Further Signs of Liberalization for E-commerce in the Shanghai Free Trade Zone

By Rainy Yao and Steven Elsinga 

SHANGHAI – Foreign investors looking to enter China’s lucrative e-commerce market are now allowed to set up wholly foreign-owned e-commerce companies on a pilot basis in the Shanghai Free Trade Zone (FTZ), according to an announcement released by the Ministry of Industry and Information Technology (MIIT) on January 13.

According to the announcement, foreign investors engaging in online data processing and transaction processing (for-profit e-commerce) businesses may control 100 percent of the shares, meaning that they are now allowed to set up a wholly foreign-owned enterprise to conduct such activities. Previously, foreign shareholding in online data and transaction processing businesses was limited to 55 percent in the Shanghai FTZ and 50 percent in other parts of China.

Online data processing and transaction processing services are defined as services provided for users through communication networks, by means of various kinds of data and transaction processing application platforms connected with the communication networks (i.e., transaction processing services, electronic data interchange services and network/electronic equipment data processing services). Transaction processing services include banking, stock trading, tickets sales, and payment.

In China, telecom services are classified into two categories: value-added telecom services (VATS) and basic telecom services. Basic telecom services are services like fixed and mobile telephone, wireless internet, mobile internet etc. Value-added telecom services are ones that use basic telecom networks to provide services.

Online data processing and transaction processing business is a type of value-added telecom services. Other value-added telecom services include:

• Domestic multiparty communication services (such as conference or group calls)
• Domestic internet protocol virtual private network services (VPN)
• Internet data center services
• Storage and forwarding services
• Call center services
• Internet access services
• Information services

Of these, call centers, domestic multiparty communication and internet access services are fully open to foreign investment in the Shanghai FTZ. Foreign shareholding in companies offering VPN services may not exceed 50 percent. 

 RELATED: Trends in China’s E-Commerce Market

Companies seeking to provide value-added services need to apply to the MIIT for the value-added telecom services permit (VATS Permit). Apart from the foreign equity restrictions, a JV looking to offer value-added services are required to have a minimum registered capital of RMB 1 million if servicing one province, and RMB 10 million for cross-province services.  

While on paper, foreign parties are allowed to invest these sectors by setting up a joint venture with a Chinese partner, in practice less than thirty have been granted one. These include major foreign multinationals like Microsoft and Amazon. Apart from these, the majority of licenses are given to fully domestic companies. 

Some investors have been able to circumvent this problem by using a so-called Variable Interest Entity or VIE. A VIE is a completely Chinese owned company, with all the capital provided by Chinese nationals, all the directors are Chinese etc. The funds to set up the company are lent to these Chinese nationals by a WFOE (a wholly foreign owned enterprise) set up by the foreign investors. The Chinese nationals and the Chinese ‘domestic’ company then sign contracts in which they grant all the rights related to the running the ‘domestic’ company to the WFOE. They also sign contracts to that the money out of the ‘domestic’ company to the WFOE.

In this way, the VIE looks like a fully Chinese company on paper, but is controlled through these contracts by the foreign investors. This set up has two major risks. The Chinese government has appeared to tolerate this practice for now, even though it is essentially a trick to get around Chinese laws and policies. The government may at any time crack down on this practice.

 RELATED: Establishing a Company in the Shanghai FTZ

Also, the only thing that keeps the foreign investors in control of the ‘domestic’ company are the contracts signed between the WFOE and the Chinese nationals. If for whatever reason they refuse to abide by the contract, it will be hard to enforce them. Chinese courts aren’t likely to enforce contracts that exist specifically to circumvent Chinese laws and regulations.

That said, these latest developments show that the value-added telecom sector in China is gradually opening up to foreign participation. With the lifting of restrictions on data and transaction processing, the door to foreign investors has opened just a little more. 

Revisiting the Shanghai Free Trade Zone: A Year of Reforms
In this issue of China Briefing, we revisit the Shanghai FTZ and its preferential environment for foreign investment. In the first three articles, we highlight the many changes that have been introduced in the Zone’s first year of operations, including the 2014 Revised Negative List, as well as new measures relating to alternative dispute resolution, cash pooling, and logistics. Lastly, we include a case study of a foreign company successfully utilizing the Shanghai FTZ to access the Outbound Tourism Industry.

Industry Specific Licenses and Certifications in China
In this issue of China Briefing, we provide an overview of the licensing schemes for industrial products; food production, distribution and catering services; and advertising. We also introduce two important types of certification in China: the CCC and the China Energy Label (CEL). This issue will provide you with an understanding of the requirements for selling your products or services in China.

Guide to the Shanghai Free Trade Zone
In this issue of China Briefing, we introduce the simplified company establishment procedure unique to the zone and the loosening of capital requirements to be applied nation wide this March. Further, we cover the requirements for setting up a business in the medical, e-commerce, value-added telecommunications, shipping, and banking & finance industries in the zone. We hope this will help you better gauge opportunities in the zone for your particular business.

• Previous Article China’s Trade With Eastern Europe and the Caucausus
• Next Article Lavorare in Cina: I Nuovi Regolamenti in Materia di Visti