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When Sun Tzu said “Energy may be likened to the bending of a crossbow; decision, to the releasing of a trigger,” in “Bing Fa” 2,500 years ago, he could have been describing the dilemma facing many Chinese companies and investors today: Is it time to release the trigger on investing in America?
Chinese investors have been slowly bending the crossbow over time, building up energy in the form of $3.7 trillion USD in foreign currency reserves. Now many Chinese investors are poised at the moment of decision, weighing the risks and rewards of investing that money in business opportunities in the United States.
Some Chinese investors aren’t hesitating to release the trigger. These investors are now swiftly taking advantage of the diverse array of business opportunities in America, not only in the traditional investment areas of the energy and natural resource sectors, but also in real estate, food production, entertainment, automotive, and many other industries. In fact, Chinese investors made 741 investments valued at $35.9 billion between 2000 and 2013, according to the Rhodium Group. 2014 promises to be even greater.
But some potential Chinese investors are holding back, concerned that too many federal, state and local legal impediments in the U.S. stand in the way of their target, including:
- Securing government approval of the transaction;
- Real estate laws;
- Labor and employment laws;
- Immigration laws;
- Protection of intellectual property.
While the legal issues are complex, it is a mistake to let manageable legal matters become barriers between an investor and a promising business opportunity. With the right legal counsel, Chinese investors can employ the following key strategies to reduce the legal obstacles of doing business in the U.S., giving the investor the best opportunity to acquire target opportunity.
Approval of the Transaction: National Security Issues
National security is a high priority for the U.S., just as it is for every other country, and the U.S. government does monitor foreign direct investment coming into the country.
Under the Exon-Florio Amendment of 1988, the U.S. government has the authority to restrict or regulate foreign investments that it deems to be a security threat. The law allows the President of the United States to stop a proposed purchase or reverse a completed transaction of a U.S. company by a foreign investor if there is credible evidence that the transaction would negatively affect national security.
The Foreign Investment and National Security Act (FINSA), passed in response to heightened security concerns after the September 11, 2001 attacks on the U.S., strengthens the provisions of Exon-Florio. FINSA requires a 45-day investigation into transactions involving foreign governments, potential security threats, or the control of critical infrastructure. The law also expands the scope of review to include any impact the transaction may have on infrastructure, energy assets and critical technologies.
Exon-Florio and FINSA are enforced by the Committee on Foreign Investment in the United States (CFIUS), which monitors foreign investment transactions. CFIUS is an inter-agency task force within the U.S. government comprised of individuals representing a wide range of departments such as Defense, Homeland Security, Commerce and Justice. Any Chinese investor hoping to complete a business deal in the United States will likely have to submit to a review by CFIUS.
Chinese investors may voluntarily give notice of any transactions to CFIUS, at which time CFIUS will conduct a review. If the transaction is cleared, it has “safe harbor” protection, meaning that the decision is final and cannot be reversed, unless there was fraud or misrepresentation. If CFIUS determines that a transaction could result in foreign control of a U.S. business with national security importance, CFIUS may require the parties to enter into a mitigation agreement.
If a foreign investor decides not to give CFIUS advance notice about a transaction, CFIUS can review the transaction at any time, including after the transaction has been finalized. If national security issues are present, then CFIUS has the power to either prevent the transaction from happening or even force the termination of a finalized transaction.
In addition to gaining approval from CFIUS, foreign investors should not forget that they must have permission to operate in the states and localities in which they do business. Some investors mistakenly think that if a corporation is legally established in one state, it is able to conduct business in all states. A corporation must register in each state in which it does business and pay taxes both to the state and local governments.
U.S. real estate is one of the fastest growing sectors for Chinese investment. Unlike in China, it is normal practice in the U.S. for an investor to purchase an unrestricted legal title to real estate, giving the investor full rights to use or sell the real estate at any time without permission from the government. Most U.S. real estate can be purchased by foreign citizens without government approval, although there are a few exceptions to the rule, such as property located near a U.S. military base.
The major risk in owning real estate in America, including buildings, is the requirement to comply with all environmental laws at the federal, state and local levels. Under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), real estate buyers are legally accountable to correct any environmental problem after the purchase is concluded, even if the buyer did not cause the problem. Before purchasing real estate, Chinese investors should consider the environmental regulations of owning the property and the accompanying financial risk.
Chinese investors purchasing large tracts of land should also pay attention to the Agricultural Foreign Investment Disclosure Act, which requires all foreigners to report land acquisitions to the Secretary of Agriculture within 90 days of purchase. The requirement applies to any purchase of land greater than 10 acres that has been used within the past five years for farming, ranching or timber production, even if the investor does not intend to use the land for agricultural purposes. Failure to report the purchase to federal authorities can have severe penalties, up to 25 percent of the value of the foreign investor’s interest in the land.
Additionally, many states regulate the purchase of agricultural property. Some states place acreage limitations on foreign ownership of agricultural land, and others strictly prohibit it. Foreign investors should make sure any land purchase complies with both state and federal requirements.
