China’s SaaS Market: WFOEs Need Not Apply

A major trend in the business software business is provision of software not through installation on a customer’s computer but rather through online access using the Internet. This approach is known as software as a service (SaaS). Though SaaS is a major trend in the U.S. and Europe, SaaS in China by a foreign company or a WFOE is not possible. This poses major issues for foreign software companies seeking to enter the China market.

China recognizes the SaaS method of providing software. However, use of the Internet requires that the provider acquire a commercial ICP license. Since SaaS by definition makes use of the Internet, all SaaS systems in China require the provider obtain a commercial ICP license.

Here is where the problem arises. A WFOE or other foreign owned entity cannot obtain a commercial ICP license in China. There are no exceptions to the rule. Accordingly, if a WFOE or foreign entity wants to offer its software in China though a SaaS system, it must do using an indirect method such as licensing the software to a licensed Chinese entity through a method often called an “Internet portal”.

China’s Ministry of Industry and Telecommunications (MIIT) is in charge of Internet licensing. The MIIT has become even clearer on the SaaS rule as it confronts the growth of software business in China. In particular, its position on foreign software providers has hardened over the past several months as China responds to Snowden’s NSA revelations and the cyber espionage claims of the U.S. against the Chinese military. In the past, many U.S. software providers argued that the commercial registration rule did not apply to their business because no e-commerce was conducted on the SaaS site. Others argued that a Ministry of Commerce exception applied to their SaaS offerings. These arguments have been forcefully rejected by both the Beijing and Shanghai offices of the MIIT and they cannot be relied on for future SaaS business in China by foreign companies.

Accordingly, a WFOE has available the following two methods for selling its software in China:

• Direct sales to customers. Software is installed on the client server and all data is housed on the client server as well. If the client wants to make the data available to the general public, the client does this on its own Internet site, under its own license. The WFOE would in no way be involved in this process. The WFOE could of course be engaged to manage the entire process, including creating an intranet available only within the client’s premises or as an Internet site available to the general public. The licensing (commercial or non-commercial) for such a public website depends on how the service is constructed.

• SasS offered through a service/license agreement with a 100% Chinese owned Internet ”portal.” As noted above, provision of software through SaaS cannot be done directly by the WFOE because the provision of SaaS services in China by ANY entity requires a commercial ICP license. That is, if a 100% Chinese owned company wants to provide its software through SaaS, that Chinese entity must obtain a commercial ICP license. Note that it is not relevant what the customer will do with the software. All that is relevant is that 1) the customer is paying for the software and 2) access to the software is delivered through the Internet. Thus, the argument that SaaS software is not commercial because no e-commerce is done on the providing website fails. If the WFOE is paid for the software the whole transaction is commercial and it is therefore subject to the commercial ICP license requirement that applies to all SaaS activities in China.

To use a SaaS approach, the WFOE will be required to offer the software through a Chinese owned company that owns a commercial ICP license. Such an entity is referred to as an Internet portal. Under an agreement with a portal, the WFOE would contractually engage the portal to offer the SaaS software package, using the portal’s license as the applicable commercial ICP license. Because the portal approach is new in China, there is currently no standard portal agreement or portal structure.

Though the portal approach is a new concept, the MIIT officials in both Beijing and Shanghai have in just the last few months told our attorneys on multiple occasions and without hesitation the following:

• SaaS CANNOT be done directly by a WFOE. There are NO exceptions.

• Indirect provision of foreign software services through a portal arrangement is acceptable because the portal entity will be entirely responsible for complying with Chinese law. All MIIT offices we have contacted have affirmatively recommended the portal approach without any prompting from us.

To summarize: there are two ways a WFOE can sell software in China: Direct sales through the WFOE or indirect sales through an Internet portal. There is no intermediate method that allows for direct sales using the SaaS approach.

Many of our clients are contacted by ISPs, cloud service providers and related entities in China who claim to offer just such an intermediate method. Such offers should be viewed with caution. In our experience, these offers are coming from two kinds of companies: 1) companies that do not understand the law and 2) companies whose business model is built around evading/violating the law. Given China’s current legal environment regarding foreign companies, it makes little sense to operate in a way that claims to exploit a loophole or grey area.