China: China Focus – September 2016

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Online Advertising in China – Regulations Commencing

China's e-commerce market has exploded in recent years becoming the world's largest e-commerce market. This growth is expected to continue and the market size is expected to reach US$ 1 trillion by 2019. Consequently, online advertising has now surpassed traditional advertising in terms of ad spending.

This exceptional growth has not been without controversy however; concerns about issues such as content control, fraud, and privacy protection have pushed the government towards strengthening the oversight of this previously minimally regulated market. In an attempt to exert more control over online advertising, the State Administration of Industry and Commerce (SAIC) issued the Interim Measures for the Administration of Internet Advertising on 4 July 2016, and took effect on September 1, 2016. One of the drivers for these measures was the well-publicised case involving search engine giant Baidu, in which a young man died after procuring cancer medicine of questionable efficacy online. With the enactment of the new measures the authorities hope to cut down on fraudulent and misleading activity while increasing transparency. The new rules will have a wide-ranging effect with "internet advertising" covering a broad scope ranging from websites and Internet applications to email advertisements.

Some of the main points surrounding the new measures include:

• Paid ads must be clearly identified;
• Ad results are limited to 30% of total search results;
• Ads must not be deceptive or misleading;
• Users should have the ability to close a paid ad with one click;
• Ads should not negatively impact on user experience; and
• Email ads should be clearly identified as such, allowing the customer to choose whether to open the ad or not.

In addition to the above general points there are particular restrictions on the online advertising of a number of specific items. The advertising of tobacco products and prescription medication is explicitly banned while providers of medical supplies and other veterinary and health products need to seek government approval for any online ads. Failure to comply with the new guidelines will see companies facing fines of between RMB 5,000 and RMB 30,000.

Digital ad spending in China is now in the region of US $40 billion. It was inevitable that the industry would come to face extra scrutiny and oversight in China. As is often the case with newly issued guidelines and regulations in China, some items remain unclear and possibly open to interpretation. Some experts anticipate a short-term drop in online ad revenues as a result of the new measures. In general the attempts to protect consumers from unscrupulous advertisers are to be welcomed. It will take some time to accurately gauge the effects of these new rules so it is advisable to keep up to date on any new developments.

Foreign invested enterprises will likely experience additional scrutiny from regulators. Therefore, they should be working with a qualified advertising partner for all their advertising needs, including new advertising platforms such as Wechat advertising, one of China's leading mobile social media platforms.

Unification of working permits for foreigners – where do you fit in?

On Friday, 2 September 2016, China Daily broke the news that the government will be launching a new pilot programme to unify work permits for foreigners. Under the current system there are two kinds of work permits. One is the "employment licence" issued by the Ministry of Human Resources; the other is the "expert work permit" issued by the State Administration of Foreign Experts. In the new pilot system the two permits will be unified into a single type of work permit. The main reasons given for this policy change are: 1) the working permit will be easier and faster for overseas talent to obtain; and 2) China will be able to attract more highly skilled foreigners to help with China's development.

Under the new programme, a point system will be introduced that will grade each foreign application and determine if they are considered a talent needed for China's growth. The new policy will rank foreign workers into three categories: A, B and C, based on their points score. The categories have been vaguely defined as follows:

A Chinese report published on the State Administration of Foreign Experts Affairs repeatedly mentions the catchphrase "Encourage the High End, Limit the Ordinary, Restrict the Low End" (鼓励高端、控制一般、限制低端) in reference to the new policy. This phrase provides some insights into the possible intent of the new regulations.

As with many pilot programmes initiated in China, it will take time before the efficacy (and the true intent) of the programme is clear. As a foreign invested company in China with foreign employees, it is important to understand how these changes may affect you and your staff. If working with a third party agent to obtain a working visa for your staff, make sure they also understand the implications of the new policy. For now, we will need to wait and see what impact this policy will have.

Low Cost Service Providers – are they worth the "cost"?

Recent articles in our China Focus newsletter have focused on identifying and working with partners in China. Partners range from corporate service providers, to importers, to distributors, among others. This article focuses on the hidden cost of low-cost service providers, such as outsourced accounting or HR services.

