FOREIGN INVESTMENT AND OPERATION IN
CHINA: OPTIMIZE YOUR DISTRIBUTION
MODELS AND STRUCTURES
DLA Piper China Investment Services
September 2014
Agenda
 Introduction
 Selling into China Through E-commerce
 Selling into China: Business Models and Issues
 Selling into China Through E-commerce: Legal Entity Structuring
2
Selling into China
Through E-commerce
DLA Piper China Investment Services
Daniel Chan, Partner, Hong Kong
September 2014
1. E-commerce in China –
Possible Business Models
Selling into China through e-commerce
Why e-commerce? Why China?
 Rise of Chinese consumers' purchasing power  increasing China's
GDP
 Geographic spread / diversity of Chinese population
 Anti-bribery campaign  wealth spread out more evenly
 Buying habits / patterns of young generations of Chinese consumers
 Rising costs of real estate / lease in major Chinese cities
5
Selling into China through e-commerce
What is possible?
1. Possible business models for selling products and services into China
through e-commerce
A) Sale of products
Model I: Selling through non-Chinese website without registering Chinese company
a)
domestic sourced goods
b)
imported goods
Model II: Non-Chinese company selling through 3rd-party Chinese e-commerce platform
Model III: Establishing a Chinese wholesale / online retail company
Model IV: Selling through Free Trade Zone e-commerce platform
B) Sale of services, apps, software, etc.
Other online “information services" for which a value added telecom (VAT) license
would be required
2.Consumer protection in China
3.Evolution of wholesale/ retail structure in China
6
Possible business models for products – model I
A) Sale of products
Model I: non-Chinese website / no Chinese subsidiaries
a) Domestically sourced goods - drop shipment from manufacturer (OEM)
Title Transfer
Foreign Seller
Physical Delivery
Online Payment
Provider
(e.g. Alipay, Unionpay, or
FX: Visa, Master, Paypal)
$?
OEM
 Drop shipment problematic
 OEM will have problems receiving foreign exchange (forex or FX) from foreign
seller (no export document)
 Consumer will be issued invoices from OEM
7
Possible business models for products – model I
Model I: non-Chinese website / no Chinese subsidiaries
a) Domestically sourced goods - use of Chinese trading company
Title Transfer
Foreign Seller
Physical Delivery
Online Payment
Provider
(Alipay, Unionpay, or
FX: Visa, Master, Paypal)
$?
Trading Agent
OEM
 Use of PRC trading agent equally problematic
 Forex remittance of costs of goods to trading agent problematic (no export
documents)
 Invoices to consumer by trading agent, not foreign seller
8
Possible business models for products – model I
Model I: non-Chinese website / no Chinese subsidiaries
Title Transfer
b) Import sales
OEM
Foreign Seller
Physical
Delivery
Bonded
Zone / HK
OEM
Logistic Company
(FedEx, DHL,
Zhongtong (中通)，
Shentong (申通))
Implementation costs:
 Logistic cost / delay
 Administrative cost / customs clearance
 Duty cost (retail price as dutiable value)
 Return / refund policies complicated with overseas sales
 Consolidation / u-turn in bonded zone / HK improves delivery time (and customer satisfaction)
9
Possible business models for products – model I
Model I: non-Chinese website / no Chinese subsidiaries
b) Import sales
Title Transfer
OEM
Foreign Seller
Physical
Delivery
Bonded
Zone/HK
Online Payment
Provider
(Alipay, Unionpay, or
FX: Visa, Master, Paypal)
OEM
Logistic Company
(FedEx, DHL,
Zhongtong (中通)，
Shentong (申通))
Use of online payment provider
 e.g. Alipay, Unionpay are the Chinese versions of PayPal
 Approved Sep 2013 to conduct cross border online payment service (RMB
FX and vice versa)
 Settlements remitted directly to international bank accounts
 e.g. Alipay transaction caps: US$10,000 for trade of goods; US$50,000 for overseas study, hotel,
airplane tickets
10
Possible business models for products – model I
Model I: Non-Chinese website / no Chinese subsidiaries
Consumer setting up an Alipay account: procedures
General process:
1) Connect bank account to Alipay account using bank number
2) For every transaction, enter name and delivery address
3) Enter Alipay account number (bank account number not necessary)
Alipay popular services:
1) 快捷支付 Quick payment
 Pay with accepted debit or credit card linked to Alipay account
2) 余额宝 Yu E Bao
 Pay with money previously deposited into Alipay account
Settlement banks:
11
Possible business models for products – model II
Model II: Non-Chinese company selling through 3rd-party Chinese e-commerce
platforms
Market Share of Chinese B2C E-commerce Platforms
天猫
京东
QQ网购
苏宁
亚马逊
唯品会
国美在线
当当网
一号店
凡客诚品
12
Possible business models for products – model II
Model II: non-Chinese company selling through 3rd-party Chinese e-commerce
platforms
13
Possible business models for products – model II
Model II: non-Chinese company selling through 3rd-party Chinese e-commerce
platforms
Top 10 by Market Share and their Key Product Category
1.
Clothes
2.
Electronics
3.
Electronics
4.
Electronic Appliances
5.
Books
6.
Books
7.
Clothes
8.
Electronic Appliances
9.
Groceries
10.
Clothes
Source：enfodesk
14
Possible business models for products – model II
Model II: non-Chinese company selling through 3rd-party Chinese e-commerce
platforms
Jd.com
"We currently do not cooperate with foreign suppliers"
Tmall.com
"There must be a business entity located in Mainland China holding
a Chinese retail business license"
Currently, for a non-Chinese company to engage a 3rd party
Chinese e-commerce platform, the non-Chinese
company must set up a Chinese company (but please
see the next slide)
15
Possible business models for products – model II
Model II: Non-Chinese Company selling through 3rd Party Chinese E-commerce
Platforms
Tmall Global (tmall.hk (天猫))





Non-Chinese companies can engage Tmall
Global to conduct sales in China without
setting up a Chinese company
Orders can be fulfilled and shipped from
outside China, and payments settled in
preferred native currency
All products need to have relevant trademark
registrations in Hong Kong
Companies are required to provide a Chinabased product return arrangement
Import and remittance procedures similar to
import sales (slides 7-8)
Import sales still suffer from logistics costs /
delays
16
Possible business models for products – model III
Model III: establishing a wholesale / online retail company in China
Setting up a Foreign Invested Commercial Enterprise (FICE) in the form of a
Wholly Foreign Owned Enterprise (WFOE, i.e. 100% owned subsidiary of a
non-Chinese parent)
OEM
Title
Transfer
Physical
Delivery
Foreign Seller
100%
Own Retail
Website
or
Wholesale /
Online Retail WFOE
OEM
contract
3rd Party E-commerce
Platform
RMB
17
Possible business models for products – model III
Model III: establishing a wholesale / online retail company in China
a) Business scope

