Local Content Requirements After China's WTO Entry

While there doesn't appear to be any explicit local content requirements in any published national or local Chinese regulations, there is the possibility that these may exist in neibu, or internally circulated administrative directives. Recent comments made by officials at the Ministry of Information Industry suggest that this may be the case. One official stated that manufacturers in the People's Republic of China were required to include at least 60% local content in their finished products. The official, however, could not cite any existing local or national regulations where this obligation was set out.

Making a Commitment to Use Local Content

Another source of local content requirements can be found in the documents prepared by foreign investors in order to form a FIE in China. During the establishment process, Chinese officials often insist that the feasibility study reports prepared by applicants include the stated intention of utilizing locally produced parts and components within their future manufacturing operations. It is also not unusual for foreign investors to be obliged to reiterate this commitment in the FIE's joint venture contract or articles of association. In circumstances where foreign investors are in an unfavourable bargaining position with the approval authorities during the establishment period, these commitments can be quite extensive. Foreign investors may be willing to concede more to the approval authorities in industries where the number of foreign players is tightly controlled, such as mobile phones manufacturing. It will be interesting to see how the recent amendments to the laws governing joint ventures and wholly foreign-owned enterprises impact upon these long-standing requirements.

Local Content Requirements and Tariff
Assessment

Local content obligations can also be found in the particular weighting of China's tariff rates and classifications for mechanical and electrical products. For example, the import of the key mobile phone components attracts a preferential duty rate of between 7% and 10%, whereas completed handsets incur a rate of 12%. In order to discourage the practice of importing into China complete handsets as disassembled components so as to avoid the higher finished product rate, Chinese customs regulations under Rule 2(a) of the General Rules for the Interpretation of the Harmonized System of the Duty Regulations under the Customs Tariff Rules state that if imported parts or components have the “essential characteristics” of the finished product, they will be charged duty at the finished product rate.

The Old Rule on “Essential Characteristics”

Under the Notice Concerning the Issuance of the Provisions Concerning the Principles for Determining Whether Imported Parts and Components Have the Essential Characteristics of Finished Mechanical and Electrical Products the Import of Which are Restricted by the State and the Examination and Approval and Levy of Duty (for Trial Implementation), effective from June 1 1987, imported sets of parts and components for mechanical and electrical products will be deemed to have the “essential characteristics” of finished products, if they have a dutiable value equal to or more than 60% of the finished products. While this rule succeeds in stopping duty evasion in this way, it also obliges manufacturers in the PRC to source substantial amounts of the parts and components for their mechanical and electrical products locally or risk paying higher duties on shipping these into the country. Perhaps this 1987 Notice may be among the first batch of regulations to be repealed once China enters the WTO.

Circumvention

Foreign investors have found ways to circumvent the existing system so as to avoid the local content obligations. For example, in some customs jurisdictions, manufacturers in the PRC have been able to purchase imported components from third parties, usually import/export companies, and have these treated as “local components” for the purposes of satisfying the 60% content rule.

Despite the continued existence of these local content obligations, as a member of the global trading body, China will need to address complaints by foreign investors that such local requirements are inconsistent with the provisions of the TRIMs Agreement. The impact of the 60% content rule may also be lessened once China reduces import duties owing on imported mechanical and electrical products, and on a wide range of products covered by the Information Technology Agreement. Time will tell, and the clock is ticking.

By Nancy Leigh,
Baker & McKenzie,
Hong Kong