;54

– income derived from agriculture, forestry, animal husbandry, fishery and infrastructure projects and from infrastructure projects supported by the State;55

– loss carryovers for up to five years;56

and

– the dividend exemption.57 • Anti-avoidance. Tax avoidance schemes in

general,58 and “round-tripping” in particular,59 have been expressly outlawed. Related rules concerning transfer pricing,60 thin-capitalization,61 and controlled foreign corporations62 and their enforcement63 have been given renewed emphasis.

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• Tax Resident Enterprise. A twin concept of “Tax Resident Enterprise” (“TRE”) and “Non-Tax Resident Enterprise” (“NTRE”) has been introduced.64

• Scope of Taxation. TRE will be taxed on its

worldwide income. NTRE will be taxed on its China-sourced income and non-China-sourced income that is effectively connected with NTRE’s entity or place of business that has been established in China.65

Though the new law has not directly addressed “reinvestment rebate,” it is widely understood that this treatment has been eliminated. Though “dividend exemption” has been retained, dividends must be qualified.66 E. Analysis With the new CIT rate of 25%, China should remain competitive as an investment destination. As compared to China, the average tax rate of the 18 surrounding countries is 26.7%67 and the average rate of the world’s 159 economies is 28.6%.68 The overall impact of the new tax system on China’s treasury seems contained. According to the government, tax equalization will result a net revenue loss of approximately US$11.6 billion69 (taking into account a net loss of approximately US$16.7billion70 from the DCEs and a net gain of approximately US$5.1 billion71 from the FIEs). That loss should be manageable for an economy the size of China’s, which now exceeds US$1 trillion. The immediate impact on foreign investment flows to China will likely be limited. Tax equalization has not made it to the top-ten operating issues for USCBC members in China in a 2006 survey. China’s shift of preferential policy away from manufacturing and export has also dovetailed with the change of China’s investment goals of many foreign investors, as borne out in the same survey.72 Even for many existing manufacturing or export-oriented FIEs, impacts may be minimal. For those granted CIT rates lower than 25%, they are accorded a five-year transition period73. For those granted the “2+3 policy,” the unused portion of the tax holiday will be permitted to sunset as originally scheduled.74 For many that have operated for more than five years, the “2+3 policy” may have already expired.75

FIEs most hard hit would likely be those manufacturers of low-end items whose margins are heavily dependent on the availability of preferential tax treatments. For these FIEs, however, relocation to even lower-cost jurisdictions in Southeast Asian nations such as Vietnam or Thailand may have been only a matter of time, an inevitable consequence of China’s maturing economy and its cost base changes. For all service provider FIEs, tax equalization has been good news. As they were not eligible for preferential tax treatments any way (since they engage in neither manufacturing nor export activities) and were subject to the 33% CIT, tax unification has effectively lowered their CIT rates by 8%. The ability of most of China’s various special zones to continue to offer benefits and incentives to foreign investors (i.e., their raison d’être) has become less than clear under the new tax law. This may lead to a reassessment of investment opportunities in many of these zones. However, the special status of the SEZs and Pudong has been reaffirmed. New-tech and high-tech enterprises recently established in these zones will continue to receive various preferential tax treatments afforded for the five-year transition period.76 F. Conclusion Decades of torrent growth, particularly in manufacturing, has resulted in alarming environmental degradation, severe depletion of limited natural resources, uneven development of China’s geographical regions and acute income disparity. The Chinese government seems aware of these challenges. A more balanced and sustainable growth is now a stated government policy.77 To that end, China’s economy will undergo many changes, as China promotes technological advancement, upgrades its industry sectors and optimizes its economic structure. Like the rest of the world, China is also focusing more on the quality of foreign investment. In that regard, it wants to attract more high-tech industries, modern service industries, high-end manufacturing and infrastructure development. This has been evident in the recently issued Foreign Investment Directives.78 These goals have now been reinforced by the many

