Understanding China’s Free Trade Agreements

February 10, 2014 Posted by China Briefing Reading Time: 8 minutes

Knowledge of China’s ASEAN FTA is Critical when Dealing with Increasing Wage Cost Concerns

Op-Ed Commentary: Chris Devonshire-Ellis

China has developed a strategic position when it comes to entering into free trade agreements – the policy of allowing dutiable and tax reduction on certain products and services being one of the main cornerstones that has projected the nation to be the world’s manufacturing hub over more recent years. Without doubt, the signing of the China-ASEAN FTA is and will continue to have a huge impact on China and Asia’s development in global sourcing and the foreign investment related to this.

Yet, with the legal and tax professions effectively split in China, not many law firms possess knowledge of China’s FTAs, and consequently ignore them when structuring foreign investments into the country. This is problematic as the identification of, and the ability to utilise applicable FTAs, should often be catered for within the articles of association – as well as be negotiated up front with the relevant customs and tax officials in China. Failing to do so can result in tax overheads that are far more than they ever needed to have been. Some consultants have also been known to deliberately withhold such data to prevent an investor gaining interest in markets externally from the PRC and losing the client to another country perhaps better suited to the client’s needs. Many China consultants simply are not aware of the significance of China’s FTAs, or even the post incorporation procedure for registering a China business with the local customs – which includes the intent to invoke treaty status under any applicable FTA. If this is not done at China customs registration, the business can lose all the treaty benefits they are actually entitled to.

That said, the situation can be retrieved – but only through firms both qualified to do so and with an understanding of China’s regulations from both the legal and the tax perspective. China has always been a tax structural play for foreign investors at the start-up stage. Attention to detail needs to be paid so as not to miss out on bilaterally negotiated FTAs that can be highly beneficial.

China’s Free Trade Agreements

China has eleven Free Trade Agreements in operation, with another three under negotiation and another three under consideration. Of these, many are relatively small, although useful for companies from the countries that have them – Chile, Costa Rice, Iceland and Peru. The Pakistan agreement is often invoked in bilateral Sino-Pak relations, which are of course strong, with Pakistan being the largest recipient of Chinese outbound investment in South-East Asia, while China also has an interesting FTA with Switzerland signed off mid last year and due to come into effect later in 2014. Switzerland notably is not a member state of the EU, although it is a member of the European Free Trade Association and has a bilateral agreement with the European Union. Switzerland is one of the few European countries to enjoy a trade surplus with China, and the deal was China’s first with a continental European nation. Switzerland’s trade surplus with China was worth some US$23 billion in 2012, notably through the sale of luxury products such as watches, in addition to chemicals. A big winner in the deal was Nestle, which will be passing on savings it can make under the agreement to reduce consumer prices in China, making its products more competitive.

China’s FTAs also include Hong Kong and Macau, with the Hong Kong version known as the “Closer Economic Partnership Agreement” (CEPA), whose regular updates in terms of its benefits we have long reported about here on China Briefing. The China-Hong Kong CEPA agreement provides numerous benefits to foreign investors that set up local companies in Hong Kong, as (after a qualifying period) these reduce withholding and dividends taxes on monies being repatriated to the territory from the mainland. Macau offers similar benefits and especially in the services and financial sectors – extremely useful given Macau’s emergence as a major tourism and casino destination.

China also entered into an FTA with New Zealand back in 2009, which is being phased in, in terms of what products it covers, over a ten year span. The FTA will eliminate all tariffs on Chinese exports to New Zealand by 2016 and will rid 96 percent of tariffs on New Zealand exports to China by 2019. The agreement will also facilitate mutual investment and trade in services. The deal has been highly beneficial for Kiwi companies such as Fonterra. New Zealand’s seafood industry has also benefitted.

Singapore, with its wealth of financial and other services, also has an FTA with China. Signed off in 2009, this particular treaty focuses on the services industry, in addition to individual income tax benefits. Singapore intends to grow its population by another 2 million people, and many of these are expected to be wealthy mainland Chinese nationals. Corporate benefits include reduction on withholding taxes for a variety of services, including chargeable royalties. This, coupled with Singapore’s low corporate and individual income tax rates, is one of the reasons Singapore is becoming a corporate regional hub for investments into China and Asia, as well as receiving increasing amounts of Chinese outbound investment going the opposite way – into Singapore and for reinvestment across Asia. As foreign investors automatically qualify as Singaporean companies when setting up a subsidiary there, they can also access Singapore’s own impressive array of international tax treaties – which include numerous other FTAs, as well as over 80 bilateral double tax agreements.

Still under negotiation are FTAs with Australia, which has dragged on for several years due to concerns from Australia’s agricultural industry, yet which may be concluded during 2014. Norway is also negotiating, and is a member of EFTA along with Iceland and Switzerland. The Norwegian-China FTA has been under negotiation since 2008, yet like Australia, there are hopes it may be ratified later this year. China is also negotiating the Gulf Cooperation Council FTA, which is a political and economic union of six Arab states that border the Persian Gulf — Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates. All six are oil exporters and represent an important bloc for China. President Xi has been directly involved in these negotiations and has pressed for them to be resolved as soon as possible.