NOTE: Under relevant Chinese laws, a FICE with a business scope of "wholesale"
should be sufficient to operate online retail business, but some cities like Shenzhen
disagree
Business Scope
Pre-packaged food (microwave,
refrigerated) and food products, drinks,
flavor additives (excluding salt and sugar),
uniforms, kitchen tools, plastic products,
metal products, paper products, display
shelves and counters, daily goods, internet
retail (excluding food), imports exports,
commission agents (excluding auction),
providing relevant consulting services
(does not involve goods leaving country,
involves quotas, licensed products,
relevant application by country)
b) Equity investment

No legal requirement according to new Company Law; however, the establishment of all
foreign invested enterprises (FIE, like WFOEs) requires approvals, and the local
approval authorities normally would impose certain minimum equity requirement
18
Possible business models for products – model III
Model III: establishing a wholesale / online retail company in China
I.
Setting up own website
a) Domain name
i.
Check to see if domain is available or for sale / auction
ii.
Register domain with China Internet Network Information Center (CNNIC organization that controls all Chinese domains (.cn))
iii. (.com) not registered with CNNIC, but if server and operator is in China, a recordal with the
Ministry of Industry of Information Technology (MIIT) needs to be done (see part b)
b) Recordal with MIIT
i.
Recordal with CNNIC to link website with owner and business
ii.
Hosting agency (usually 3rd party) and IP addresses regulated by MIIT
c) Online payment service
i.
Need a value-added telecommunications services (VATS) license
ii.
Usually use 3rd party service: Alipay, Unionpay
d) Social media networking
i.
E.g. WeChat and Sina Weibo are the most popular for businesses
ii.
Some also develop their own apps for consumers' convenience
19
Possible business models for products – model III
Model III: establishing a wholesale / online retail company in China
II.
Engage 3rd-party e-commerce platform
How to set up a store on Tmall?
Step 1: Apply for a new
Alipay account (for Tmall
only)
Step 1: Record and
submit information to
Tmall
Step 2: While waiting 37 business days can
start to configure Tmall
shop
Step 2: Select name
and domain name, and
sign online service
agreement
Wait 7 days for Tmall to
get back to you
Step 1: Sign Alipay
witholding agreement
and other business files
Step 2: Pay annual fee
Step 3: Sell your
products
20
Possible business models for products – model IV
Model IV: Sales through free trade zone e-commerce platform
OEM
Foreign Seller
Title Transfer
FX
Physical Delivery
Free Trade Zone
Online
Payment
Provider
RMB
E-Commerce
Platform
Cash / Payment
bonded
Warehouse
OEM
Customs
declaration
Order
Goods remain
in bonded
status
a) Foreign seller to contract with Chinese e-commerce platform registered in a Free Trade
Zone (currently only Kua Jing Tong in Shanghai Free Trade Zone), which is specifically
allowed to contract with foreign sellers.
b) Goods may (i) be stored in a bonded warehouse inside the Free Trade Zone before
distribution, or (ii) be directly shipped to China customers from overseas
c) E-commerce platform undertakes “consolidated custom declaration" for importation
d) On-line payment provider collects RMB payment from customers and pays FX to foreign
seller
21
Possible business models for products – model IV
a) Kua Jing Tong (www.kuajingtong.com)
 The first cross-border B2C e-commerce enterprise granted by Chinese government
 A platform registered in Shanghai PFTZ and supported by Shanghai customs, Shanghai
CIQ and SAFE
 EasiPay as the on-line payment service provider, also with government investment
 Amazon and Yi Hao Dian have signed up with Shanghai PFTZ
 More FTZ e-commerce platforms expected
b) Special customs procedure under new custom regulation
 E-commerce platform, FTZ warehouse operators, payment service provider and logistics
service providers are connected to China customs' E-port system, and required to submit
transaction data
 E-commerce platform and its agents should undertake to complete customs declaration
procedure and withhold / pay off customs duty by cooperation with payment service
provider
 Goods can be released to customers based on check list, while customs declaration can
be conducted on consolidated and monthly basis
 Goods will be deemed as articles purchased by individual for assessment of custom duty,
rather than merchandizes imported for business, and the custom duty rate generally will
be lower
22
Possible business models for services, apps,
software, etc.
B) Sale of services, apps, software, etc. (i.e. non-trade items)
Foreign Service Provider
Online Payment
Provider
(Alipay, Unionpay,
Visa, Master, Paypal)
Online
purchases of
services, apps,
and software
(limits on
type and
amount of
transaction)
23
Possible business models for services, apps,
software, etc.
 Under relevant Chinese laws, certain service offerings such as the
following require special operating licenses issued by MIIT
(e.g. VATS license)
a) Information services
 e.g., app store, online advertising, online games
b)
Store and forward services
 e.g. email
c) On-line data processing and transaction processing services
 e.g. e-commerce
d)
Domestic multi-party communications services
 e.g. video-conference and Internet conference
e)
Internet data center services
 e.g. server leasing or hosting
f)
Call center services
24
Possible business models for services, apps,
software, etc.

Service offerings such as the above would trigger VATS license
requirements; there are generally 2 main issues in this regard:
a)
b)


Difficulty of getting a VATS license if applicant is FIE
Restriction on foreign ownership on application (mostly 50% cap on
foreign ownership, with some exceptions)
Current Chinese law is not clear whether the above requirements apply
to non-Chinese websites selling into China
From our practical experience, in some locations in China, government
officials interpret the above based on the following factors:
a)
b)
Operator is in China? or
Server is in China?
25
Possible business models for services, apps, software
etc.

Common business models to overcome the above issues:
Variable interest entity (VIE) models
Foreign Service Provider
Nominees
(profits stripping)
service fee
WFOE
LLC
VATS License
management consultancy
service / license
(management control
document)
26
Possible business models for services, apps,
software, etc.
 Other issues if operating a non-Chinese website only
1. Tax

Whether foreign seller establishes a permanent establishment
(PE) in China
2. Duties
3. Sensitive contents

State secrets, politically sensitive content, etc.

