By Dezan Shira & Associates
Editor: Zolzaya Erdenebileg
Free trade zones (FTZs) are a specific type of special economic zone (SEZ) where goods can be imported, handled, manufactured, and exported without direct intervention from Customs. They play an important role in modernizing China’s business landscape and serve as areas where authorities can experiment with pro-business regulations.
Currently, there are 11 FTZs in China; seven planned FTZs were announced in August 2016. Each FTZ has an industry focus and matching incentives to attract investment. FTZs are of critical consideration for foreign firms, but this decision process is highly dependent on an investor’s business focus and growth prospectus.
Overview of China’s FTZs
Inaugurated in 2013, the Shanghai FTZ was the first in mainland China. It acted as a testing ground for legal innovation, attracting foreign investment with fewer restrictions. The Shanghai FTZ was created with four goals in mind:
- Maintaining and increasing competitive edge;
- Transitioning to a more market-friendly regulatory environment;
- Internationalizing the RMB; and,
- Testing new strategies for reform with intent to duplicate.
By implementing policies meant to fulfil these goals, the Shanghai FTZ laid the foundation for FTZs nationwide. It relaxed incorporation requirements, adopted the use of the Negative List for pre-approval procedures, and implemented a one-stop application process, all measures which were eventually adopted nationwide.
In 2015, the government announced three more FTZs in Fujian, Guangdong, and Tianjin. This time, the government assigned strategic positions for each of the FTZs: Fujian supports trade with Taiwan; Guangdong supports economic integration with Hong Kong and Macao; and, Tianjin supports the northeastern region and helps develop offshore financial markets.
In 2016, the government announced plans for seven more FTZs, underlining the government’s long-term plans to develop inland China and support the One Belt, One Road (OBOR) initiative. The FTZs are in Chongqing, Liaoning, Henan, Hubei, Shaanxi, Sichuan, and Zhejiang.
Major incentives provided by FTZs
There are several incentives to invest in an FTZ. Here, we explore: tax; customs clearance; international trading center benefits; and, industry-specific liberalizations.
The following FTZs offer a reduced corporate income tax (CIT) of 15 percent if the firm fulfils certain requirements:
- Hengqing New Area, Guangdong FTZ;
- Qianhai Shenzhen-Hong Kong Modern Service Industry Cooperation Zone (Qianhai Shenzhen- Hong Kong Zone), Guangdong FTZ; and,
- Pingtan Comprehensive Experimental Area, Fujian.
As FTZs are areas for policy piloting, lower tax rates do not feature as heavily as might otherwise be expected. However, FTZs have started to experiment with other forms of tax benefits. For instance, in the Shanghai FTZ, a FTZ-registered company can pay CIT in installments over a five-year period if the value of its interest in a portfolio company increases because of non-cash restructuring.
Moreover, unless otherwise stipulated, most FTZs allow duty free import for any machinery and other equipment for company self-use.
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The customs clearance process is more streamlined within the FTZs, particularly in regards to clearance declarations and payments. For instance, firms can declare several batches of goods on a single form and make a collective declaration for imports and exports of goods. This reduces clearance costs and increases declaration flexibility for firms.
Additionally, if the firm has provided adequate guarantees, it can pay tax in a one-off lump sum payment within a specified period for goods that have already been imported. To maintain oversight, customs will follow up with tax audits.
In the Shanghai FTZ, border clearance can be done on a monthly or quarterly basis with all waybills. Goods shipped to the FTZ can be directly sent to the warehouse without having to first clear customs. Previously, shipments may have had to wait a few weeks before being sent to the warehouse. When being shipped outside of the FTZ, the goods must clear customs, but the clearance time has been decreased to about two to three days.
Qianhai Shenzhen-Hong Kong Modern Service Industry Cooperation Zone
In the Qianhai Shenzhen-Hong Kong Zone, companies must be engaged in encouraged industries, meaning that their primary businesses are listed in the Preferential Corporate Income Tax Catalogue including modern logistics; information services; science and technology services; and, professional services.
To benefit from the lower CIT, firms have to submit an enterprise income tax preferential application form stating preferential items to the tax authority.
