APD Columns | New cross-border E-commerce tax scheme--A game changer?

APD Columnist|Ling Zou

“Winter is coming.”

  ————- says a cross-border e-commerce professional in China

Cross-border e-commerce has been one of the few bright spots of the Chinese economy since its inception. In 2014, this specific trade category has amounted to 71.8 billion USD in terms of volume according to MOFCOM. It has further increased by 30% in 2015 (or 2.5% of total trade), despite overall trade volume on a decline. One of the key policy levers here is taxation, as traded goods could be tax-free if the tax bill is less than 50 RMB.

Tax breaks led to a sensational “from zero to one” boom in the cross-border e-commerce space, but also fostered a number of issues: for one, volume has overtaken quality, with customers not really appreciating the “high-quality” foreign products but voicing increasing complaints; more e-commerce companies have been trying to cut the corners in order to qualify for the tax break; volume and even product fraud is also prevalent on some online platforms.

All of this may come to a halt tomorrow, as the SAT (State Administration of Taxation) will carry out a new taxation policy on April 8th (http://www.chinatax.gov.cn/n810341/n810755/c2044092/content.html) for cross-border imports, with all products – even those with tax bills below 50 RMB – under the new taxation scheme.

The effective tax rate will be elevated from 0 to 11.9% (VAT only) and even 32% (when consumption tax is applied). Despite the fact that there is a maximum tax-free quota of 2,000 RMB per transaction and 20,000 RMB per person, it is insignificant for any major players endeavoring to make a profit.

A Short History of Cross-border E-commerce and Zhengzhou’s Early Lead

The whole story of the “cross-border e-commerce” scheme started in July 2014, where the General Administration of Customs enacted policies to approve major tax exemption of imported e-commerce products.

For normal good imports, a product is subject to both tariffs, VAT(11.9% of value) and consumption tax (further 20-40% based on product type, if it is a luxury item or tobacco/alcohol). Meanwhile, the new policy never suggests zero taxes for e-commerce, as it is still subject to a personal postal articles tax (行邮税) that is inclusive of VAT and consumption tax. However, once the tax bill is below 50 RMB, the product is completely tax-free.

Normally, this tax exemption is only applicable for ones who are bringing individual gift items for their family members or friends, which is certainly not the case for e-commerce players. In order to enjoy the tax break, bulk purchases from overseas are subsequently divided into individual items in the Foreign Trade Zone and are repackaged into smaller value items.

As the repackaged items didn’t hit the taxation threshold, it is subject to no taxation whatsoever. Since then, cross-border e-commerce volume has skyrocketed, with the major items imported include mom & baby products (25%), cosmetics (23%) and health supplements (22%).

One of the key beneficiaries are the 12 local governments that are “piloted zones” for warehouses dedicated to cross-border e-commerce within the foreign-trade zone, including Shanghai (Shanghai FTZ), Ningbo, Hangzhou, Tianjin, Hefei, Chengdu, Dalian, Qingdao, Chongqing, Guangzhou, Shenzhen (Qianhai FTZ) as well as Zhengzhou. Five of these cities had an early start and a more comprehensive data set. The data below showed an interesting case where Zhengzhou was ranked the top of the chart, despite being an inland city:

According to an industry veteran, Zhengzhou was leading the chart because of three main reasons: For one, the governor of Henan was directly in charge of this project, showing keen interests in developing Zhengzhou as a inland logistics center; Zhengzhou also enjoyed a unique geographical advantage of situating in the center part of China, allowing it to distribute products countrywide easier than coastal areas; moreover, Zhengzhou developed a system of integrating customs and quarantine inspection, enabling a system called “custom clearance by second”, where the customs was able to process 84 orders simultaneously in one second. All these factors combined towrads a significant advantage of Zhengzhou against other coastal ports.

Zhengzhou’s cross-border e-commerce warehouse, source: ZYnews.com

New tax scheme affect major players in different scales

There are two major types of business models in the cross-border e-commerce space: the first being the “stocking model”, where the B2C players directly procured a number of items based on previous sales trends and then placed them in different warehouses nationwide.

