Currently, only 1 per cent of foreign capital invested directly in China is invested in the commercial sector. At the end of June 2001, the number of foreign-invested commercial enterprises in China accounted for only 0.1 per cent of the country's total investment in the sector. The liberalisation of the distribution and trading rights regime under China's World Trade Organisation (WTO) commitments will no doubt change this landscape and change business strategies for firms that currently conduct distribution via middlemen and trading companies in bonded zones.
The retail sector
China's WTO accession pact in the retail sector includes the following provisions:
-upon accession, minority retail joint ventures may be set up in Zhengzhou and Wuhan;
-no more than two retail joint ventures may be set up in each of the five special economic zones (Shenzhen, Zhuhai, Shantou, Xiamen and Hainan) along with Tianjin, Guangzhou, Dalian and Qingdao. Four joint ventures are permitted in both Beijing and Shanghai. Two of the four joint ventures set up in Beijing may set up multiple branches in the city;
-within two years of accession, foreign majority equity share is allowed in these joint ventures and geographical restrictions will be further liberalised to include all provincial capitals and Chongqing and Ningbo;
-within three years of accession, there will be no restrictions.
Even before China's accession to the WTO in December last year, under trial measures on foreign-invested commercial enterprises issued in June 1999, foreign investors were permitted to establish retail joint ventures in all provincial capitals, special economic zones, capitals of autonomous regions and municipalities directly under the central government. However, the establishment criteria for such ventures was high: foreign investors had to show an average annual merchandise sales volume of at least US$2bn during the three years preceding the application and assets of not less than US$200m in the year before the application.
Oddly, some of China's WTO commitments in this sector seem more restrictive than what was allowed previously. For example, the WTO commitments place a limit on the number of ventures that may be established; this was not the case under the trial measures. Furthermore, the trial measures permitted the establishment of commercial ventures in all provincial capitals, whereas the WTO commitments only do so two years after accession. These inconsistencies must still be ironed out.
For foreign-invested retail ventures already in existence, it is likely that China will adopt a grandfathering clause and allow ventures operating outside the parameters of the WTO commitments to continue operations. However, the rising number of illegal locally approved foreign-invested commercial enterprises – according to the trial measures, all ventures had to be approved by the Ministry of Foreign Trade and Economic Co-operation (Moftec) and the State Economic and Trade Commission (SETC) – has led to a crackdown on such ventures.
In August 2000, Moftec, SETC and the State Administration for Industry and Commerce issued a more stringent notice requiring all such ventures be rectified by the end of 2001. According to SETC statistics, 356 foreign-invested commercial enterprises had been operating in China since 1992, but only 40 had obtained central government approval. The notice sent a message that the central government intended to clean up the sector prior to WTO entry, but new statistics are not yet available as to how many of the 356 enterprises successfully obtained approval before the deadline.
As a sign that the government intends to abide by its WTO commitments, recent reports indicate that Carrefour, the French retailer, obtained approval to establish five more purchasing centres in China six months after it was ordered by the government to apply for SETC approval for 27 of its stores in China that had previously only obtained local approval. Furthermore, Wal-Mart, the giant US retailer, has obtained approval to establish operations in Beijing.
The wholesale sector
China's WTO commitments in the wholesale sector include:
-within one year after accession, foreign suppliers of wholesale trade and commission agents' services will be permitted to establish joint ventures to engage in the wholesale business of all imported and domestically produced goods, except for sensitive goods, including salt, tobacco and books;
-within two years of accession, majority foreign-owned joint ventures will be allowed and all geographical and quantitative restrictions will be eliminated;
-within three years of accession, there will be no restrictions.
Interestingly, the trial measures also allowed for the establishment of foreigninvested wholesale joint ventures to engage in the wholesaling of domestically-made products and products imported for their own account and the export of domestically-made products. As with retail enterprises, the establishment requirements for such enterprises are high.
However, the trial measures clearly stated that such ventures could not conduct import/export agency business. China's WTO commitments in the wholesale sector, along with its commitments on trading rights, imply that after WTO, such wholesale ventures may be permitted to conduct foreign trade in accordance with the phase-in periods described below.
Before accession, companies that wanted to sell and distribute goods not produced by them had to do so via a multi-level structure. Goods were brought into China by domestic companies with foreign trading rights, or import/export rights (often referred to as trading rights). Once goods entered China, they were sold to licensed distributors that on-sold them to retailers. As part of China's WTO accession, China has agreed to phase in foreign trading rights for:
-minority foreign-owned investment joint ventures within one year of accession;
-majority foreign-owned investment joint ventures within two years; and
-wholly foreign-owned enterprises within three years.
Expanding trading rights
China has also committed to expand the business scope of enterprises with foreign trading rights to include agency business and has clarified that trading rights will be extended to both FIEs and foreign companies without a presence in China. This liberalisation of the trading rights regime will eliminate the need to use intermediaries to import and export goods.
In fact, progress has already been made in this sector in a notice issued in July 2001, which makes provisions for limited import/export rights to manufacturing FIEs, foreign-invested holding companies and foreign- invested research and development companies. Fulfilling certain requirements, the notice permits: manufacturing FIEs to purchase and export non-state-controlled goods; holding companies to import products in small quantities from their parent companies and sell them on a trial basis; and foreign-invested research and development companies to import and sell their parent companies' high-tech products in small quantities.
It is also important to note that in the past many foreign investors set up companies in Shanghai's Waigaoqiao free trade zone to conduct domestic trade. Wholly foreignowned trading companies established in Waigaoqiao can conduct international, domestic and intra-zone trade. Trading companies can purchase foreign or domestically produced goods and sell directly, either in yuan or foreign currency, to customers in China and abroad, through the Waigaoqiao commodities exchanges. The commodities exchanges clear the goods through customs and issue VAT invoices for a fee. Once goods are brought into China, import duties apply.
With the liberalisation of the trading rights regime, using Waigaoqiao trading companies to conduct domestic trade will likely lose its appeal to foreign investors. Waigaoqiao companies operate outside the territory of Chinese customs and are treated as foreign companies for customs purposes. Once FIEs are permitted to engage in foreign trade, it may be more efficient to position trading companies inside China.
This article was written by Joanna Ip, a manager in the tax division of Deloitte Touche Tohmatsu in Hong Kong. She can be contacted at email@example.com.