Chinese authorities can block access to non-Chinese websites
from China if there are issues
27
2. Consumer Protection in China
Consumer protection - overview
 Consumer protection in e-commerce in China is still relatively new,
given the e-commerce market growth in scale and in complexity,
Chinese government has been paying increasing attention
consumer protection and transparency and strengthening
supervision against unlawful behaviors on the Internet
but
the
on
its
 Key legislations:
1.
2.
3.
4.
5.
Consumer Protection Law (Revised in 2013)
E-commerce Law (2014)
Anti-Unfair Competition Law (1993)
Anti-Monopoly Law (2008)
Advertising Law (1995)
 Consumer protection provisions might be repeated in multiple pieces
of laws, rules and regulations, as applicable
29
1. Consumer Protection Law
 Law of the People's Republic of China on the Protection of Consumer
Rights and Interests (Revised in 2013) promulgated by the Standing
Committee of the National People's Congress and taking effect since
15 March 2014
 First major overhaul to Chinese consumer protection law in 2
decades
Source：technode.com
30
1. Consumer Protection Law
 Salient points re e-commerce
 Online purchases: consumers shall have the right to return goods within 7
days upon receipt of such goods (with exceptions) without giving any reason
 Returned goods shall be in good condition
 Seller to return payments within 7 days
 Online sellers shall provide consumers with information such as business
address, contact number, product quantity/price, etc.
 Personal data collection / use: business operators shall expressly provide for
the purpose, way and scope of the information to be collected / used, obtain
consumers' consent, and keep personal data confidential
 Consumers whose rights are infringed shall have the right to seek
compensation from the sellers / service providers; where online trading
platforms fail to provide the real identity of the sellers / service providers;
consumers may seek compensations from such online trading platforms
31
2. E-commerce Law
 Administrative Measures for Online Trading promulgated by the State
Administration for Industry and Commerce and taking effect since 15
March 2014
 Salient points
 Online business operators shall observe the Consumer Protection Law and
shall not infringe on the consumers' legitimate rights and interests
 During their course of business, online business operators shall state
information such as business address, contact details, product quantity /
service quality, price / fees, payment method, return and replacement policy,
safety precautions, risk warnings, after-sale services etc., and shall take
safety measures to ensure that transactions are safe and reliable and
provide goods or services as promised
 Information on goods or services provided shall be authentic and accurate no false promotion or expression shall be made
32
2. E-commerce Law
 Salient points (cont'd)
 Returns of goods without reason within 7 days (see slide 29)
 Information collected, whether consumer personal data or trade secrets of
operators, shall be kept strictly confidential
 Online business operators shall not engage in the following unfair
competition acts by using online technical means or carriers:
1. to use, without authorization, the same or similar domain name, name or
logo of a well-known website so as to cause misrecognition by
consumers
2. to use or forge, without authorization, electronic logos of governmental
departments or social organizations to conduct misleading and false
promotion
3. to make lottery sales with virtual items as the prizes (the agreed amount
of such virtual items in online market exceeds the limit allowed by the
laws and regulations)
33
2. E-commerce Law
 Salient points (cont'd)
4. to improve the business reputation for themselves or others by fictitious
transactions, deleting unfavorable evaluation or other means
5. to harm competitors' business reputation by malicious evaluation
contrary to the facts after a transaction
6. other unfair competition acts as provided by laws and regulations
 Online 3rd-party trading platforms shall take necessary measures to protect the
exclusive rights to use registered trademarks, enterprise name rights and other
rights
34
3. Anti-Unfair Competition Law
 Anti-Unfair Competition Law of the People's Republic of China
promulgated by the Standing Committee of National People's Congress
and taking effect since 1 December 1993
 Salient points
 Businesses shall not use advertisements or other means to falsely or
misleadingly promote their products regarding their quality, ingredients,
manufacturer, useful life, place of origin etc.
 Businesses shall not sell their goods below cost so as to exclude their
competitors
 Businesses shall not make tie-in sale against the wishes of consumers, or
attach other unreasonable conditions to a sale
 Businesses shall not fabricate stories in order to damage the goodwill of their
competitors’ products or their business reputation
 Please refer to unfair competition acts under E-commerce Law (slides 31-32)
35
4. Anti-Monopoly Law
 Anti-Monopoly Law of the People's Republic of China promulgated by the
Standing Committee of the National People's Congress and taking effect
since 1 January 2008 (AML)
 Salient points
 "Monopolistic practices" include:
1.
2.
3.
the conclusion of monopoly agreements between operators
the abuse of dominant market position by operators
concentration of operators which has or may have the effect of eliminating or
restricting market competition
 "Monopoly agreements" include those on:
1.
2.
3.
4.
5.
6.
fixing or changing prices of goods
limiting production or sales volume of goods
dividing a sales market or sourcing market of raw materials
restricting purchases of new technology or new equipment or preventing the
development thereof
boycotting trading
other monopolistic practices as determined by government enforcement
agencies
36
4. Anti-Monopoly Law
 Price fixing
 Business operators are prohibited from concluding the following monopoly
agreements with their trading counterparts:
1.
2.
3.
fixing the prices for resale to a third party
restricting the minimum prices for resale to a third party; and
other monopoly agreements as confirmed by government enforcement authorities
 What about a minimum advertised price (MAP)?

