China has traditionally restricted foreign investment in the retail and wholesale sectors with the aim of nurturing strong domestic players before their foreign counterparts would be allowed into the country.
But since becoming a member of the WTO, the country has gradually opened its distribution sector to foreign investment.
A revised policy implemented through a number of regulations – the key ones being the "Measures for the Administration of Foreign Investment in the Commercial Sector" (Commercial Measures), introduced June 1, 2004, and the "Notice of the Ministry of Commerce on Entrusting Local Authorities with the Examination and Approval of Commercial Enterprises with Foreign Investment", which came into effect March 1, 2006 – is part of a wider drive to give foreign investors greater access to foreign trade rights.
Foreign investors are permitted to engage in four forms of distribution activities: commissioning agents' services, retailing, wholesaling, and franchising.
Investors must establish a commercial enterprise with foreign investment – a commercial FIE – if they wish to engage in these distribution activities. The parties involved can be foreign companies, enterprises or other economic organisations as well as foreign individuals.
Commercial FIEs can be established in partnership with Chinese counterparts in joint ventures or as wholly foreign-owned enterprises. However, not all of these enterprises may be fully controlled by an overseas party.
As it stands, products including books, magazines, motor vehicles, newspapers, pharmaceuticals, pesticides, chemical fertilizer, processed oil, grain, sugar and cotton are subject to restrictions. Commercial FIEs with more than 30 outlets dealing in such goods sourced from multiple suppliers must take the form of a joint venture in which the foreign investor has a minority stake. The restrictions are due to be lifted on December 11, 2006.
Investors are required to have good reputation and be law-abiding. In terms of minimum registered capital, the figure is RMB30,000 (US$3,700) for commercial FIEs engaging in wholesale or retail activities. However, the authority in charge of approving the establishment may impose a higher registered capital requirement to match the proposed scale of a commercial FIE's business activities.
The investment must comply with the minimum debt to equity (registered capital) ratios imposed under Chinese law unless the commercial FIE deals in agricultural by-products and agricultural production materials.
The term of operations should normally not be longer than 30 years but may be as long as 40 years in the central and western regions of China.
A retail commercial FIE may engage in commodity retailing, commodity import for its own account, sourcing of domestic products for export and other relevant ancillary activities. Activities such as commodity wholesaling, the commissioning of agents' services (except for auctions) and commodity import-export are open to wholesale specialists.
A commercial FIE may engage simultaneously in one or more of the listed business activities and may authorise third parties to open franchise shops.
For guidelines regarding the operation of franchising business, it is necessary to turn to the "Measures for the Administration of Commercial Franchising Operations" (Franchising Measures), effective from February 1, 2005.
In order to grant franchises, a franchisor must have operated two directly owned stores in the PRC for at least one year.
The measures are silent on the principles governing the granting of franchises by overseas operators to franchisees inside the PRC. It is expected that relevant regulations will be issued in due course.
A commercial FIE must specify the range of products it distributes in the business scope of its corporate establishment documents. Thereafter it is only permitted to deal in those types of products.
The import and distribution of certain categories of products in China are subject to various forms of state control. If the products in which a commercial FIE deals are covered by special state regulations or are subject to import-export quotas and licensing controls, the enterprise must comply with the relevant requirements.
Whilst the Ministry of Commerce (MOFCOM) is the principal approval authority for commercial FIEs, it has largely delegated its approval powers to the provincial level departments in charge of commerce.
Within the scope of these powers, the provincial commerce authorities can approve the establishment of commercial FIEs and are only required to report the matter for the record to MOFCOM.
However, there are circumstances in which ministerial approval is required. A commercial FIE involved in sales through television, telephone, mail order, Internet or automatic vending machines can only do business with MOFCOM's say-so.
The same applies to enterprises that distribute important raw materials such as steel, rubber, fuel oil and precious metals or those that deal in products including books, newspapers, periodicals, processed oil, pharmaceuticals, motor vehicles, tobacco, salt, edible sugar, grain and cotton.
In those instances where approval by MOFCOM is required, an application for the establishment of a commercial FIE must be submitted first to the provincial commerce authority in the proposed investment location. After preliminary examination, the provincial commerce authority forwards the application to MOFCOM within one month.
MOFCOM then has three further months to decide whether or not to give the green light.
If an existing FIE intends to expand its business scope with distribution rights, it must follow the same approval procedures that apply to the establishment of new enterprises.
Commercial FIEs may set up shops provided that this complies with urban development and urban commercial development regulations.
An already established commercial FIE may only set up a new outlet if it has passed the annual inspection and has paid up its registered capital in full.
Applications to open new outlets are dealt with by MOFCOM. Authority can be delegated to provincial level officials – who then simply inform the ministry of approval – in certain circumstances, namely:
o the area of a single outlet does not exceed 5,000 square meters and there are not more than three outlets in total, and the foreign investor has not opened more than 30 outlets in the same class in China through commercial FIEs;
o the area of a single outlet does not exceed 3,000 square meters and there are not more than five outlets in total, and the foreign investor has not opened more than 50 outlets in the same class in China through commercial FIEs;
o the area of a single outlet does not exceed 300 square meters.
Hong Kong and Macau
Qualified Hong Kong and Macau service suppliers are granted greater access to the distribution sector than other suppliers under the provisions of the Closer Economic Partnership Arrangements (CEPA).
These Special Administrative Region suppliers can set up wholly-owned car retailers without any restrictions.
Hong Kong service suppliers are also permitted to operate commission agents' services for business relating to chemical fertilizer, processed oil and crude oil. The same provisions apply in wholesale and retail services for chemical fertilizer, on a wholly-owned, equity joint venture, or contractual joint venture basis.
There is also preferential treatment for Hong Kong service suppliers who open more than 30 stores on the mainland selling a wide range of products including books, newspapers, magazines, motor vehicles, pharmaceuticals, pesticides, staple food and cotton.
If those goods are of different brands and come from different suppliers, the Hong Kong service supplier may be the controlling shareholder in the commercial FIE. The maximum permitted shareholding is 51%.
Franki Cheung is a partner and leads the China practice group at law firm Deacons