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E-commerce and the Chinese consumer

Tax and Finance

By Damon Paling, Partner PwC Shanghai

E-commerce in China is forecasted to grow to an over US $350 billion industry by 2016 as internet connectivity expands and consumer purchasing power grows.

Before a New Zealand company is online and making sales, they are faced with the challenging task of setting up their web platform and deciding whether it should be hosted locally in China or in New Zealand. E-fulfillment should also be considered under this context. The results of these decisions lead to different outcomes in China. But whether it is e-commerce or traditional commerce, New Zealand made goods are still crossing the Chinese border to get to the Chinese consumers. So how do you manage the China customs and trade implications of e-commerce, lest they negate the opportunities on offer?

Potential Business Models

The Organization for Economic Cooperation and Development (OECD) defines an e-commerce transaction as the sale of goods or services, whether between businesses, households, individuals or governments, conducted over the internet. The payment and delivery of the goods or services may ultimately be conducted on-or-off line. Key issues that capture the attention of companies looking to launch an e-commerce platform often begin with marketing, online branding, translation, cyber security or “localization” of their current platform. But ultimately, how will goods purchased online end up at the consumer’s location? E-commerce is changing the way consumers purchase as well as their expectations for delivery speed and convenience in the delivery location (i.e., brought straight to their door). Meanwhile, Chinese consumers are also on the hunt for high quality, favorable prices and variety. Chinese consumers want to be able to browse and purchase products anywhere, any time and from any device. As Chinese consumers specifically direct sellers to send them certain products in a specific amount of time, a pull distribution model is emerging and companies need to determine the e-fulfillment solutions required to accommodate these changes.

What is the position in general of the World Customs Organisation (WCO) on e-commerce shipments and distribution? After all, the collection of revenue is one of the main cornerstones of a China Customs and they want to ensure that all goods have been equitably appraised. The WCO is not surprisingly silent on these aspects of e-commerce. The revised Kyoto Convention allows for a country’s national legislation to define the circumstances when liability to duties and taxes is incurred. So for revenue collection, China determines its own threshold to combat smuggling and tax evasion but to ensure that tax is collected in a cost effective manner while allowing consideration for personal parcels.

Scenario 1- Sales through a New Zealand website / direct shipment

Perhaps the simplest way to “test the waters” of e-commerce, an online store is supported by an existing website and its server located in New Zealand. A Chinese customer will place a purchase order (PO) directly through the website and pay using a credit card in foreign currency. The products are shipped from the New Zealand seller’s warehouse via postal or express courier services. The online store or New Zealand company does not at this stage establish a local presence in the China market.

Initially, this sounds like a very safe and simple strategy for a New Zealand company to begin to break into the China market. Additionally, China offers a personal parcel exemption (PPE), meaning that if a personal parcel is below a determined threshold of duty and VAT, the PPE can be leveraged to get products to the consumer as quickly and inexpensively as possible. China Customs can still call for inspection or examination of personal items as deemed necessary.

Mail for personal use having customs duty payable of RMB 50 (NZD 9.50) or less can be imported free of duty unless belonging to “20 commodities prohibited from duty exemption.” Additionally, mail for personal use having a total value of RMB 1,000 (NZD 190) or less, or if the package contains 1 article with a value exceeding RMB 1,000; China Customs will use an “assessed value” approach. 4 ranks of customs duty rates (i.e. 10%, 20%, 30% and 50%) are applied depending on the category of the imported articles.

The Free Trade Agreement

Where applicable, the New Zealand seller should aim to fulfill the terms of the Free Trade Agreement so as to benefit from a 0% customs duty rate when product is imported into China. The goods and their packaging should be marked with marks of New Zealand origin. Of note is the “direct transport” rule which requires goods to be shipped from New Zealand directly to China without passing through any other countries or regions except on the way. Where the goods are transported to China via other countries or regions, such as Hong Kong, including the cases of change of vehicle or temporary storage, the “direct transport” may be retained, subject to certain conditions. The Importer shall submit a copy of the Certificate of Origin as issued by authorized agencies in New Zealand. A Statement of Origin may be used where the total duty-paid value of the goods determined by China Customs is less than USD 1000 (NZD 1,200) or a valid administrative ruling for the same goods exists, or where due to some other reason a Certificate of Origin is not required.