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sweeping reforms introduced in the 2007 Income Tax Law. Author: Cheng Wang is one of the founding members of the Houston-based firm of Tong & Sung, P.C., and Libby Hugetz is an intern with that firm. Mr. Wang may be reached at [email protected]. 1 The Income Tax Law of the People’s Republic of China for Enterprises with Foreign Investment and Foreign Enterprises, promulgated on April 9, 1991 (the “1991 Income Tax Law”); Detailed Rules for the Implementation of Income Tax Law of the People’s Republic of China for Enterprises with Foreign Investment and Foreign Enterprises, promulgated on June 30, 1991 (the “1991 Tax Implementing Rules”). 2 Enterprise Income Tax Law of the People’s Republic of China, promulgated on March 16, 2007 (the “2007 Income Tax Law”). 3 Article 60 of the 2007 Income Tax Law. 4 Article 57 of the 2007 Income Tax Law. 5 Part I of the March 8th, 2007 Report to National People’s Congress Regarding the Draft 2007 Enterprise Income Tax Law of the People’s Republic of China, Mr. Jin RenQin, Finance Minister of China (the “Jin Report”). 6 Part I of the Jin Report. 7 Id. 8 Id. 9 Id. 10 Such as alarming environmental degradation, severe depletion of limited natural resources, uneven development of China’s geographical regions and acute income disparity. 11 The 2006 U.S. China Business Council Member Priorities Survey (the “2006 Survey”). 12 2006 Survey and Foreign Investment in China, USCBC, in February 2007. 13 Foreign Investment in China, USCBC, published in February 2007. 14 Id. 15 Id. 16 Part I of the Jin Report. 17 Foreign Investment in China, USCBC, published in February 2007. 18 Part I of the Jin Report. 19 Id. 20 Foreign Investment in China, USCBC, published in February 2007. 21 2006 Economic Indicator, USCBC, published in 2007 (“2006 Economic Indicators”). According to estimates by

USCBC, as compared with 2005, in 2006 the Chinese economy grew by 10.7%, the fastest pace in 11 years. 22 According to the 2006 Economic Indicators, China’s 2006 trade surplus surged 74%, hitting a record US$ 177.5 billion. 23 According to the 2006 Economic Indicator, in 2006, China’s foreign-exchange reserve topped US$1 trillion, overtaking Japan and becoming the world’s largest. 24 Foreign Investments in China, USCBC, published in February, 2007. 25 Article 57 of the 2007 Income Tax Law. 26 Paragraph 1 of Article 8 of the 1991 Income Tax Law. 27 Paragraph 1 of Article 73 and paragraph 7 of Article 75 of the 1991 Tax Implementing Rules. 28 Paragraph 8 of Article 75 of the 1991 Tax Implementing Rules; Paragraphs 1 and 2 of Article 6 of the High-Tech Zones Tax Provisions. 29 Part 3 of Paragraph 1 of the State Council Notice on Implementing the Development of Western China, promulgated on October 20, 2000 (the “Western China Development Notice”); and Paragraphs 1 and 2 of the SAT Notice on Implementing Preferential Treatments to FIEs Established in Central and Western China, promulgated on September 17, 1999 (the “CWA Tax Notice”). 30 Article 10 of the 1991 Income Tax Law. 31 Paragraph 1 of Article 81 of the 1991 Tax Implementing Rules. 32 Article 10 of the 1991 Income Tax Law and Paragraph 1 of Article 81 and Article 80 of the 1991 Income Tax Implementing Rules. 33 Article 11 of the 1991 Income Tax Law and Article 76 of the 1991 Income Tax Implementing Rules. 34 Articles 19(1) and 19(3) of the 1991 Income Tax Law and Article 18 of the 1991 Income Tax Implementing Rules. 35 Article 9 of the 1991 Income Tax Law. 36 Examples of national level special zones include, among others, the Special Economic Zones such as Shenzhen, Zhuhai, Hainan, Xiamen and Shantou (“SEZs”), the Shanghai Pudong New Area (“Pudong”), the Economic and Technological Development Zones (“ETDZs”), the High-technology Zones (“HTZs”), and the Coastal Economy Open Areas (“CEOAs”). 37 Article 5 of the Provisions on the Taxation of the National New and High Technology Industrial Development Zones, promulgated on March 6, 1991 (the “High-Tech Zones Tax Provisions”). 38 Paragraphs 1 and 3 of Article 7 of the 1991 Income Tax Law; Paragraphs 1, 4 and 5 of Article 73 of the 1991 Tax Implementing Rules; Article 1 of the 1991 Capital Cities Notice. 39 Paragraph 2 of Article 7 of the 1991 Income Tax Law; Article 1 of the SAT Notice on Certain Tax Policies Issues Involving Foreign Investment in Capital Cities, promulgated on September 18, 1992 (the “1992 Capital Cities Notice”).