AML is not clear on whether the fix or restriction of the advertised price falls within
the fix or restriction of the resale price; however, a general view is that such fix or
restriction is permissible as long as it does not substantially affect the resellers'
right to sell the products at the price they choose independently
 But what about a manufacturer suggested retail price (MSRP)?
 Each case needs to be considered on its own merits
37
5. Advertising Law
 Advertising Law of the People's Republic of China promulgated by the
Standing Committee of the National People's Congress and taking
effect since 1 February 1995
 Salient points
 Advertisements shall not contain any false information and shall not deceive
or mislead consumers
 Where an advertisement involves patented products or patented methods,
the patent number and patent category shall be clearly indicated
 Advertisements shall not include any content denigrating the goods or
services of other businesses
 Advertising companies, advertising agents and advertising publishers shall
not engage in any form of unfair competition in the course of carrying out
advertising activities
38
3. Evolution of Wholesale/
Retail Structures in China
Evolution of wholesale / retail structures in China
Single FICE Structure
(1) Sourcing or Sourcing + W/S Only
tapping into retail
(2) Sourcing + Wholesale (“W/S”)
& Retail Only
Multiple FICEs Structure
(3) 1 Sourcing + W/S FICE
& 1 Retail FICE (with branches)
expanding retail business
(4) 1 Sourcing + W/S FICE &
Multiple Retail FICEs (with branches)
LLC Sub Structure
improved business model
(5) W/S + Retail LLC Subs (with
branches)
40
Scenario 1 - Centralized sourcing +
wholesale structure
 When an MNC expands from pure sourcing operation to include wholesale, for better control / efficiency of
various aspects of the sourcing and wholesale organizations – a centralized sourcing + wholesale entity
with improved risk management can work as follows:
Overseas
IP Owner
3P
Suppliers
Overseas
Parent
3
royalties
Sourcing
Service
Offshore
China
1
goods
RO
W/S + Sourcing
FICE
Sourcing FICE
2
goods
Centralized functions:
- wholesale
- import/export
- sourcing/QC
- shared services (accounting,
treasury, tax, legal, etc.)
- logistics
3P
Suppliers
3rd Party
Resellers
1. FICE sources goods from overseas domestically
2. FICE sells goods to 3rd party resellers
3. FICE pays royalties to overseas IP owner
41
Scenario 2 – Single FICE with sourcing,
wholesale and retail functions
 Adding Retail: Foreign brand wants to undertake direct retailing in China; can expand FICE
to include "retail" in business scope; FICE (with sourcing, wholesale and retail functions) can
set up self owned direct stores, and also could consign goods to department stores under
retail consignment arrangement:Overseas
Supplier
Overseas
IP Owner
Offshore
1
4 retail consignment
Department
Stores
China
5
FICE
(W/S & Retail)
Sale of goods
consignment
Payment of royalties
3
2
Direct
Stores
3rd Party
Resellers
Retail
Branches
Consumer
1.
2.
3.
4.
5.
FICE sources goods from overseas
FICE sells goods to end consumers through its own direct stores
FICE wholesales goods to 3rd party resellers for retail
FICE consigns goods to department stores under retail consignment arrangement (Retail Consignment)
FICE pays royalties to overseas IP owner
42
Scenario 3 – 2-tier structure (separate wholesale +
retail operations / entities)
 2-Tier structure:
 Essentially, a two-tier structure would have the first-tier entity conduct sourcing/wholesale and the
second-tier entity conduct retail
 Retail FICE sells directly in China through its direct stores, and through Retail Consignment
Overseas
IP Owner
Overseas
Supplier
Offshore
1
5
FICE
(Sourcing + W/S)
2
(Retail)
4
2
3rd Party
Resellers
China
FICE
3 retail consignment
Direct
Stores
Department
Stores
Retail
Branches
Consumer
1.
2.
3.
4.
5.
Sourcing + W/S FICE imports goods from overseas
Sourcing + W/S FICE sells goods to Retail FICE and the 3rd party resellers
Retail FICE consigns goods to department stores under retail consignment arrangement
Retail FICE sells goods to end consumers through its direct stores
Retail FICE pays royalties to overseas IP owner
Sale of goods
consignment
Payment of royalties
43
Scenario 4 – 2-tier structure
(multiple retail entities)
 Variation to Scenario 3:
 PRC political reasons – major cities (e.g. Beijing and Shanghai and some local governments) prefer foreign investors to
set up separate retail FICEs (rather than branches)
 Also different brands in the same group might prefer to operate independent retail FICEs
 This two-tier structure under this Scenario 4 will have a first-tier entity to conduct sourcing and wholesale activities and
multiple second-tier retail entities to conduct retail activities
Overseas
IP Owner
Overseas
Supplier
5
5
1
FICE
(Retail)
2
Offshore
FICE
(Sourcing + W/S)
China
FICE
(Retail)
2
2
Direct
Stores
Department
Stores
3
3
Direct
Store
4
Department
Stores
3rd Party
Resellers
4
Consumer
3
1.
2.
3.
4.
5.
Sourcing + W/S FICE imports goods from overseas
Sourcing + W/S FICE sells goods to each retail FICE and the 3rd party resellers
Retail FICEs sell goods to end consumers through direct branches
Retail FICEs also consign goods to department stores (Retail Consignment)
Retail FICEs pay royalties to overseas IP owner
3
Sale of goods
consignment
Payment of royalties
44
Scenario 5 – Wholesale Consignment Structure
Addressing VAT consolidation restrictions issues: Foreign brand seeks to manage restrictions on VAT
consolication. Under this Scenario 5, Wholesale FICE does not "sell" goods to Retail FICEs but
"consigns" the goods to FICE's HQ and to each direct store (sales branches of the retail FICEs) at
"wholesale" price (wholesale consignment). In addition the retail FICE HQ consigns the goods to the
department stores directly at "retail minus" prices (retail consignment)
Overseas
IP Owner
Overseas
Supplier
6
3
FICE
(Retail)
4
3
Direct
Stores
1
FICE
(Sourcing + W/S)
2
3rd Party
Resellers
Offshore
5
3
China
FICE
(Retail)
4
Direct
Store
3
Department
Stores
Department
Stores
Consumer
1. Sourcing + W/S FICE imports goods from overseas
2. Sourcing + W/S FICE sells goods to the 3rd party resellers
3. Sourcing + W/S FICE consigns goods to Retail FICEs (Wholesale Consignment) for further consignment to
department stores (Retail Consignment.) (back-to-back consignment arrangements)
4. Sourcing + W/S FICE consigns goods to direct stores (Wholesale Consignment)
5. Retail FICEs pay royalties to overseas IP owner
Sale of goods
consignment
Payment of royalties
45
Scenario 6 – LLC sub structure
(further refinement to scenario 5)
 Alternative Structure (Further refinement to 2-Tier Structure): Foreign brand may set up separate retail entities in the
form of limited liability companies under Sourcing / Wholesale FICE (LLC Subs basically Chinese owned LLCs – in this
case owned by Sourcing + W/S FICE). The LLC Sub each sets up its own direct stores in the form of branches
 This structure allows certain consolidation of cash flow and operational results, given LLC Subs are limited risk retailers
Overseas
Supplier
Overseas
IP Owner
1
5
FICE
(Sourcing + W/S)
5
3
LLC Sub
(Retail)
3
W/S
consignment
W/S
consignment
3 retail
consignment
Department
Stores
Direct
Stores
1.
2.
3.
4.
5.
2
Offshore
China
LLC Sub
(Retail)
3 retail
consignment
Department
Stores
4 W/S consignment
Sale of goods
consignment
Payment of royalties
Share holding
Direct
Stores
3rd Party
Resellers
W/S FICE imports goods from overseas