But what if the goods are moved by express courier and not via a national postal service? Who is the importer of record (IoR) in this transaction? In China an individual consumer is not registered with China Customs and thus not able to act as the IoR for importation. A company with import/export rights will need to be used to clear the goods on the consumer’s behalf.

Proper use of INCOterms and sharing this with the Chinese customers upfront when they place the order is imperative. In many cases, a PPE may not be applicable and the packages will be assessed customs duty and import VAT via typical import formalities. Although the average consumer might not understand INCOterms, explaining very clearly that the seller will deliver the goods to a place specified by the consumer but the consumer is ultimately responsible for clearing the goods, paying any import duties and carrying out import formalities, i.e. DAP (buyer’s home) is vital to avoid a misunderstanding. Customers also need to understand that if they become liable to pay duty for the goods, the duty will be levied on the CIF price, which includes the cost of shipping and insurance from New Zealand to China.

The Chinese consumer is expecting to receive their goods faster and with less hassle than via traditional distribution models, so upfront planning is essential.

What happens for returns under this model though? A return of a defective or unwanted product to New Zealand would technically require export formalities and subsequent re-import formalities in New Zealand making it extremely difficult for the New Zealand company to process. Companies should consider how they will handle this issue such as determining their cost threshold to simply provide the Chinese customer with a new replacement product.

What if the New Zealand seller wants to remove some of the uncertainty, cost, and hassle of import formalities from the Chinese consumer to offer a better customer service experience. This could potentially be accomplished by the New Zealand seller using the INCOterm DDP (buyer’s home). Some sellers have begun to outsource their e-fulfillment operations to 3rd party service providers who will handle all of the shipping, clearance and delivery to the consumer for a flat fee, which is ultimately passed on to the seller. This would be a good option for a seller that does not want to assume the maximum amount of risk by always selling on a DDP basis.

Scenario 2- Sales through a New Zealand website / shipment via a China bonded zone

In this scenario, an online store is still supported by a New Zealand website. The New Zealand company will make bulk shipments of inventory in advance of any sale (i.e., lower shipping costs when shipped in bulk) to a China bonded warehouse. The assessment of duties and other import taxes will be deferred until a PO is placed on the website by a Chinese customer. The Chinese customer will still make the payment via a credit card in foreign currency. A third-party logistics provider will manage the goods in the bonded warehouse and can post the goods to the customer via a domestic courier service once the goods are sold. The online store would not set up a local e-commerce presence in the market at this stage.

This model may assist in overcoming the competitive disadvantage of distance. After all, the ability to consign goods as late in the supply chain as possible will save costs. But what type of bonded warehouse or bonded zone should be utilized for the storage and maintenance of goods? In China, for example, public customs warehouses are open to any person having the right to dispose of their goods and are typically run by private enterprises (i.e., 3PLs). They can be located within a bonded zone, such as a Free Trade Zone or a Bonded Logistics Park, or many are located outside of the zone such as within a Tier 1 or Tier 2 city. The warehouse operator often provides services to the seller in addition to storage or stock-keeping; they can assist with logistical support, knowledge of China regulations (i.e., tariff classification, valuation, origin) as well as acting as the IoR for importation. These are services that would be undeniably valuable to a New Zealand company that does not have a local team on the ground. However, all of these services don’t come without a price. In practice, a New Zealand seller will enter into a service agreement with the 3PL for such assistance. Yet, according to customs valuation regulations that “assistance” may need to be factored into the dutiable value of goods at the time that they are finally imported into China.