Chinese investors interested in purchasing real estate for the purposes of mining its gas, oil or mineral resources will need to understand state and federal regulations on mining natural resources. In particular, the Mineral Lands Leasing Act of 1920 bars foreign investors from leasing the oil, gas and mineral rights on land owned by the federal government if the foreigners’ country restricts U.S. companies from likewise investing in the mining of their natural resources. Trade agreements between China and the U.S. can create exceptions to the Act, so Chinese investors should carefully review the opportunities.
Taxes are always an issue for Chinese businesses that want to do business in the United States, and Chinese investors should have a thorough understanding of the tax treaty that exists between the U.S. and China. The tax treaty not only defines which taxes are owed to domestic and foreign governments, but also requires the U.S. and China to provide foreign tax credits to their residents to avoid double taxation on the same profits.
According to the tax treaty, foreign investors pay corporate income taxes to the country in which their business has a “permanent establishment.” Examples of permanent establishments include a branch office, a factory, or a place for the extraction of natural resources.
Taxes on dividends, interest or royalty payments are owed to the country in which the recipient resides. These payments may also be taxed up to ten percent, however, by the country in which the business is located.
The U.S. government also imposes an additional tax on foreign corporations’ earnings and profits that occur as a result of the foreign corporation’s activities in the U.S., known as the “branch tax.” The tax is determined by comparing the net equity of the branch at the end of the tax year to the previous year. If the current net equity is less than the previous year, the foreign investor may owe additional tax. The tax can often be lowered or avoided, however, by reinvesting earnings back into the U.S. branch.
Income generated from the ownership of property, such as rent, is taxable by the nation in which the property is located. When U.S. property is sold, however, the sale is subject to a 20 percent tax on capital gains under the U.S. Foreign Investment in Real Property Tax Act. To ensure payment of the taxes, the U.S. buyer must withhold 10 percent of the sale price.
Foreign investors also need to pay attention to any state and local taxes which will be due where a foreign investor does business in the U.S.
Labor and Employment Laws
Chinese investors hiring workers in the United States must pay close attention to American labor and employment laws. The U.S. federal government has strict minimum wage and overtime wage laws to which all companies must adhere, as laid out in the Fair Labor Standards Act.
Foreign investors must also ensure that the workplace meets all industry safety standards, which are enforced by the Occupational Health and Safety Administration (OSHA). OSHA can conduct on-site safety inspections at any time without warning, and issue a citation and/or fine for any violation of industry safety standards.
American workers have the right to unionize and strike under the National Labor Relations Act (NLRA). Employers are prohibited from retaliating against employees that engage in any of the activities protected by the NLRA.
The strength of unions varies by industry and state. About half of U.S. states do not have “right to work” laws, meaning that unions in those states can have agreements with employers that require all workers to pay union dues. Although no employee can be forced to join a union, the requirement to pay dues makes unions very powerful in those states.
Once an acquisition or a joint venture in America is finalized, a Chinese company will need to send its key executives, managers and skilled workers to America to manage the new investment. Foreign investors must understand how U.S. immigration laws work, because these laws govern who can be transferred to the U.S. to work. Furthermore, the government limits the number of certain types of visas that may be granted each year, which can delay the process.
Chinese companies have two options for American visas for their workers. The first option is a temporary visa, which is granted for a specific period of time. After the visa expires, the worker must return to China and has no right to remain in America. The second and more desirable option is a permanent resident visa, also known as a green card. Once approved, green cards allow Chinese workers to stay in America for as long as they wish.
Workers’ visas must be approved by the U.S. Department of Labor (DOL). Before granting a labor certification, the DOL will review the responsibilities and compensation for the position to ensure that they are standard for the job type. The DOL will also take into account the employer’s recruitment efforts to determine whether a qualified U.S. worker is available to fill the position. Highly qualified applicants, such as researchers or athletes, may qualify for “priority” status and avoid the DOL review process.
The U.S. has strong federal laws protecting intellectual property in the form of patents, trademarks and copyrights. The protection of trade secrets is also very important in the U.S. because trade secrets are widely used in the U.S. Trade secrets can cover a broad scope of information that gives a business its edge by virtue of being unknown to its competitors.
One way Chinese companies can protect their trade secrets is to require employees with access to confidential information to sign secrecy agreements called “nondisclosure agreements.” Under some circumstances, employers can also require their employees to sign non-compete agreements to prevent employees from going to work for competitors. Note, however, that there are usually limits on the enforceability of non-compete agreements, such as a limited time period and geographic radius.
In the next five years, Chinese companies will actively explore the wide variety of foreign direct investment opportunities in the United States. In my opinion, American companies are more interested now in doing business with Chinese companies than at any time in the past. While there are risks for investors, savvy business owners and their lawyers can manage those risks with careful planning, and the strong potential for profit typically outweighs the risks.
Dennis Unkovic is a partner at Pittsburgh-based law firm Meyer, Unkovic & Scott and has more than thirty years of experience as an international transactional attorney. He has authored seven books, edited or contributed to four other books, and written more than 165 articles. He frequently is invited to speak to business groups across the globe, and has given presentations in more than 38 countries. Dennis graduated with distinction from the University of Virginia with a bachelor of arts degree, and earned his juris doctor from the University of Pittsburgh School of Law.