Consumer
W/S FICE sells goods to 3rd party resellers
W/S FICE consigns goods to LLC Subs (Wholesale Consignment) which may further consign to department stores (Retail Consignment)
W/S FICE consigns goods to direct stores (Wholesale Consignment)
LLC Subs pay royalties to overseas IP owner
46
Selling into China:
Business Models and Issues
DLA Piper China Investment Services
Daniel Chan, Partner, Hong Kong
Windson Li, Senior Legal and Tax Manager, Hong Kong
September 2014
Contents
I.
Regulations on foreign investment in commercial fields
II. China distribution models and issues
 Scenario 1 – Offshore indent sales
 Scenario 2 – Onshore centralized distribution
 Scenario 3 – Bonded zone centralized distribution
 Scenario 4 – Onshore two-tier structure
 Scenario 5 – Onshore two-tier consignment structure
III. After-sales service models and issues
IV. Prepaid card operation
48
Foreign investment in commercial fields
 Governing regulation
 The Administrative Measures for Foreign Investment in Commercial Fields, Order of the Ministry
of Commerce [2004] No.8
 Covering various foreign invested “commercial activities" in China: commission sales, wholesale,
retail (including retail through TV, telephone, mail, Internet and vending machines), franchising,
auction, etc.
 These on-shore Commercial Activities can only be conducted through foreign invested entities
inside China
 Restriction on special commodities
 Books and magazines, gas stations, automobiles, medicine, fertilizer, refined oils, food, vegetable
oil, sugar, cotton, salt, cigarettes, etc.
 Separate and additional regulation on distribution of certain special commodities (e.g. books and
magazines, medicine, gas, automobile)
 Requiring joint venture and restriction on % of foreign equity interest (medicine, pesticides,
agricultural films, fertilizers, etc.)
 Retail of cigarette, and wholesale of sale and cigarette are prohibited for foreign invested
enterprises
49
Foreign investment in commercial fields
 Separate and additional rules on auction and franchising
 The Administrative Regulations on Commercial Franchising
 The Measures for the Administration of Information Disclosure of Commercial Franchises
 The PRC Auction Law
 Favorable treatment of Hong Kong / Macao investors
 Relaxed restriction in distribution of some special commodities
 Generally applies to
 Set-up of new foreign invested enterprise and
 expansion of existing foreign invested enterprises' business scope
 acquisition of existing Chinese domestic commercial enterprises
50
Scenario 1 – offshore indent sales
 Features
 Sales of industrial equipment, heavy machinery,
industrial electronics and other non-consumer
products
3P Suppliers
Products
 Sales to China subsidiaries of international MNC
customers
 Sales to a small number of customers in some
specific industries / business sectors
 Highlights
 Offshore distributor not directly subject to China
regulations
 Minimum local entrepreneur marketing and sales
activities
 Minimum China establishment and administrative
/ compliance burden
Offshore
Distributor
Sourcing
Service
Import
Offshore
Import
China
Sourcing
Service Co.
3P Wholesalers
Products
Aft.
Sales
Service
China Customers
Products
3P Suppliers
 Unable to control wholesale / retail prices in
China market
 Unable to control and ensure sales and aftersales service quality
 Products from China 3P suppliers have to be
routed thorough offshore or a China logistics park
Goods Title
Service
Affiliates
3rd parties
51
Scenario 1 – offshore indent sales
 Issues
 Customs and foreign exchange procedure
 Customs and foreign exchange compliance burden on China 3P Distributor and customer
 Preferred by customers enjoying special customs duty exemption, which however are
diminishing
 Permanent establishment
 Permanent Establishment risk for overseas distributor, if 3P distributor recognized as an
dependent agent of overseas distributor
 Government procurement
 Potential loss of opportunity in bidding for government procurement projects
 Government procurement rules in favor of "domestic procurement" and/or "domestic products,“
and this trend is expected to be further strengthened
 Logistics
 Lead time for distribution in China
 Others
 No onshore marketing or retail activities
52
Scenario 2 – onshore centralized distribution
Products
Offshore
Entrepreneur
IP Owner
Trademark royalty
3P Suppliers
Offshore
Import
Sourcing Service
3P Wholesalers /
Resellers
Direct
Service
China Customers
Wholesale
Aftersales
Service
China
FICE (Wholesale /
Retail / Sourcing)
Consign
ment
Departme
nt Stores
Deemed
sales
Affiliates
3rd parties
Domestic
procure
ment
FICE
Branch
Stores
Goods Title
Products
3P Suppliers
Service
Royalty
Retail
 Features
 Sales of consumer electronics, fashions, shoes, cosmetics and other consumer products
 Sales to a uncertain number of customers in certain local China market (Beijing / Shanghai /
Guangzhou)
 Distribution of commodities that subject to substantial customs duty
 Business that requires consistent marketing and sales front
 MNCs that would like to have onshore control of distribution channels or set up self-owned stores
53
Scenario 2 – onshore centralized distribution
 Highlights
 Can cover sourcing, wholesale, retail and after-sales service in one legal entity
 to enable centralized management control and improve management efficiency;
 to consolidate tax and legal administration and minimize compliance and maintenance burden;
 Branches need to:
 obtain retail license (i.e. with "retail" in approved business scope) for operating retail stores
(Branch Stores)
 comply with branch tax filing rules
 Can transact with 3rd-party distributors
 sell to 3P distributor (including 3P wholesalers and retailers) in parallel
 Can enter into "Consignment Wholesales Arrangement" with 3P department stores
 Products consigned to 3P department stores for retail
 Wholesale to 3P department stores is recognized and booked upon realization of retail
 Better flexibility to generate "domestic products" for catching government procurement projects
based on domestically sourced products
 May operate in parallel with Scenario 1 – offshore indent sales
54
Scenario 2 – onshore centralized distribution
 Issues
 Custom duty on royalty
 FICE may pay trademark royalty to overseas IP owner based on sales in China
 Royalty payment from FICE to overseas IP owner may be deemed as dutiable, which could
substantially add on the FICE's costs
 Branch tax filing
 Need to comply with branch tax filing rules, and conduct VAT and Enterprise Income Tax filings
for Head Office and every branches
 Value Added Tax (VAT)
 Movement of products among Head Office and Branches in different cities will trigger
“deemed sales" and VAT.
 VAT compliance procedure could be very burdensome and tedious alone the increase of
branch stores
 VAT consolidation only available within the same province and subject to approval of tax
authority (cross-entity reconciliation is possible for recognized chain stores)
 Enterprise Income Tax (EIT)
 Should allocate 50% of overall EIT payable among the Branches based on proportion of each
Branch's sales, assets, and personnel salary expenses
 Require IT system's ability to maintain separate book for Head Office and each Branch, as well
as maintenance of separate P&L and balance sheets
55
Scenario 2 – onshore centralized distribution
 Transfer pricing
Decision has to be made on the characterization of FICE's distribution activity, from an overall point
of view

