Over the past several years the market for selling goods online in China has grown dramatically and China is now one of the world’s biggest markets for online sales. For example, Taobao Co. Ltd. held a promotional campaign called “Double Eleven” on November 11, 2014 during which sales in the first 39 minutes of the promotion exceeded RMB 10 billion. There can be little doubt that the Chinese market for online sales is enormous; however when companies such as Alibaba, JD and other e-Business companies raise funds by listing, they do so overseas. One of the primary reasons for this is that foreign investment is, to some extent, restricted in the field of telecommunications (under which online sales falls). Thus, online sales are subject to strict supervision from the government.
This paper begins with a brief overview of the supervisory procedures related to foreign investment in online sales. Afterwards, it will distinguish different categories of online sales and the supervision and restrictions of each category.
1. Categories of Telecommunications Services and Supervisory System Involved With Each
As per the Catalog of Classification of Telecommunication Services (电信业务分类目录), telecommunications are broken down into two broad categories: “basic telecommunication services” and “value-added telecommunication services.” Value-added telecommunication services refer to the telecommunication services provided via the public telecommunication network. Value-added telecommunication services are further broken down into the “first category” and the “second category.” Foreign investment in the first category is always subject to approval. Foreign investment in the second category is also generally subject to approval but there are exceptions where such investment is subject only to record-filing.
Online sales fall into the second category and further fall into the “information services” sub-category. Once again, this sub-category can be further broken down into two categories: “business activities” and “non-business activities.” If the online sales are classified as a business activity then a “license for telecommunication operations” (category B2) must be obtained from the relevant entity. However, if it is classified as non-business activity then the investment need only be filed for the record as an internet content provider (ICP) with the relevant telecommunication supervision department. The next section will discuss business and non-business activities.
The following figure shows the breakdown of categories just described:
2. Different Categories of Selling and the Corresponding Approval or Record-Filing Needed
Foreign investment in online selling generally falls into one of three categories: (1) an enterprise selling its own products online; (2) an enterprise selling other products online; (3) providing an online trading platform for third parties.
(1) An Enterprise Selling Its Own Products Online
Gap and Zara fall into this category.
If the foreign enterprise sells its own goods online and does not charge except for online sales (including shipping fees) this service would be categorized as “non-business information services” and would only need to file as an ICP with the administrative bureau of the telecommunications in the province, autonomous region or municipality where it is located.
(2) An Enterprise Selling Other Products Online
JD, YHD and Newegg fall into this category.
As with the category above, these businesses only charge for products sold online (including shipping fees). These enterprises, however, do not have their own brand of products to sell. Just as with the previous category, this service would be categorized as “non-business information services” and would only need to file as an ICP with the administrative bureau of the telecommunications in the province, autonomous region or municipality where it is located.
(3) Providing an Online Trading Platform for Third Parties
Taobao and Amazon fall into this category.
These companies provide three related services: (1) information services for buyers; and (2) an online trading platform for buyers and sellers; and (3) transaction processing. If these services generate profits directly (e.g. transaction fees, recommendation fees, ranking fees) or indirectly (e.g. advertisements or some other means) then they are categorized as business information services and must file for approval and obtain a license category B2.
In practice it is quite difficult for foreign invested enterprises to obtain a B2 license. Although some companies, such as Amazon, were able to do so earlier, these licenses have become harder to obtain.
3. Other Requirements for Foreign Investment in Online Sales
In order to receive the necessary approval or complete the required record-filing, foreign investors should comply with several other requirements as well.
(1) Proportion of Capital Contributions
The proportion of capital contributions by the foreign investor(s) in value-added telecommunication services (including radio paging business as part of its basic telecommunications services) shall not be more than 50% of the total registered capital (i.e. there must be Chinese parties that own at least 50%).
(2) Good Track Record
The major foreign investor in value-added telecommunications services must have a good track record in the performance and operating experience in managing value-added telecommunications business.
(3) Minimum Registered Capital
The minimum registered capital for any enterprise that provides value-added telecommunications services within a province, autonomous region or municipality directly under the central government shall be RMB 1 million. The minimum registered capital for any enterprise that provides value-added telecommunications services throughout the country or across different provinces, autonomous regions or municipalities directly under the central government shall be RMB 10 million.
(4) Leasing of the License is Prohibited
There are strict restrictions as to who can operate a value-add telecommunications services. According to the Circular of the Ministry of Information Industry on Strengthening the Administration of Foreign Investment in Value-added Telecommunications Services (关于加强外商投资经营增值电信业务管理的通知) the operator of a value-add website must have received approval to operate such a business and the type of business must be within the scope of the business purpose of the enterprise.
As discussed above, it is generally quite difficult for foreign invested enterprises to obtain a B2 license, a necessary element of the approval to run a value-add telecommunications service. As such, it is generally not possible for an enterprise that has a B2 license to lease it to a foreign invested enterprise.
4. Special Policies of the China (Shanghai) Pilot Free Trade Zone for Online Selling
Inside the China (Shanghai) Pilot Free Trade Zone (“Pilot Zone”), regulations on telecommunications are more flexible than in the rest of the country.
(1) Relaxed Requirements on the Proportion of Registered Capital
For businesses that are only app stores the proportion of the registered capital that can be foreign capital can be higher than 50%, presumably as high as 100%. However, for businesses that engage in data or transaction handling (i.e. e-commerce) the proportion of foreign capital cannot exceed 55%.
(2) Lower Minimum Registered Capital Requirements
The minimum registered capital requirement for all such enterprises is RMB 1 million.
(3) Simplified Procedure for Examination and Approval
In most of the country, the approval procedure requires three obtaining certificates and generally takes about five months. First, an “Examination Decision on Foreign Investment in Telecommunications” (外商投资经营电信业务审定意见书) must be issued to the enterprise by relevant telecommunications administration department. Secondly, once this examination decision has been reached, the enterprise should apply for a “Certificate of Approval for Establishment of Foreign Investment Enterprises” (外商投资批准证书) Finally, the enterprise should obtain a “Licenses of Value-added Telecommunication Business” (增值电信业务经营许可证) from the relevant telecommunications administration department.
However, in the Shanghai Free Trade Zone only the “Reply of China (Shanghai) Pilot Free Trade Zone to the Pilot Operation of Value-added Telecommunications Business by Foreign Investment” (中国（上海）自由贸易试验区外商投资经营增值电信业务试点批复) is needed and, as such, the approval time is shortened to about two months.
Over the past few years, online enterprises have begun to look for offshore financing. In theory, if the relevant conditions are satisfied a foreign investor can invest in a Chinese telecommunications enterprise; however in practice few foreign investors have been approved. In addition, the Provisions on the Merger and Acquisition of Domestic Enterprises by Foreign Investors (关于外国投资者并购境内企业的规定) impose several restrictions on foreign investors. As such, many investors have turned to the Variable Interest Entity (VIE) structure as a way to avoid the above mentioned restrictions.
The VIE structure was created in order to evade relevant restrictions and, as such, might come under stricter scrutiny and further restrictions in the future. Thus, investors should carefully weigh the risks and rewards and exercise care in ensuring their business follows the letter of the law.