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40 Paragraphs 1, 2 and 3 of Article 75 of the 1991 Tax Implementing Rules. The “5+5 policy” was offered by the Special Economic Zones of Shenzhen, Zhuhai, Hainan, Xiamen and Shantou (“SEZs”) and the Shanghai Pudong New Area (“Pudong”). The policy required FIEs to have a term of over 15 years and to engage in certain preferred projects such as airports, harbors, railways, or power stations. 41 Paragraph 4 of Article 75 of the 1991 Tax Implementing Rules. Though FIEs in the service sectors were generally not accorded special tax treatments, at one point SEZs were permitted to offer the “1+2 policy” for service-sector FIEs with a term of 10 years and a minimum investment of US$5 million. 42 Article 57 of the 2007 Income Tax Law. 43 Article 4 of the 2007 Income Tax Law. 44 Article 5 of the 1991 Income Tax Law. 45 Article 28 of the 2007 Income Tax Law. 46 Id. 47 Articles 27, 28, 30, 32, and 33 of the 2007 Income Tax Law. Article 27 permits CIT exemption or reduction for qualified technology transfer. Article 33 permits accelerated depreciation for technology upgrading. 48 Articles 27, 33 and 34 of the 2007 Income Tax Law. Article 27 permits CIT exemption or reduction for incomes derived from qualified projects that can protect the environment or conserve on the use of energy or water. Article 33 permits a deduction for income derived from the manufacture of products compliant with State industrial policies provided the manufacture involves comprehensive use of resources. 49 Articles 27 and 34 of the 2007 Income Tax Law. Article 34 permits a tax reduction for purchases of specialized equipment that are environmentally friendly, safe production-friendly or that conserve the usage of energy or water. 50 Id. 51 Article 31 of the 2007 Income Tax Law provides that investments made by venture capital enterprise that are supported by the State may be given a deduction calculated based on a percentage of the investment amounts. 52 Articles 27, 28, 30 and 32 of the 2007 Income Tax Law. 53 Article 57 of the 2007 Income Tax Law and Part III of the Jin Report. 54 Id. 55 Article 27 of the 2007 Income Tax Law. 56 Article 18 of the 2007 Income Tax Law. 57 Article 26 of the 2007 Income Tax Law. 58 Article 47 of the 2007 Income Tax Law. 59 Part I of the Jin Report. 60 Article 41, 42, 43, and 44 of the 2007 Income Tax Law. 61 Article 46 of the 2007 Income Tax Law. 62 Article 45 of the 2007 Income Tax Law. 63 Article 48 of the 2007 Income Tax Law.