Full-fledged distributor ?

Import price usually determined based on cost plus or resale minus, relatively stable

Marketing investment and expenses on FICE

Usually fixed royalty fee/rate
 Limitation on profit expatriation

Stripped risk distributor, or distribution service provider?

Import price need to be monitor and frequently adjusted to reflect overseas entrepreneur's
undertaking of market and business risk

Marketing penetration expenses should be passed on the overseas entrepreneur

Profit level of FICE expected to be stable
 Maximize profit expatriation through import price and royalty
 Frequent import price adjustment may lead to customs questioning


Aftersales service (for stripped risk distributor, or distributor service provider)

Separate transfer pricing arrangement, or as part of distribution?

Pricing arrangement for warranty and non-warranty services?
Sourcing service usually requires separate transfer pricing arrangement and justification
56
Scenario 2 – onshore centralized distribution
 Profit expatriation
 Limited channels for profit expatriation: (i) royalty, (ii) IC service, (iii) product / store design
service and (iv) dividends
 Comprehensive and synchronized planning is a must for the following ends to meet each other
 Financial target based on transfer pricing arrangement
 Feasible profit expatriation channels and practical restrictions (such as typical royalty rate
range)
 Accounting cost alignment and business function allocation
 FX control over non-trade transactions have been relaxed, Profit expatriation through non-trade
transactions are still subject to strict review of tax authority (although supposed to be recordal
only by law)
 Political concern
 Local authorities may expect / require set up of entities, rather than branches
 Incentives
 No state level incentive specifically designed for distribution companies under the China tax law
 Local incentives are possible in form of financial subsidy or refund, which are subject to
negotiation during entity set up
57
Scenario 3 – bonded zone centralized distribution
Products
Offshore
Entrepreneur
IP Owner
Trademark royalty
Import
Sourcing
Service
Bonded Zone
3P Wholesalers /
Resellers
Wholesale
(RMB / FX)
Direct Sales
(RMB / FX)
China Customers
3P Suppliers
Transport
sales
Offshore
China
3rd parties
FICE
Consignment
(RMB)
Deemed
Sales
(RMB)
FICE
Branch
Stores
Departme
nt Stores
Affiliates
Domestic
procure
ment
Goods Title
Products
Service
Royalty
3P Suppliers
Retail
 Features
 Often used by MNCs engaged in distribution of equipment or industrial material sourced from
overseas (or from China by way of import/toll processing)
 Preferred by distributors that are sensitive to customs duty and wants to maintain flexibility of
inventory flow among Asia regions
 Preferred by distributors with a mixed China customer group that prefer either RMB (i.e. domestic)
procurement or FX (i.e. import) procurement
58
Scenario 3 – bonded zone centralized distribution
 Highlights
 Similar to Scenario 2, FICE can
 set up branch stores around the nation to conduct retail (subject to retail license)
 enter into consignment arrangement with department stores
 conduct direct sales to customers
 Unlike Scenario 2, FICE may also
 maintain bonded inventory and conduct transport sales
 conduct USD sales to China 3P distributors / customers (3P distributor / customer as importer)
 Issues
 Same as in Scenario 2
 Subject to special customs and foreign exchange rules / practice in bonded zone
 Higher maintenance cost in bonded zone
59
Scenario 4 – onshore two-tier structure
IP Owner
Import
Trademark royalty
Retail FICEs
(Retail and Aft.
Sales)
Deemed
sales
Aftersales
Service
Retail FICE
Branch Stores
China
Customers
Products
Offshore
Entrepreneur
Wholesale
Department
Stores
Offshore
Sourcing
Service
Wholesale FICE
(Wholesale &
Sourcing)
Consignment
3P Suppliers
Wholesale
China
Affiliates
Domestic
procure
ment
3P Wholesalers /
Resellers
3P
Suppliers
3rd parties
Goods Title
Service
Retail
 Features
Royalty
 First tier to conduct import, sourcing and wholesale at nation level
 Second tier to conduct retail and after sales service at locality level, and may use multiple retail
FICEs for retail
 Often used for distribution of automobile (which by law should set up a two-tier structure for
distribution)
 Often used for sales of consumer products, consumer electronics, fashions, shoes, cosmetics,
groceries around the nation
60
Scenario 4 – onshore two-tier structure
 Highlights
 Consolidated importation / procurement, wholesale and sourcing functions in the Wholesale FICE
 Wholesale WFOE may
 consolidate management and supporting functions (accounting, admin, legal, tax, logistics, etc.)
 consolidate consignment sales with 3P department stores
 Regional retail FICEs
 may help to address local authority's political concern/request
 need to separately apply for retail license at local level
 may set up multiple branch stores in its locality
 Aftersales service function may be distributed among retail FICEs or consolidated at wholesale
FICE
 May use entrustment loan or cash pooling arrangement to improve cash flows among wholesale
FICE and retail FICEs
61
Scenario 4 – onshore two-tier structure
 Issues
 Custom duty
 Wholesale FICE as the importer
 Royalty payment may be made by retail FICE to reduce the customs duty risk (see discussion
under Scenario 2)
 Separate royalty agreements between retail FICEs and overseas IP owner could significantly
increase FX administration burden, depending on the number of retail FICEs
 VAT and Branch Tax Filing
 Movement of products (i) from wholesale FICE to retail FICEs, (ii) among retail FICEs, or (iii)
from a retail FICE to a branch store in different city, will trigger VAT compliance
 VAT compliance procedure could become very burdensome and tedious alone the increase
retail FICEs and branch stores
 VAT consolidation only available within the same province and limited to branches of the same
entity – VAT compliance burden could quite significant
 Retail FICE and its branches should also comply with branch tax filing rules (see discussion
under Scenario 2)
62
Scenario 4 – onshore two-tier structure
 Transfer Pricing
 Characterization of wholesale FICE and transfer pricing arrangement (similar to Scenario 2)
 Decision should also be made on the characterization of retail FICEs
 Relatively independent retailer vs. retail service provider
 Functions and risks should be properly allocated between wholesale FICEs and retail FICEs
 Profit fluctuation of each retail FICE should be justifiable
 Pricing policy between wholesale FICE and retail FICEs should be carefully considered in view
of their characterization, as it has significant impact on profit distribution between wholesale
FICE and retail FICEs, as well as their tax contribution to different local tax authorities
 Functions, operating expenses (including marketing expenses) should be properly allocated and
aligned among wholesale FICE and retail FICEs, with due consideration to special factors to
each retail FICE, if any
 Pricing policy for cross-entity charge should also be planned
 Allocation of supporting service charge from overseas affiliates
 "Shared services" provided by wholesale FICE's management, supporting and
administration teams
 Movement of slow inventory from one retail entity to another
63
Scenario 4 – onshore two-tier structure
 Income tax efficiency
 Consolidated income tax filing for all entities is not available
 Overall income tax efficiency
 depends on consistency of profit / loss level of retail FICEs and wholesale FICEs
 variation of profit level / status could result in high effective income tax rate for the entire
China operation
 Adjustment on transfer prices between wholesale FICE and retail FICEs
 may help to improve overall income tax efficiency, but
 is subject to the restriction of characterization and transfer pricing policy, and
 could significantly add on VAT administration burden
 Advanced transfer pricing arrangement between wholesale FICE and retail FICE is critical for
minimizing effective income tax rate
64
Scenario 4 – onshore two-tier structure
 Inter-company transfer of inventory among retail FICEs
 "Deemed Sales" and cumbersome VAT compliance procedure could prevent inter-company
transfer of inventory among retail FICEs
 Should set up appropriate internal inventory transfer mechanism in view of improving inventory
turnover rate, and with due consideration to individual retail Entity's business concern.
 Reverse logistics and after-sales service
 Wholesale FICE would be responsible to pass on returned products to 3P suppliers for repair,
replace and rework
 Need to take care of cumbersome "VAT Red Invoice" procedures for (i) return from retail FICE
to Wholesale FICE, and then (ii) return from wholesale FICE to local 3P suppliers
 warranty responsibility and risk should be properly allocated to either Wholesale FICE or Retail
FICE based on transfer pricing characterization
 Profit expatriation
 Significant administration burden for each retail FICE to separately conduct royalty agreement
registration and recordal, and remit royalty to overseas IP owner
 Higher risk of administration difficulties if concentrate royalty payment at wholesale FICE
65
Scenario 5 – two-tier consignment structure
IP Owner
Products
Trademark royalty
Retail FICEs
(Regional
Management)
Aftersales
Service
Wholesale
Consignment
Retail FICEs
Branch Stores
Departme
nt Stores
3P Suppliers
Offshore
Sourcing
Service
Wholesale FICE
(Wholesale &
Sourcing)
Consignment
China
Customers
Products
Offshore
Entrepreneur
China
Affiliates
Products
3rd parties
Wholesale
3P Wholesalers /
Resellers
3P
Suppliers
Goods Title
Service
Retail
Royalty
 Features
 Wholesale FICE consigns products to branch store of retail FICEs for distribution (Wholesale
Consignment)
 Head office of retail FICEs only undertakes regional retail management role, or also houses a retail
store
 Retail FICEs recognize procurement and wholesale FICE recognize wholesales upon realization of
retail to customers
66
Scenario 5 – two-tier consignment structure
 Highlights
 This two-tier consignment structure is a refinement to the onshore two-tier structure, and may bring
the following improvement
 VAT
 VAT payment by wholesale FICE and retail FICE could be postponed to realization of sales
to customers
 IC inventory movement
 Inventory before sales may move freely among wholesale FICE and retail FICEs without
triggering deemed sales and VAT
 Transfer pricing and income tax efficiency
 All retail FICEs will be characterized as consignment retail service providers
 Possible to control and enable a stable profit for retail FICEs
 Can concentrate profit / loss fluctuation at the wholesale FICE, and thus improve overall
effective income tax rate
67
Scenario 5 – two-tier consignment structure
 Issues
 Accounting
 Accounting-wise, retail FICEs need to recognize COGs based on value/price of consigned
products before retail, based on expected retail price and "Retail Price Minus"
 Adjustment against COGs will be required, if the retail price is frequently fluctuating, which could
significantly add on to accounting and VAT invoice administration burden
 Could be difficult to implement, if a retail FICE sells many different products with frequently
fluctuating retail price and very different profit margin
 Transfer pricing
 Retail FICEs should be characterized as limited function consignment service providers, while
wholesale FICE as risk taking wholesaler with all distribution and management functions
 Transform from the onshore two-tier structure to two-tier consignment structure could lead to
significant change to the profit level of an existing Retail FICE, which could be questioned /
challenged by local tax authority
68
After-sales service – offshore service
 Return and rework
 China customers export the defective / broken
products and reimport reworked / replacement
products under the customs code of “goods of
no consideration"
Offshore Distributor
(Repair Center)
Reworked /
Replacement
products
Offshore
 Exempted from customs duty
China
 Subject to strict customs supervision and
procedure
China Customers
 Offshore warranty and non-warranty
repair
 China customers export products for warranty
and non-warranty repair
 Customs duty may be exempted for reimport of
products exported for warranty repair
 Customs duty exempted for warranty repair
 Heavy administrative burden for China
customers to go through customs procedures
for export of defective / broken products, and
would not be acceptable if the goods are for
daily operation purpose
Defective
/ broken
Products
Offshore Distributor
(Repair Center)
Repaired
products
Non-warranty
service fee
Defective
/ broken
Products
Offshore
China
China Customers
Goods
Fee
Service
69
After-sales service – onshore service
Service
Fee
 Onshore warranty repair (A)
 Use bonded warehouse to reduce lead
time for provision of spare parts
 3P / affiliate service provider conduct
on-shore repair service and charge the
offshore distributor, but does not take
title of spare parts
 Customs duty may be exempted on
spare parts for warranty service
 China customers still need to
undertake customs procedure for
importation of spare parts
 Onshore warranty repair (B)
 Use bonded warehouse to reduce lead
time for provision of spare parts
 3P / affiliate service provider keeps
minimum spare part inventory to
ensure immediate supply to customers
 Customs duty payable on imported
spare parts
 3P / affiliate service provider
responsible for customs procedures
Offshore Distributor
Spare
Parts
Defective
/ broken
parts
Bonded
Warehouse
China
Customers
Repair
service
Service
Fee
Offshore Distributor
Spare
Parts
3P / Affiliate
service
provider
Defective /
broken parts
Bonded
Warehouse
China
Customers
Spare
Parts
Spare
Parts
Goods
Repair
service
Fee
3P / Affiliate
service
provider
Service
70
After-sales service – onshore service
 Onshore non-warranty repair
 3P / affiliate service provider import
from overseas supplier
 3P / affiliate service provider conducts
onshore repair service and charge the
China customer
Spare
Parts
Overseas Supplier
Spare part
import price
3P / Affiliate
service
provider
Bonded
Wareho
use
 Defective/broken parts