The core advantage of this model is that customer usually could get whatever they want at a tremendous speed, the flipside is that the quality may be compromised, as the stock might be in the warehouse for a while and there is inventory risk; the other model was called the “collection model”, where the goods were purchased overseas after an order was booked, and eventually shipped to the customer.

The advantage of this is that usually these products were up-to-date and there could be zero inventory risk, but on the other hand it takes more than weeks for the order to be fulfilled and that also affects customer experience.

A number of players have benefited from the scheme – Tmall Global is probably the strongest one, inviting the likes of Macy’s, Sainsbury, Costco, Kao and Danone to sell directly on its platform, with the total amount of brands reaching more than 5,400 as of year end 2015. Some listed company’s platforms were also quite aggressive in this field, including JD.com, vipshop, jumei.com, and Netease’s kaola.com.

Most of them were B2C players, procuring products directly overseas. Private companies, such as mia.com and xiaohongshu.com, were also key players of the race, both of which valuation exceeded 1 billion USD in the private market. There is also a unique C2C category, where the platform is just facilitating individuals to trade directly with each other (similar to the taobao model).

The new taxation scheme will have distinct effects on these players – for marketplace like Tmall Global, the impact is almost minimal, as it is charging the players on the platform a fixed fee and brands might market themselves even more aggressively post-tax change to establish an edge.

Meanwhile, B2C players that normally sell products with a low average selling price will suffer quite a severe margin compression. That said, the tax policy has been announced since January and most online platforms have prepared this day for long and probably have educated their customers well enough to smooth the transition.

C2C players seem to be the luckiest ones, as they proclaim their business model to have zero impact from the taxation scheme. However, one of the industry insiders have informed us that the Customs will implement a new system starting this June to prevent C2C players from taking advantage of the system, which will eventually cost them a fortune on tax bills.

Mia.com reminds every buyers and sellers that they need to pay taxes now

Ensure fair competition a key motive behind this regulatory action

It is unfair to say this is a “protectionist” move, as it lacks a real target to protect. Brick-and-mortar retailers that still survives have a different target audience from the online shopaholics. Meanwhile, consumers yearn for overseas products for quality, yet they lacked real protection, particularly in the case of “stocking model” as products cannot be recalled and replaced after long stocking period.

Plus, most e-commerce trading platforms have been taking advantage of this tax scheme for long, and this is not a normalized policy stance in the medium term. While the “policy dividend” of “tax-free treatment” might be considered as a short-term incentive by the government to expand imports and diversify choices for customers, there are quite a few caveats behind this scheme:

1. complaints by customers are on a rise and not at all addressed – Cross-border e-commerce complaint percentage has amounted to 17% according to Ningbo customs, one of the highest amongst all categories, but less than 50% of the complaints were properly addressed by major e-commerce platforms.

2. Volume and product fraud- a number of online platforms have stated astonishingly high GMV figures, in order to expand their valuation in the subsequent financing rounds. This has also given room to a lack of data transparency in this field. There is even product fraud, where the product is manufactured in China instead of overseas, and that constituted a severe violation of law ;

3. Closing the taxation gap between online and offline players is indeed a move of normalization, which means the “pilot scheme” may come to an end, and the government have appreciated the significance of this particular segment, looking for more regulated and healthy growth.

While the new tax scheme is seen to be a rather conservative move, it is by all means necessary to regulate the market as the laissez-faire policies have not done any good to the consumers.

This has been a policy well-communicated rather than a short-term notice. The key for online players for the future is to focus not only on GMV, but also on the quality of its products and enhance the satisfaction rate of its customers, which is a sustainable growth pattern. While the tax scheme may not be a game changer for a lot of the players, it might be a turning point towards quality in the near term.

(CNSPOON)

Ling Zouis the founder of cnspoon.com, a business-focused news & commentary website dedicated to provide more up-to-date, on-the-ground and actionable information for global readers. Its content ranges from macro economy, business sentiment to specific industries, such as properties as well as entertainment and filming.

Zou currently works for a China-focused private equity firm in Hong Kong. He received his bachelor's degree from Yale University in History major and Master of Science Degree from London School of Economics in Economic History.