64 Article 2 of the 2007 Income Tax Law. An enterprise that has been registered in China, or one that has not been registered but has an “effective management entity” in China, is considered a TRE. An enterprise that has been registered outside of China and does not have an “effective management entity,” but has established an entity or a place of business in China, or has China-sourced income (if it does not have an entity or a place of business in China) is considered a NTRE. 65 Article 3 of the 2007 Income Tax Law. Under Article 4 of the 2007 Income Tax Law, the China-sourced income of an NTRE that does not have an entity or a place of business in China will be taxed at 20%. 66 Article 26 of the 2007 Income Tax Law. Dividends between TREs are exempt. So are dividends paid by a TRE to an NTRE if the dividend is otherwise effectively connected with the NTRE’s entity or place of business established in China. 67 Part III of the Jin Report. 68 Id. 69 Part IV of the Jin Report. 70 Id. 71 Id. 72 According to the 2006 Survey, 57% of the respondents indicated that their main investment objective was to access the China market. Only 18% invest in China as an export platform to the U.S. market and the remaining 25% export to other countries in Asia or the rest of the world. 73 Article 57 of the 2007 Income Tax Law. 74 Article 57 of the 2007 Income Tax Law. While the original “2+3 policy” is tolled until an FIE’s first profitable year, under Article 57 the sunset period starts in 2008. 75 It is possible that for some, the “2+3 policy” has not expired as the five-year holiday starts from the first profitable year of an FIE’s China operation. 76 Article 57 of the 2007 Income Tax Law and Part III of the Jin Report. 77 Foreign Investment Directives, promulgated by China’s National Development and Reform Commission (“NDRC”) in Nov. 2006. 78 Foreign Investment Directives, promulgated by China’s Ministry of Commerce (“MOC”) on March 6, 2007.

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The U.S.-Chile Free Trade Agreement: Current Results and Future Possibilities

By Farrah Rajabi

I. Introduction Over the last 25 years, Latin America has suffered the worst economic growth performance in its modern history.1 From 1980 to 2005, real income per person in the region grew by only 13%.2 This statistic is dismal when compared to the 82% growth in per capita income in the 20 years prior (1960-1980).3 However, unlike the rest of its neighbors in the region, Chile has avoided the same problem, having experienced more than twice the per capita growth in the last two decades than it did in the two decades preceding 1980.4 Many attribute Chile’s sustained growth rate to its strict adherence to the neo-liberal policies pushed by the dictatorship of General Augusto Pinochet.5 While it is debatable how closely Chile has really adhered to true neo-liberal policies, Chile has nonetheless been touted as the regional model for other developing countries in Latin America as a result of its economic success.6 When General Pinochet overthrew the demo- cratically elected socialist government of Salvador Allende in 1973, Pinochet quickly implemented an aggressive policy of unilateral tariff reduction while lowering the trade barriers for non-tariff goods.7 As a result, an “open regionalism” trade policy developed in Chile focused on joining together different trade associations, such as the Andean Community and Mercosur.8 In addition to its policy of open regionalism, Chile is also an attractive partner for bilateral and regional trade agreements because of its market-based economy, which is the most open and liberalized in Latin America.9 In fact, since the late 1990s, Chile has entered into multiple free trade agreements with partners such as Canada, China, the European Union, Korea, Mexico, Peru and Singapore, among others.10 II. The U.S.-Chile Free Trade Agreement The U.S.-Chile Free Trade Agreement entered into force in 2004 and is noteworthy for two reasons: it increased trade between the two countries and it is the United States’ first trade

agreement with a South American country.11 Additionally, the pact is important because it demonstrates how policy issues, both political and economic, can be resolved between a small developing country and a large developed one.12 Due to the significance the trade alliance had for both countries, many saw the U.S.-Chile agreement as a step towards hemispheric unification.13 The agreement includes 24 chapters, some of which cover broad aspects of trade, such as definitions and other general provisions that establish the free trade zone, while others are more specific and deal with issues like financial services, electronic commerce and telecommunications.14 This article provides an overview of two important issues related to the U.S.-Chile Free Trade Agreement: enforcement of intellectual property rights and the economic benefits to each participating country.