For many small and medium-sized enterprises, cost is an important factor when deciding how to manage support functions required to operate a company, such as accounting and HR payroll benefits. Effectively, there are two options for companies: 1) outsource to a third party service provider(s); or 2) hire an in-house employee. Both options can be effective if done properly, but what happens if a low cost service provider is chosen or a less-than qualified (low cost) employee is hired? What are the risks? What is the real cost?

Below we will discuss the potential risks and costs of engaging low cost service providers, specifically accounting services, but much of what is said can be applied to HR services as well.

Service providers are typically separated into three tiers:

1. Large international firms;
2. Mid-level foreign invested firms;
3. Local firms (including "micro-firms" and freelancers).

Large international firms tend to be extremely expensive for the services they provide and there is little variance in the price between companies. However, in the mid-level foreign invested firm and local firm category, the pricing spectrum can range from what some would consider expensive (but still less than the large international firms) to extremely cheap. This massive pricing difference can make it extremely difficult for a company to decide on which service provider to choose. After all, you don't want to pay an arm and a leg for a service you can get for much less, and a high price does not necessarily mean good service (but a very low price almost certainly guarantees that lack of it).

Low cost service providers are usually, but not always, local firms. They are typically able to offer their clients below market rates for their services, which on the surface seem like an amazing deal. However, as the saying goes, if something is too good to be true, it probably is.

Some of the ways low cost service providers can offer extremely low rates include, but are not limited to, the following:

Paying employees illegally

China has strict labour laws that require individual income taxes and social benefits to be paid on an employee's full gross income. This can make the cost of the employee to the company 40% or more of an employee's gross salary. To avoid this, companies will pay employees a very low salary and then make up the salary gap with a cash payment. This is an illegal practice and opens the service provider up to various risks – from disgruntled employees seeking legal remedies to the tax bureau investigating unpaid taxes and social benefit payments.

Overburdening staff

Accounting and HR services both require careful attention to detail and minor mistakes can be extremely costly to a company. Giving employees too large a case load will increase the chances of errors occurring and possibly encourage the employees to cut corners in order to finish their work. Errors and omissions can be extremely costly for a company to rectify once found. This is something to beware of, regardless of the service provider, although it generally occurs more frequently with low cost providers.

Not accepting responsibility

Even when not overburdened, accountants and employees are only human. Errors can be made. If an error occurs, will a low-cost service provider accept responsibility for its mistake? A reputable service provider will be accountable for the actions of their employees and take responsibility. They will also typically have processes in place to minimise the potential for errors to occur.

Receiving kickbacks!

Perhaps the most common way for low-cost providers to offer extremely low rates is to subsidies their fees through kickbacks from the local tax bureau based on the amount of tax revenue collected (yes, you read it correctly). In some cases, the local tax bureau will pay the service provider a percentage of the amount of taxes collected. This encourages the accounting service provide to manipulate the book so that you pay more tax!

Case Example

A foreign invested enterprise located in a second tier city near Shanghai, has been using a low-cost outsourced service provider for their tax and accounting needs for many years. The company is now considering the closure of their office and their lawyer contacted Sovereign for potential assistance. We were informed that when the company's books were reviewed, there were a number of discrepancies and inaccuracies. When these were discussed with the accounting firm, the accountant said that everybody in [city X] does things the same way (this is commonly used in China as a way to deflect mistakes). When asked if this will cause problems with the closure, the accountant said "yes, there will likely be penalties due to non-compliance." Furthermore, it is likely that the low-cost service provider will not take accountability for any fines or penalties incurred due to their misfiling.

It may have cost the company more upfront to file their taxes in a compliant manner, but they would not be facing penalties or delays in the closure of their office.

Shortcuts and other methods low-cost service providers take to offer low fees may never become an issue for their clients – until they do! Besides potentially paying more taxes than necessary, other errors and shortcuts can cause significant problems if you want to close or restructure your company. Furthermore, if your company becomes subject to an audit and errors are found, the fines can be egregious.

To avoid the potential headaches – and costs – it is best to select a reputable service provider that looks out for your best interests. In future issues, we will discuss the steps you should take in selecting the right outsourced service provider.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.