Introduction and benefits of Free Trade Zones in China

1. Introduction and characteristics of free trade zones in China

Free trade zones are economic and customs enclaves attached to a city, a district or a port area. They have administrative and fiscal measures that are different from those applied at the national level. They have been a tool for facilitating the establishment of foreign companies in China, a command economy. The first free trade zones appeared in the coastal cities of Shanghai and Shenzhen in the early 1990s.

To attract foreign investment, they offer preferential investment conditions and a good quality of improved infrastructure and modern warehouses.

Free trade zones are also delimited free trade territories. They offer tax benefits to attract investment and develop economic activity in them. They also offer a good quality of infrastructure and warehouses. The regulatory and tax environment for companies in these regions is often more favorable than in the rest of China. Goods brought in are, from a customs point of view, considered not to be released for consumption in China. As such, they are exempt from import duties. Thus, the free trade zones were pioneers in hosting sites for assembly and production activities of foreign companies. In its nature, they are special economic zones in which enterprises can import and manufacture their products with customs control upon entry but without collecting customs duties.

2. Chinese bonded FTZ history and development

3. The up to date list of China's 21 provincial FTZs

Note : The encouraged activities are almost all those that the Chinese authorities wish to welcome in priority. They are mainly modern and high added value activities. They are non-polluting and respect Chinese standards which have become very demanding in terms of environmental protection.

In this list, the Shanghai and Hainan zones are the best known

Shanghai Free Trade Zone : It is the first one established in China. It covers an area of 240 square kilometers, twice the size of most of the others. Since the 1990s, it has been home to importers/distributors and production sites with a 100% export orientation. More recently, it has attracted a wide variety of industrial and commercial companies, international freight forwarders, CAAC and NVOCC approved carriers, warehousing service providers, storage platforms, offices of e-commerce startups, fintech and iCloud service operators. Since 2013, it has consisted of the combination of the 4 zones of Waigaoqiao, Yangshan (Shanghai deepwater sea port), Pudong International Airport, and a part of Lujiazui Financial Zone, the chinese Manhattan. In 2019, the Lin Gang port area was also included.

Hainan Free Trade Zone : In April 2018, the Chinese government announced its intention to form a pilot free trade zone that covers the entire island of Hainan, or more than 35,000 km2. This area is comparable to that of the neighboring island of Taiwan (36000 km2), slightly larger than the area of Belgium (30500 km2) and slightly smaller than Switzerland (41000 km2). The government plans to create a free port "with Chinese characteristics". In June 2020, the government announced 5 administrative regulations applicable to the Hainan pilot zone. They are in force since June 28, 2020 until December 31, 2024. They cover regulations on customs guarantees, customs duties, international shipping, ship inspection, offshore facilities and domestic waterway transport.

4. Why set up a business in the Free Trade Zone ?

As elsewhere in the world, the average cost of storage and intra-zone transit services is often higher than in other special economic zones. In return, the authorities offer preferential measures to investors who set up a wholly foreign-owned company (WOFE) or a sino-foreign joint venture (JV).

a. Introduction to preferential tax benefits

Some free trade zones offer a significant reduction in corporate income tax (CIT). In China, the standard corporate tax rate is 25% on profits.

For example, some companies registered in the designated sites of the free trade zones in Guangdong and Fujian pay only 15% CIT.

In the Shanghai Free Trade Zone, the level of taxation can also be negotiated to a lowered rate, but is not automatically granted. For example, companies operating in 4 key sectors and registered within the Lingang zone pay only 15% tax for the first 5 years of establishment. These sectors are electronics R&D and production, artificial intelligence, biotechnology and civil aviation. However, the authorities will have requirements in terms of tax profitability for example and possibly for other criteria of their assessment, depending on the sector and the investor's reputation.

b. Duty-free importation and bonded warehousing

Free Trade Zones allow companies to import products free of duties and taxes. Customs duties are paid only if products finished or assembled in the Zone enter China. For this reason, many companies that import high value-added products have set up a storage warehouse in the Zone. These items include high value-added electronic components, perfumes, cosmetics, luxury leather goods, high-end cars, wines and spirits. Generally speaking, all products that are heavily taxed upon importation find benefits to be stored in these bonded zones.

From the point of view of storage conditions, there are modern storage warehouses that meet the requirements of the China FDA (food) or NMPA (cosmetics, medical devices) for the most sensitive products. These requirements include food products, pharmaceuticals and medicines.

In addition, if the compliance conditions are met, most of them allow duty-free imports for capital goods useful for manufacturing or production activity.

Products imported on a temporary basis, for outward processing in China for example, may benefit from being modified in these zones.

c. Import customs clearance, cross-border sales and in-bond logistics

Free trade zones streamline the import clearance process. Import declarations are made online. The payment of duties and taxes to Chinese customs can be done by direct debit. Thanks to an adequate infrastructure and consistent means, the clearance and delivery of goods are fast. Sometimes it takes only a few hours..

French and Western exporters who do not have a presence in China can also opt for a consignment solution of a bonded stock in China. This allows them to make cross-border sales and deliver to their Chinese customers from a stock in China. A saving of time and cost of routing products.

d. Towards a certain financial liberalization of bonded zones

Financial deregulation in free trade zones contributes to a certain fluidity of capital. For example, the free convertibility of the yuan (CNY) is allowed on capital accounts and for cross-border trade between zones. Elsewhere in the country, the Chinese currency is still not freely convertible.

e. Restrictive investment conditions for international companies

China has established a national negative list of foreign investments. The term "negative list" refers to areas where investment is restricted or prohibited for foreign companies.

Compared to the national negative list, the one for free trade zones describes measures to open up a few key areas. These are agriculture, mining, culture and value-added telecommunications. This illustrates that the country continues to gradually ease its restrictions on foreign investment. The most favorable sectoral openings are often in the free trade zones first.

China should continue to reduce its negative list to increase access for foreign investment and offer more business opportunities to French and Western companies. The current negative list dates back to 2022. The next update is expected in 2023 or 2024.

5. Current performance of Chinese free trade zones

They represent 17.6% of foreign investments made in an area of less than 4‰ of the national territory.

By the end of 2021, a total of 393,000 enterprises have been established in the then 18 zones. With less than 4‰ of the territory, these free trade zones host 17.6% of foreign investment and account for 14.7% of China's imports and exports. They play an important role in stabilizing foreign trade and investment in China.

From its establishment in 2013 to 2019, 11,000 new foreign-owned companies have been registered. This accounts for 20% of the 55,000 companies established in the zone. In 2020, the cumulative foreign investment amounted to USD 26.3 billion.

During 2019 alone, 1,300 foreign-owned enterprises are newly incorporated in Shanghai FTZ. They weigh a total investment of 6.77 billion USD, accounting for 39.13% of Shanghai's foreign investment in the same year.

There are some new government projects that welcome foreign investment in Shanghai. They include the first vocational training institution, first international ship management company, first medical institution. These sectors were previously reserved for domestic investors only.

In Hainan, 149,000 new enterprises were established in 2020, an increase of 107% over 2019. Among them, 1,005 new foreign-owned enterprises are established, an increase of 197% compared to 2019.

In 2020, the total sales of duty free stores in Hainan amounted to 33 billion RMB (5.1 billion USD). This is an increase of 127% over the previous year.

Chinese authorities say "the construction of pilot free trade zones with high standards will help stabilize trade, investment and build a high-level open economic system". In the future, China should continue to develop FTZs that will be more and more autonomous.

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