A. Intellectual Property Chapter 17 of the FTA concerns intellectual property rights and contains detailed provisions relating to issues such as internet domain names, the rights of performers and producers of phonograms, remedies against the circumvention of effective technological measures and the protection of encrypted program-carrying satellite signals.15 In the more traditional area of trade-related intellectual property rights, the agreement expands the coverage of trademarks and the protection of pharmaceutical products.16 Thus far, however, the U.S. has not been pleased with Chile’s enforcement of the intellectual property provisions laid out in the FTA.17 In September 2006, the International Intellectual Property Alliance (IIPA), a private-sector coalition that represents U.S. copyright-based industries, recommended that Chile be elevated from the Watch List to the Priority Watch List, citing its “lack of progress on combating piracy” and “the slow process of legislative reform” in the country.18 In early 2007, the United States Trade Representative (USTR) followed the recommendation, noting

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disappointment with Chile’s insufficient protect-tion of intellectual property in light of its status as a bilateral free trade partner.19 In the special report relied upon by the USTR, the IIPA expressed a similar concern that Chile’s lack of progress was especially troubling because it was the first Latin American free trade partner to sign a agreement with the U.S. that provided a high level of copyright and enforcement obligations.20 In its report, the IIPA urged Chile’s government to publicly announce its willingness to fight piracy on a national level.21 According to the IIPA, despite Chile’s economic development, piracy levels in the country remain high, and in 2006, the copyright industries reported no improvements in the piracy situation.22 The problems the U.S. regards as the most pressing include street piracy, music piracy, business software piracy, audiovisual piracy, book piracy and entertainment software piracy.23 The IIPA explains that, even though the police carry out raids, criminal prosecutions are rare, and if they occur, copyright infringe- ment cases are usually dropped before adjudication.24 In 2006, only 26 sentences were issued for copyright violations; two people were incarcerated and four people served time on a part-time basis.25 A lowered status on the piracy watch list does not seem to concern the government of Chile, which has stated that piracy issues will not affect bilateral trade between the two countries.26 Specifically, the Chilean Director of International Economic Relations responded that, although his country complies with the international standards of intellectual property protection, there is room for improvement, and his government is currently making efforts in that direction.27 Some in Chile still express fear that the U.S. could use the report to unilaterally adopt methods that will negatively impact the country, such as increasing tariffs or taking away certain advantages, for example, but Chile has disregarded the importance of the lowered status by explaining that any effect would be de minimus.28

B. Foreign Investment and the Tariff Structure

With regard to investment, the U.S.-Chile Free Trade Agreement creates incentives for U.S. manufacturers, banks, insurers, telecommunica-tion companies, and most other U.S. enterprises

to enter the Chilean market with virtually no restrictions.29 The tariff schedule was structured so that tariffs on 85% of the consumer and industrial goods covered by the agreement were eliminated immediately. Most of the tariffs will be gone in 2008 (four years after the effective date of the agreement), and all of the tariffs will disappear entirely within 12 years of implementation of the agreement.30 The textile and apparel sector is one of the industries in which tariffs were removed immediately.31 By contrast, tariffs on agricultural goods will be abandoned gradually and selectively, and may be subject to a safeguard provision that allows either party to impose additional import charges over the preferential tariff if a good is imported into either country in such increased quantities as to cause serious damage to the domestic market.32 The effects of the agreement began to materialize soon after it was implemented, and the initial results were promising. In early 2005, after one year of being in force, U.S. exports to Chile had increased by 25% while Chilean exports to the U.S. rose 27%.33 Also, Chile’s economy grew 3.3% in that year.34 After three years of being in force, commerce between the two countries increased by 154%.35 However, recent reports indicate that Chile’s exports to the U.S. have not grown as significantly as was originally predicted.36 In fact, from January to August of 2005, which marked a period of strong expansion in Chile’s foreign trade, exports to the U.S. grew by only 15%, whereas imports from the U.S. grew by 54.9%.37 During the first year the agreement was in effect, although the overall trade increased between the countries, the results were similar in that there was a net overall growth of imports, but the percentage of exports to the U.S. was below the general average.38 The opposite was true of imports from the U.S.39 Such discrepancy arises from the fact that approximately 98% of Chile’s exports to the U.S. are unprocessed natural resources, such as metals, seafood and fruit, whereas the country’s imports from the U.S. primarily consist of manufactured goods, such as automobiles, computers and related technology, as well as mining machinery.40 Also, as a result of the exclusion of agricultural liberalization in the agreement, Chile sustained a substantial welfare loss, but the U.S. felt no major negative impact.41 Along with the issue of insufficient exports, a parallel concern for Chile is the fact that export activity is concentrated within very few