Qianhai Shenzhen-Hong Kong Zone also offers preferential individual income tax (IIT) policies to those who work in the Zone or whose talents are judged to be in line with encouraged industries. If these workers’ IIT on salaries and wages exceeds 15 percent, then the Shenzhen government will subsidize the excess. The IIT preferential policy is only available to candidates who are:
- An overseas high-end talent as measured by the national, provincial, or city level government;
- Management or technical talents from World Top 500 enterprises or its branches, as well as enterprises headquartered in Qianhai Shenzhen-Hong Kong Zone;
- Have internationally recognized qualifications or an invention patent needed domestically;
- Management or technical talent of other enterprises with above-medium level position; or,
- Identified as a talent in short supply needed for the development of Qianhai.
The individual must have worked in the Qianhai-based enterprise for more than one year, and the IIT must be legally paid in the Qianhai tax bureau. The IIT fiscal subsidy should be applied for in the first two months of the year.
International trading center
Due to the number of companies already located within the FTZ and the existing infrastructure, FTZs have supply chain advantages.
In the Shanghai FTZ, for example, goods can be delivered to the FTZ and stored within a warehouse without paying customs tax. The customs tax will only be due if it is shipped domestically. If the goods are shipped internationally, then they are not subject to tax or customs clearance.
In the Plan for the Comprehensive Deepening of the Reform and Opening-up of the China (Shanghai) Pilot Free Trade Zone (“the Plan”), issued by the State Council on March 31, 2017, the government announced creation of a “single window” for goods and services trade. Based on the UN standard, the single window would establish a single point for customs clearance, documentation, IT, regulatory oversight of shipments, and connections with other major ports.
FTZs have liberalized policy for FIEs in specific industries or capabilities that are not yet widely available in China. For instance, logistics companies established within FTZs are allowed to invest up to 51 percent in international or domestic shipping agencies. Additionally, in the Shanghai FTZ, foreign ships are allowed to ship to other domestic ports; shipment between domestic ports was previously limited to Chinese-owned ships.
In the pharmaceuticals sector, under article 10 of the Plan, owners of intellectual property (IP) for medical devices can now entrust production of the device to an eligible OEM manufacturer in Shanghai; the IP owner and the manufacturer previously had to be the same.
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Where to set up
FTZs allow the government to test and adjust policies for eventual expansion. As such, many foreign investors are confused as to the strategic advantage of establishing inside an FTZ in the first place.
When first rolled out, the Shanghai FTZ was highly attractive to investors for its one-stop application processing and reduced minimum registered capital requirements. However, both of these policies were implemented nationwide, leading some to question: should investors focus only on FTZs or should they expand their focus to other classes of special economic zones? It depends on your industry and business needs.
According to Amber Liu, Senior Manager of Corporate Accounting Services in Shenzhen, preferential tax policies is one of the major advantages of establishing within the Qianhai Shenzhen-Hong Kong Zone. But she warns that companies should be vigilant about their eligibility and the application process. “Companies must first be within the industries that are encouraged within the FTZ, and fulfil revenue requirements. Furthermore, they should be aware of, and diligent in, the application process – otherwise their application may be denied.”
The Chinese government plans to continue piloting policy innovations in FTZs, meaning that investors would be the first to benefit from any new policies. For example, the Shanghai FTZ debuted a corporate registration website that allows for online appointments, pre-registration services, and a trial mobile app. On the other hand, as the first to pilot new policies, entities within the FTZ are also the ones that would have to deal with the initial confusion and lack of clarity.
Establishing within an FTZ does not guarantee success. For some businesses, the policy and trade environment within the Zone may present competitive advantages, while it may be less beneficial for others. Before making the decision, firms should do their homework and consult with experts to understand which path is the best path for the company’s expansion.
This article is an excerpt from the latest issue of China Briefing magazine, titled “China’s Investment Landscape: Finding New Opportunities.” In this issue of China Briefing magazine, we examine how foreign investors can capitalize on China’s latest FDI reforms. First, we outline new industry liberalizations in both China’s FTZs and the country at large. We then consider when an FTZ makes sense as an investment location, and what businesses should consider when entering one. Finally, we give an overview of China’s latest pro-business reforms that streamline a wide range of administrative and regulatory measures.
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