Goods
Service fee +
Spare part
price
China
Customers
Repair
service
Fee
Service
Option 1 – Return as components of original equipment
Option 2 - Return as imported replacement components
Option 3 – Export sales of the defective spares to overseas (tax/pricing / forex)
Disposition in China – scrap / repair for domestic use/sale
with different customs, tax, pricing and foreign exchange implications
 Non-repair after-sales services
 Maintenance, calibration, training, hotline service, technical support, etc., can be either rendered
onsite of offsite, onshore or offshore
71
After-sales service – onshore service
 Issues
 Customs
 If spare parts are sourced from outside of China or where repair has to be done offshore,
customs procedure and lead time are critical for timely and efficient after-sales service,
election of proper customs codes and procedure is important
 China customers are usually reluctant to undertake customs procedures
 Tax
 Some non-repair aftersales service are still subject to business tax, instead of VAT, which
requires separate and accurate accounting for revenue derived from different after-sales
service.
 Transfer pricing
 If a Chinese company undertakes both warranty and non-warranty service, the non-warranty
service could be considered as an internal comparable for benchmarking the warranty
service price
 Adds on the complication of transfer pricing planning and justification, if a China distribution
company conducts after-sales service together with distribution activities
72
Prepaid card operation
 Single-purpose prepaid card
 Prepaid cards issued by enterprises
engaged in retail, hoteling, catering
and residential services
 Prepaid cards used for purchasing
commodities or services provided by
the issuing enterprise, company
group, or franchising group
 Payment usually in cash
 Multiple-purpose prepaid card
 May be used in business beyond
retail, hoteling, catering and
residential services
 Payment service provider should
hold a payment service license, and
be subject to supervision of the
People's Bank of China
 Payment can be made in form of
cash, check, or other in kinds
acceptable by the payment service
provider
(1) Sales of Prepaid Cards / Invoice
(1) Advanced
Payment
Customers
• One company; or
• One company group;
or
• One franchising group
(2) Commodities
/ Service on
redemption
(1) Payment Service
Agreement
Payment
(4) Settlement
Service
Provider
(2) Sales of
Prepaid (2) Advanced
Cards /
Payment
Invoice
Customers
Company A
Company B
Group C
Group D
(3) Commodities /
Service on redemption
73
Single-purpose prepaid card
 Highlights
 Pre-paid cards issued by company group or franchising group can be used
nationwide across entity and stores within the group
 General conditions
 Company group or franchising group or
 Annual revenue > RMB 5 million; or registered capital > 1 million, if in the first
year of operation
 Recordal and report
 Recordal with Commerce Authority is compulsory
 Quarterly on-line report should be filed with Commerce Authority
 Limit on par value and annual amount
 RMB 5,000 for registered card
 RMB 1,000 for unregistered card and
 Limit on total value issued per year, depending on (i) business, (ii) identity of
issuing party, and (iii) revenue of previous year
 Limitation on use of funds
 Pre-paid funds should only be used for the principal business activities of the
issuing company / group
74
Single-purpose prepaid card
 Issues
 Spread out of prepayment balance
 Prepayment balance will spread out among retail entities and need to be maintained on
entity basis
 Payment of VAT before determination of VAT rate
 VAT should be paid front end on sale of prepaid card, while the target commodity and
corresponding VAT rate can only be determined on redemption
 Require ability to track use of prepaid card and redemption record for retroactive VAT
adjustment
 Cross-VAT taxpayer redemption
 Different entities, and branch stores at different localities are separate VAT taxpayers
 Sales of prepaid card by one VAT Taxpayer and redemption by the other need to deal with
the disconnection of sales and costs
 No specific accounting and VAT guidelines for dealing with cross-VAT taxpayer redemption
except in few provinces
 Some local tax authorities in practice discourages cross-VAT taxpayer redemption
 Prepayment balance on closing
 Prepayment balance of a closing entity / branch store should be transferred to another
operating entity / branch
 Transfer of prepayment balance and related VAT credit (i.e. VAT paid on sales of prepaid
card) subject to acceptance of local tax authority.
75
Selling into China through
E-commerce: Legal Entity
Structuring
DLA Piper China Investment Services
Steve Weerts, Partner, DLA Piper, San Diego
Eric Ryan, Partner, DLA Piper, Silicon Valley
September 2014
Selling into China through e-commerce
What is possible?
1. Possible business models for selling products and services into China
through e-commerce
A) Sale of products
Model I: Selling through non-Chinese website without registering Chinese company
a) domestic sourced goods
b) imported goods
Model II: Non-Chinese company selling through 3rd party Chinese e-commerce platform
Model III: Establishing a Chinese wholesale / online retail company
Model IV: Selling through Free Trade Zone e-commerce platform
B) Sale of services, apps, software, etc.
Other online "information services" for which a value added telecom license
would be required
77
Legal entity structuring – model I
A) Sale of products
Model I: Non-Chinese website / no Chinese subsidiaries
a) Domestically sourced goods - drop shipment from manufacturer (OEM)
Title Transfer
U.S. Seller
Physical Delivery
Unrelated Online Payment
Provider
(e.g. Alipay, Unionpay, or
FX: Visa, Master, Paypal)
$?
Unrelated OEM
 No related entity in China
 Consumer invoiced from unrelated OEM; unrelated payment provider
 Some concern re: PE since purchase and sale both take place inside China
 Issues regarding logistics, FX, etc.
78
Legal entity structuring – model I
Model I: non-Chinese website / no Chinese subsidiaries
Title Transfer
b) Import sales
OEM
U.S. Seller
Physical
Delivery
Bonded
Zone / HK
OEM
Logistic Company
(FedEx, DHL,
Zhongtong (中通)，
Shentong (申通))
 No related entity in China