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businesses in that country.42 Of the estimated 600,000 businesses in Chile, only 6,000 exported their goods in the last few years.43 In 2004, the top 10 companies exported 45% of all Chilean goods internationally, and the top 50 companies represented 70% of all exports.44 This concentration is even more pronounced with respect to Chilean exports to the U.S.45 The top 10 companies in the country exported an estimated 50% of all goods to the U.S., and the top 50 exported approximately 86%.46 Such data suggest that, even with the agreement in place, barriers still exist to prevent the vast majority of Chilean enterprises from engaging in international trade. Further, although commerce between Chile and the U.S. has experienced an overall increase since the agreement went into force, U.S. direct investment in the country, somewhat ironically, has dropped in spite of the ease with which the agreement allows U.S. companies to enter the Chilean market.47 According to Chile’s Committee on Foreign Investment, in 2004 and 2005, only 2.8% of the capital that entered Chile came from the U.S., whereas 60.8% came from Spain.48 The Committee noted that the volume of U.S. investment in the country has steadily dropped from $1.8 billion in 2001 to $78 million in 2005.49 The same is not true of overall foreign investment, which has seen more ups and downs in the same period of time.50 These results seem paradoxical since trade and investment tend to be linked, and because the agreement protects U.S. companies’ interests in Chile.51 Experts cannot account for the discrepancies, but the president of the American-Chilean Chamber of Commerce explains that, because the major telecommunications and pharmaceutical corporations have already installed themselves in the country, Chile should now focus on attracting investment from U.S. companies associated with less developed technology sectors in order to expand and diversify the country’s economy while simultaneously breaking its continued dependence on exporting natural resources.52 III. Conclusion Even though the U.S.-Chile Free Trade Agreement has not been as advantageous for Chile as it originally hoped, Chile has protected itself with numerous regional and bilateral trade agreements and with its commitment to democracy and a market-based system. Thus,

Chile will likely continue to be successful in its long-term trade objectives. Because Chile remains a prime market for foreign investment, especially in light of the recent rise of the copper industry, U.S.-based corporations would be wise to take advantage of the incentives the trade agreement offers to investors. Author: Farrah Rajabi is a third year student at South Texas College of Law and the first place winner of the 2007 Law Student Writing Contest sponsored by the International Law Section of the State Bar of Texas. She can be contacted at [email protected]. 1 PUBLIC CITIZEN, THE USES OF CHILE: HOW POLITICS TRUMPED TRUTH IN THE NEO-LIBERAL REVISION OF CHILE’S DEVELOPMENT 3 (2006), available at http://www.citizen.org/ documents/chilealternatives.pdf. 2 Id. 3 Id. 4 Id. 5 See id. at 5. 6 Id. 7 David Travers, You Have to Fight for Your Right to Work: The U.S.-Chile Free Trade Agreement and Global Labor Standards, 29 SUFFOLK TRANSNAT'L L. REV. 337, 347 (2006). 8 Id. 9 Id. at 347. 10 Foreign Trade Information System, available at http://www.sice.oas.org/Trade/chi_e.ASP. 11 The U.S.-Chile Free Trade Agreement: Economic and Trade Policy Issues, September 10, 2003 RL31144, available at http://www.opencrs.com/document/RL31144/. 12 Id. 13 Clinton Porteous, Trade to Flow Freely between Chile and the US, CHRISTIAN SCIENCE MONITOR, June 6, 2003, available at http://www.csmonitor.com/2003/0606/p07s02-woam.html?related. 14 U.S.-Chile Free Trade Agreement, U.S-Chile, June 6, 2003, available at http://www.ustr.gov/Trade_Agreements/ Bilateral/Chile_FTA/Final_Texts/Section_Index.html. 15 Id. 16 Id. 17 See U.S., Chile To Discuss Tariff Acceleration, Rules Of Origin, INSIDE U.S. TRADE, Feb. 9, 2007. 18 International Intellectual Property Alliance, 2007 Special 301 Report: Chile, at 17 [hereinafter IIPA Report], Feb. 12, 2007.

