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SaaS in China: The 101

Monday, October 10, 2016 7:16
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(Before It's News)

China SaaSCountless foreign software companies wish to deliver their software as a service (SaaS) to China. But since China requires commercial ICP licenses for commercial Internet services within China and generally forbids foreign enterprises from obtaining such licenses, directly providing SaaS through a server in China is typically not possible for foreign software companies.

So what can be done? How can a foreign software company get its software to China’s consumers via SaaS? Two methods for providing foreign SaaS in China have been developed. These methods depend on whether the server will be located outside of China or within China. If the server is located outside of China, we use the reseller model. If the server is located within China, we use the license model.

Many foreign software companies waste a lot of time and money in searching for or trying to develop a third model. Many Chinese companies — out of either ignorance or greed — encourage such searching and trying.

In the reseller model, the foreign SaaS provider brings on one or more resellers in China. At a minimum, the reseller locates customers for the foreign company’s SaaS product. The reseller provides the ultimate customer with a user name and password that allows the customer to connect to the foreign server hosting the SaaS product. The reseller collects the fee from the customer and deducts and pays applicable Chinese business and income taxes and then remits the remaining amount to the foreign software provider.

Though very common, this SaaS reseller system does not strictly comply with Chinese law, since the Chinese Government has never reviewed or approved the software content. However, to date, the Chinese government has permitted the reseller model to be used. This reseller model is permitted because it includes the following safeguards that protect the interests of the Chinese government:

  • Access to the offshore server can easily be blocked by using China’s Great Firewall. If the SaaS content is not acceptable to the PRC government or if the SaaS is used for an unacceptable purpose, the connection to the offshore  server can and will be blocked with no prior notice. This happens regularly in China, often to SaaS/cloud products that seem innocent on the surface. The risk of being blocked is therefore the most significant risk in using the reseller model. Some SaaS is at much higher/lower risk of being blocked than others and part of our role as China lawyers is to help our clients analyze this risk.
  • The reseller is liable under Chinese law for the content of the SaaS product. The reseller is not treated as a neutral, ISP type entity; the reseller is treated as though it is the developer of the SaaS product. This is true even where completely independent third parties are the source of content on the SaaS platform. More important, the reseller is liable for quality as well as content. Consider the potential liability here: some SaaS platforms are used for off site medical diagnosis. What happens if the diagnosis is wrong and the patient is injured or dies? The reseller is potentially liable.
  • All applicable taxes are withheld and paid. Through the reseller approach, the PRC government is able to impose double taxation. Taxation first on the income of the reseller and then taxation on the income remitted to the foreign software company. This access to tax revenue results in a more accommodating regulatory response from the Chinese government, but also in lower income for the foreign software provider.

There are several reasons foreign SaaS providers decide they must locate their server in China. Many do so for the generally faster service speed and connection reliability. Others do so to lower their risk of having their software blocked. Some simply cannot find reliable resellers willing to take on the substantial work and risk. Foreign software companies that use a Chinese server do so via a licensee model.

Under the licensee model, the foreign software company does not directly offer its SaaS product in China nor does it directly control the China server. It instead licenses its software platform to a Chinese entity. that obtains the commercial ICP license that allows for offering the SaaS service to Chinese customers through a Chinese server.

The minimum terms of this sort of SaaS Licensing Agreement are as follows:

  • The Chinese licensee owns the ICP license. Acquiring a commercial ICP license is expensive, and the licensee must pay all the costs. Because of the considerable expense, it is difficult to find Chinese companies willing to take on the financial burden of acting as a licensee.
  • The licensee owns the URL that provides access to the server.
  • The licensee holds a license for the entire content of the SaaS platform software. As with resellers, the licensee is liable for the content and performance of the software.
  • If the SaaS platform is hosted on a cloud server, the licensee has the the contractual relationship with the cloud service provider.
  • The licensee has direct contact with and collects the income from the customers The licensee pays a license fee to the foreign software provider under normal license royalty rules.
  • Since the server is located within China, the Chinese government has the right to access the content of the server at any time.

As the above discussion makes clear, neither the reseller model nor the licensee model are ideal solutions for companies wanting to provide SaaS to China. Most of our foreign SaaS developer clients have used the reseller model successfully. However, the licensee model has been the only solution for some of our clients. For example, for SaaS software that will be used by a Chinese government institution such as a hospital or university research center, Chinese government regulation normally requires the SaaS software be housed on a server located in China. The same rules typically apply for SaaS software used by PRC banks and other financial institutions. Since these situations require a server located in China, the licensee model is the only choice available.

Bottom Line: If you are a software company looking to sell your SaaS software in China, you can do so using either the reseller or licensee model.

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.

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