A notice issued in July 2006 by the PRC Ministry of Information Industry (“MII”) may significantly impact the way foreign invested Internet and related telecom companies are structured in China.

PRC regulations currently restrict foreign ownership of companies that provide VAT service. According to China’s WTO commitment, foreign investors may invest in the VAT service sector by forming joint ventures with Chinese partners, but their combined stakes may not exceed 50 percent. Moreover, it is very difficult in practice for such joint ventures to obtain the necessary VAT business licenses from MII. To comply with PRC regulations, foreign investors and Chinese Internet companies looking for foreign capital have developed complex business structures to operate in China.

The Notice Concerning Strengthening Administration of Foreign Investment in Operation of Value-added Telecom Business (“Notice”) calls for an immediate stop of unauthorized foreign investors providing VAT service in China and prohibits domestic telecom companies from leasing, transferring or selling telecom business operation licenses in any form to foreign investors. It also stipulates that domestic telecom companies must not offer resources, premises or facilities in any form to foreign investors who operate telecom businesses illegally in China. For companies which are deemed not in compliance with the new rules, their VAT business licenses may be revoked.

The Notice does not intend to prohibit foreign investors from entering into VAT service sector in China. Instead, Paragraph 2 of the Notice provides that the cooperation between the foreign investors and domestic VAT business operators must be regulated in accordance with the following requirements:

  • the Internet domain name and registered trademark must be owned by the relevant VAT business operator under the name of the company (including a shareholder of the company);
  • the applicant for VAT business must have the requisite premises and facilities which should be set up within the scope of area covered by the relevant VAT business license and be suitable for its approved VAT business;
  • the VAT business operator must perfect the measures for network and information security, formulate the relevant administration system and establish an emergency reaction procedure for network and information security.

At this stage it remains unclear what the true impact of the Notice will be. However, by requiring VAT business operators to own the Internet domain names and trademarks that they use in their services, foreign-invested Internet companies in China may need to re-look at the way their operations are structured.

Originally appeared in Dorsey's China Report