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19 Schwab Announces Results of Chile IPR Review, Cites Deteriorating Performance, Jan. 8, 2007, available at www.ustr.gov. 20 IIPA Report, supra, at 17. 21 Id. 22 Id. at 21. 23 Id. at 21-22. 24 Id. at 23-24. 25 Id. at 24. 26 Chile: nueva clasificación no afectará comercio con EEUU, ASSOCIATED PRESS, Jan. 9, 2007, available at http://mx.news.yahoo.com/s/ap/070109/latinoamerica/ams_ eco_chile_eeuu_comercio. 27 Id. 28 Id. 29 See Porteous, supra, note 13. 30 Id. 31 Id. 32 Id. 33 Danna Harman, Hemispheric Trade Zone Stumbles, CHRISTIAN SCIENCE MONITOR, Nov. 23, 2004, available at http://www.csmonitor.com/2004/1123/p04s01-woam.html. 34 Id. 35 Office of the United States Trade Representative, Chile FTA Facts: Economic Benefit to Chile of FTA, Sep. 2007, available at http://www.ustr.gov. 36 EFE, TLC EEUU-Chile no logra metas, BILATERALS.ORG, Nov. 6, 2006, available at http://www.bilaterals.org/ article.php3?id_article=6403; Hugo Fazio, A dos años de subscribirse el TLC con EEUU, BILATERALS.ORG, Nov. 17, 2005, available at http://www.bilaterals.org/article.php3?id_ article=3126. 37 Fazio, supra, note 37. 38 Id. 39 Id. 40 Pablo Ferrero, TLC Chile-EEUU: Más anuncios que hechos, ALIANZA SOCIAL CONTINENTAL, Jan. 11, 2005, available at http://www.asc-hsa.org/article.php3?id_article= 216; http://www.ustr.gov/Document_Library/Fact_Sheets/ 2004/The_US-Chile_Free_Trade_Agreement_An_Early_ Record_of_Success.html. 41 See Alvin Hilaire & Yongzheng Yang, The United States and the New Regionalism/Bilateralism, 38 J. WORLD TRADE 603, 613, tbl. 3, 617-18, 619, tbl. 5 (2004). 42 ALIANZA CHILENA POR UN COMERCIO JUSTO Y RESPONSIBLE, TLC CHILE-ESTADOS UNIDOS: UN “TRATADO MAL TRATADO” 6 (2005), available at http://www. comerciojusto.cl/alcadoc/tlc_usa_final_261005.pdf. 43 Id. 44 Id. 45 Id.

46 Id. 47 EFE, supra, note 37. 48 Id. 49 Id. 50 Id. 51 Id. 52 Id.


INTERNATIONAL LAW SECTION OF THE STATE BAR OF TEXAS MEMBERSHIP INFORMATION

If you or your colleagues are interested in joining the International Law Section of the State Bar of Texas, please register at http://www.texasbar.com/Template.cfm?Section=Sections. The $25 Membership includes a subscription to the TTLQ.

If you have further inquiries regarding the International Law Section’s membership and activities, visit our website at http://www.ilstexas.org or contact the Section’s Secretary and Treasurer, Steve Davis.

Stephen D. Davis Secretary/Treasurer Vinson & Elkins LLP

1001 Fannin, Suite 2500 Houston, Texas 77002-6760

Tel.: (713) 758-3862 Fax: (713) 615-5597

E-mail: [email protected]

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