A little further down the pipeline are potential agreements with India, South Korea and a China-Japan-Korea agreement.

Many of these FTAs, once agreed, are being phased in – meaning that consultants handling inbound investment into China from any of these countries or regions need to be on top on the latest developments to allow their clients to take full advantage of what these can, and later will, provide.

However, by far the most important FTA China has negotiated thus far is with ASEAN. With the ASEAN bloc including the Asian Tigers of Indonesia, Malaysia, Philippines, Singapore, Thailand and Vietnam, together with smaller regional players such as Brunei, Cambodia, Laos and Myanmar, this single agreement is reshaping how China and ASEAN manufacturing develops. Many China commentators have been focusing on the increasing labor costs in China, and noting how many China-based businesses are now struggling in the face of rising wages. The ASEAN agreement offers a way out by allowing companies to reposition manufacturing to other low cost areas of Asia, take advantage of these lower costs, yet still be able to service the China market via the duty free imports permitted under the FTA.

This agreement was signed off in 2002, and came into effect three years ago. The ASEAN–China Free Trade Area is the world’s largest free trade area in terms of population and third largest in terms of nominal GDP after the European Union and NAFTA. The original FTA reduced tariffs on nearly 8,000 product categories, or 90 percent of imported goods, to zero. These favourable terms have taken effect in China and original ASEAN members, including Brunei, Indonesia, Malaysia, the Philippines, Singapore and Thailand. Cambodia, Laos, Myanmar and Vietnam will also implement these terms in 2015.

With the implementation of the ASEAN-China Free Trade Area in 2010, the average tariff rate on Chinese goods exported to the ASEAN bloc fell to just 0.6 percent, down from 12.8 percent. The tariff rate on ASEAN goods exported to China also fell from 9.8 percent to 0.1 percent.

The 2015 deadline is of huge significance to China as this includes Vietnam, which has gradually become an alternative destination to China for manufacturing. With Vietnamese wages currently at about a third of those in South China, manufacturing capacity for products ultimately destined for the China market is increasingly finding its way to Vietnam. Details of the China-ASEAN FTA can be found on our ASEAN Briefing website, which also includes regular updates on China’s tax treaty updates throughout the region. Knowledge of what products can now be manufactured externally from China and at lower costs, yet imported into the country duty free is a strategic and economic issue for many manufacturers. Foreign manufacturers automatically qualify for the ASEAN treaty benefits by setting up in an ASEAN nation (such as Vietnam), the qualification requirement being purely geographical.

China’s Free Trade Agreements and especially that with ASEAN should be part and parcel of the new Asian knowledge required to make informed and economically astute investment decisions for international executives when it comes to addressing the China question.

The practical steps to take when looking at invoking FTA benefits are as follows:

Examine whether or not your products are included under the specific FTA;
Examine whether the FTA includes any other benefits such as withholding or dividend tax reductions;
Where applicable, include any applicable treaty benefits into your pre-incorporation business plan and articles of incorporation;
Examine any customs registration processes that may require additional registration and intent to invoke treaty status. This certainly applies in China;
If you have not completed this process or are unsure, seek professional advice to remedy the situation. Even given fees, the tax amount saved will almost certainly cover them in year one alone.
When completed, your business is FTA enacted and will save on the import and services taxes that would otherwise have been due.

Chris Devonshire-Ellis is the Founding Partner of Dezan Shira & Associates – a specialist foreign direct investment practice providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.

For further details or to contact the firm, please email china@dezshira.com, visit www.dezshira.com, or download the company brochure.

You can stay up to date with the latest business and investment trends across Asia by subscribing to Asia Briefing’s complimentary update service featuring news, commentary, guides, and multimedia resources.

Related Reading

AB-Tax-Treaties-Cover An Introduction to Tax Treaties Throughout Asia
In this issue of Asia Briefing Magazine, we take a look at the various types of trade and tax treaties that exist between Asian nations. These include bilateral investment treaties, double tax treaties and free trade agreements – all of which directly affect businesses operating in Asia.

An Introduction to Development Zones Across Asia
In this issue of Asia Briefing Magazine, we break down the various types of development zones available in China, India and Vietnam specifically, as well as their key characteristics and leading advantages. We then go on to provide a snapshot of the latest development zones across the rest of Asia. With several hundred development zones operating in the region, it is impossible to cover them all in the pages of just one publication. However, we hope that this issue will provide the basic fundamentals to understanding one of the most important business tools available to international businesses operating in Asia.

Are You Ready for ASEAN 2015?
ASEAN integration in 2015, and the Free Trade Agreements China has signed with ASEAN and its members states, will change the nature of China and Asia focused manufacturing and exports. In this important issue of Asia Briefing we discuss these developments and how they will impact upon China and the Global Supply Chain.

Manufacturing in Vietnam to Sell to ASEAN and China
In this issue of Vietnam Briefing Magazine, we introduce our readers to manufacturing in Vietnam as a key part of their business strategy within the ASEAN region and beyond. Specifically, we explain the new ASEAN Free Trade Area, outline what foreign investors can look forward to when creating their manufacturing presence in the country, and introduce the country’s key tax points.