Since June 2015, China’s regulations on how foreign investors can do business in its E-Commerce sector has gone through a significant liberalization. Both the Ministry of Industry and Information Technology (MIIT) and the State Council have promulgated two important publications, formulating new rules for the implementation of foreign investment in the E-Commerce market in China.
A Series of Ground Breaking Reforms
Reform on foreign investment through the State Council Guidance: the “Opinions”
The Opinions, issued in January 2015, explain the new Chinese Investment Law and includes the Guidance on Promoting the Healthy and Rapid Development of Cross-border E-commerce. Through these policies, the State council aims to develop cross-border e-commerce and create global brands among Chinese E-commerce companies. On one hand, the Opinions call for the facilitation of custom procedures, implementing favorable import and export tax policies, introducing credit insurance services and launching pilot programs to reform overseas payment regulations. On the other hand, it states a will to see the establishment of new logistics distribution networks and warehouses, which are crucial in supporting the Chinese E-commerce activity.
The MIIT Circular in effect: the E-Commerce sector open to full foreign ownership
A pilot program was launched in January 2015 and new foreign investment regulations were implemented within the Shanghai FTZ. Since June 19th 2015, Circular 196 or the Notice on Opening up the Limitation on Foreign Ownership in Online Data Processing and Transaction Processing Services (or OTPs) lifted with immediate effect restrictions on foreign investment nationwide, allowing full foreign ownership of companies in this sector all over China.
Why does it matter?
Historical Background: China’s protective policies against foreign investments
The Foreign Investment Catalogue provided by the Chinese Government lists each sector that is restricted to Foreign Investment. These sectors are open only through a partnership with a Chinese company, referred to as a Joint Venture (JV). The telecommunication sector fell under that title for years, and China has always monitored it closely, with foreign ownership restricted to 50%. Moreover, to do business in the E-commerce sector, a JV needed a Value-Added Telecommunication Services (VATs) license delivered by the MIIT. It was quite difficult for a JV to obtain these VATs Permits even though they were entitled to apply for them.
Breakthrough for Foreign ownership of e-commerce business
The Circular 196 concerns only OTPs which include banking services, share trading services, ticketing sales services, commodity auctioning services and payment services. Even though full ownership of a OTPs company is now possible, the foreign investors still need a VATs Permit. To open an E-Commerce company they also have to prove an expertise in the sector, as well as be active and successful in this sector outside of China. When selling third-party products through an online platform, OTPs companies fall under the Information Services Business category because their website is making direct profit. In this case, they need an Internet Content Provider Permit (ICP Permit) rather than a VATs Permit. To know exactly which category your company falls into, you should get in touch with the MIIT authorities and go through the technicalities of your operations. This determination can also vary according to location.
The end for Variable Interest Entity structures (VIE)
VIE structures are used by foreign investors to get around investment restrictions. How? A Wholly-Foreign Owned Enterprise (a WFOE) operating in an encouraged or permitted sector effectively controls a Chinese Owned Enterprise (COE) through an elaborate series of contracts and have ways to extract profit from that business. Usually the WFOE, instead of a direct investment, will lend some money to the COE. The Chinese government seems to have decided to act against this practice. Through its Opinions, the State Council does not deny the legal validity of the contracts between the two entities but considers new definitions of what foreign companies and foreign investments are. This new definition states that any COE effectively controlled by a WFOE will be treated as a foreign entity and the same restrictions will naturally apply to them. Using a VIE structure as an investment vehicle in China is no longer possible and foreign investors in E-Commerce using VIE have to either stop their operations in China or open a WFOE.
It is still a challenge for foreign investors to enter the Telecommunication and Internet market in China, especially in the E-Commerce market with giants like Alibaba (in Chinese 阿里巴巴) and JD (in Chinese 京东), we can take NetEase as an example. This foreign gaming and Internet Company launched a website called Kaola.com, and though they are only accounting for a small portion of e-commerce spending in China, they still make significant profit through cross-border E-Commerce. They are positioned in the fast-growing segment of selling foreign products to Chinese customers. This segment is said to be worth 6.5 trillion RMB ($1.02 trillion) by 2016, with a gross rate of 20% according to official figures. Chinese tourists are known to go abroad in countries like South Korea and Japan mainly for shopping purposes. Kaola announced their partnership with a Japanese brand for home appliances; a popular brand which Chinese tourists bring back from Japan.
China will remain a difficult market to enter, but the State Council and MIIT announcements are a real breakthrough and an opportunity worth considering.
- INS Global Consulting
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— Daxue Consulting (@DaxueConsulting) August 28, 2015