What about the return of unsold inventory? A New Zealand seller would still face complications when a customer wants to return defective or unwanted goods as export formalities removing the goods from commerce and back into a bonded zone would need to be completed.

Furthermore, under both of these scenarios, the seller is also assuming that the consumer has the ability to make payment via their website on a credit card in foreign currency. In China, incorporating Alipay, an escrow based payment system which allows a consumer to verify that they are satisfied with goods before releasing the payment, has almost become a necessity to meet consumers’ demands.

Lastly, if a New Zealand company retains a home-based web platform, are they sure that they are reaching the maximum possible amount of consumers to generate sales?

Scenario 3- Sales through a local website / shipped and imported by a legal resident entity

So the New Zealand seller has “gone local”. The online store is supported by a local website where the server is located in China. Goods are imported (duty paid) by a domestic legal entity and stored domestically until a customer places the PO through the online store. Payments would most likely be made in RMB. The ordered goods are posted from the warehouse of the domestic online store direct to the Chinese customer via a domestic courier service. The domestic online store would establish a presence in the market to support logistics, customer service, returns of the goods sold, etc. A bulk shipment of goods would be made regularly from New Zealand to China to support the sales of the domestic online store, subject to traditional import declaration and import licensing formalities (as required).

For a Chinese consumer, this is the ultimate hassle-free e-commerce experience. Customs clearance and import licensing (if applicable) have been resolved up-front, goods can be returned easily and possibly exchanged with other non-bonded goods that may be in stock, payment for goods can be charged on a local credit or debit card, bank transfer or cash on delivery, and it’s possible that the consumer can receive their goods “next day delivery”. For the New Zealand seller though, the costs and the risks have just increased substantially. Not to mention the fact that returning unsold inventory to New Zealand may require an export license, be subject to foreign exchange controls, and is thus essentially prohibitive.

In China, this might be a good option for a company that already has a brand presence, a local team on the ground and is looking to make a long term investment in the market. However, it will require advance work in obtaining an Internet Content Provider (ICP) license from the Chinese Ministry of Industry and Information Technology, which is required to operate a website in China. Alternatively, a third party ICP provider, such as TMall may be used.

Summary

Although not inclusive and not covering all issues that a New Zealand seller may encounter (still need to consider licensing, FOREX controls and any state controls on e-commerce transactions), this table is a summary of questions that a New Zealand company could use to start thinking of the cross-border e-fulfillment implications.

Conclusion

According to the Ministry of Commerce, China’s ecommerce transactions grew 29 % year on year in 2011; not to mention that there are currently almost 400 million consumers shopping online. Ultimately, e-commerce will continue to grow because it provides for lower cost products and more variety and flexibility in brands and product variation, which in turn leads to an enhanced shopping experience. Online security is also improving and an increased number of consumers are beginning to shop from their mobile devices.

If a New Zealand company decides to maintain a New Zealand platform, there is much more to consider than Chinese language translation. Shipping, customs clearance, payment methods as well as how and where to maintain a physical stock of inventory should all be considered. Despite the local versus New Zealand platform decision, Chinese consumers’ expectations in their e-commerce transactions will continue to increase and eventually New Zealand companies might discover that there is not one perfect distribution solution.

Damon has 15 years experience in Asia advising companies on customs, trade and related supply-chain and logistics matters, the last 9 years of which have been spent in Shanghai, China. Damon assists clients in various areas, including: customs audit and investigation dispute resolution, customs compliance and opportunity reviews, establishing customs-supply chain efficient business models, establishing regional distribution centres, establishing a customs centre of excellence, reverse logistics and low cost sourcing. Damon is a member of the AMCHAM Shanghai Customs Task Force and co-authored the Kluwer Law publication "A Quick Reference to The Trade and Customs Law of China".

We would like to share your industry knowledge and expertise on trade with China. Please contact Luke Qin at luke.qin@nzcta.co.nz