Bonded zone / HK and foreign OEM may reduce PE risk
Administrative cost / customs clearance issues
79
Legal entity structuring – model II
Model II: Non-Chinese company selling through 3rd-party Chinese e-commerce
platforms




No related entity in China
Assuming provider is based in HK and all product is imported from
outside of China, no physical presence in China, so probably minimal
PE exposure
As all purchases and sales are with third parties, no Subpart F sales
income
Additional planning to minimize tax (or risk of tax) in HK
80
Legal entity structuring – model III
Model III: Establishing a wholesale / online retail company in China
Setting up a Foreign Invested Commercial Enterprise (FICE) in the form of a
Wholly Foreign Owned Enterprise (WFOE, i.e. 100% owned subsidiary of a
non-Chinese parent)
OEM
U.S. Seller
Interco
contract
Transfer pricing issues on
intercompany sales
FX
WFOE profits subject to
tax at 25% in China
100%
Own Retail
Website
Wholesale /
or Online Retail WFOE
3rd Party E-commerce
Platform
3rd
party
contract
If no physical presence in
China, probably minimal
PE exposure for US seller
RMB
OEM
If CFC in supply chain,
then CFC profits on sale
to WFOE or services to
WFOE customers may be
Subpart F income
Repatriation of dividends
from China subject to
10% WHT
81
Alternative structuring for investment in WFOE
HK continues to be preferred jurisdiction for investment into China
Separate tax system but otherwise
within jurisdiction of China
U.S. Parent
HK Holdco
100%
WFOE
Proximity makes substance in HK
a practical option
HK operation may already be
involved in sourcing/ manufacturing
side of supply chain
Reduce withholding tax rate on
dividends from 10% to 5%
Sale of WFOE by HK Holdco is
subject to Chinese tax
 But sale of HK Holdco by US
Parent is generally not subject
to Chinese or HK tax
 May be subject to Circular 698
in China
82
Alternative structuring for Investment in WFOE
A number of other countries have also entered into tax treaties with China
providing advantages over the China-US treaty
Singapore


U.S. Parent
Holdco
100%

5% dividend withholding tax
Singapore company subject to
China tax on share sale
No Singapore tax on dividends or
capital gains
Ireland
 5% dividend withholding tax
 Irish company not subject to tax in
China on share sale (rare benefit)
 Dividends subject to Irish tax (net
of FTC); capital gains potentially
exempt from Irish tax
WFOE
Netherlands
 5% dividend withholding tax
 NL company subject to China tax
on share sale
 Dividends/gains may qualify for
participation exemption in NL
Others – Bermuda, Mauritius
83
Alternative structuring for investment in WFOE
Issues to consider in establishing holding company
U.S. Parent
Holdco
100%
WFOE
Increased focus on substance by
China, in line with international
trends (e.g., BEPS)
 Beneficial ownership of
payments from WFOE and
treaty LOB provisions
 Circular 698
Third country focus on substance in
Holdco for other group transactions
involving Holdco (e.g., withholding
tax, TP, etc)
Certain Holdco jurisdictions
(HK/Singapore) have no US treaty
 Risk of ECI in the US
 No reduction of withholding tax
on certain payments to the US
(though no dividend withholding
tax under HK/Singapore
domestic law)
Consider impact of Subpart F on
transactions involving both Holdco
and WFOE
84
Alternative structuring for investment in WFOE
Opportunities for de-risking existing structure
U.S. Parent
Holdco
100%
WFOE
When considering establishing a
holding company and injecting
substance to support treaty
benefits, other opportunities arise
Companies may have buying
office structure in the region with
little substance (e.g., China
Business Trust)
 CBT and similar structures are
more likely to come under
attack for lack of substance
 Consider using Holdco as new
buying office and using
planned injection of substance
to qualify for “substantial
contribution” under Subpart F
Companies may have IP holding
structure with little substance
 Consider migrating offshore IP
to new holding company to
take advantage of substance
 Most Holdco jurisdictions are
also candidates for IP
85
Thank you! Questions?