Export Procurement Centres as a New Foreign-invested Trading Vehicle

However, for the purpose of introducing advanced management skills into China and to encourage greater exports, the government has introduced the FIEPC Procedures. Foreign investors may establish foreign-invested export procurement centres (FIEPC), which engage in the procurement of products in China and the exportation of the same products abroad. Under the FIEPC Procedures, a foreign investor can wholly own an FIEPC (a trading company with full rights of exportation) a year prior to the schedule for complete opening of the trade sector according to China¡¦s WTO commitments.

In addition, although by the end of 2004, the trading industry will be fully open to foreign investment, it is well accepted that such a commitment means only that foreign investors may apply for the establishment of wholly foreign-owned trading enterprises by this time. It is entirely possible that new requirements for foreign investment and engagement in trading (e.g., registered capital and annual turnover requirements from the investor) will be introduced or existent requirements will be adapted. Accordingly, it appears that an FIEPC may still be used as a foreign-invested trading vehicle in circumstances wherein a foreign investor cannot satisfy all requirements for the establishment of a foreign-invested trading company.

Establishment of an FIEPC

An FIEPC must be a limited liability company, i.e., either a wholly foreign-owned enterprise or a Sino-foreign equity joint venture. The following requirements must be met for the establishment of an FIEPC: (i) a foreign investor applying to establish an FIEPC must maintain an international marketing network and be capable of export procurement; (ii) the Chinese investor must maintain a good credit record and must be able to engage in export procurement if an export procurement centre takes the form of a Sino-foreign joint venture; and (iii) the registered capital of an FIEPC must be at least Rmb30 million. The requirements for a marketing network and the capability to conduct export procurement are subjective and therefore registered capital is the more critical requirement.

In order to establish an FIEPC, the applicant (the Chinese investor if the intended FIEPC takes the form of a joint venture, or the foreign investor if the intended FIEPC takes the form of a wholly foreign-owned enterprise) should apply to the authority in charge of foreign investment at the provincial level by submitting documents including, among others: (i) an application letter signed by the applicant; (ii) a copy of the business licence or the certificate of incorporation of the intended FIEPC; (iii) a credit rating certificate for the foreign investor; (iv) a copy of the identification certificate of the legal representative of the intended FIEPC; (v) a feasibility study report; (vi) articles of association of the intended FIEPC (and the joint venture contract if the intended FIEPC takes the form of a joint venture); and (vii) a list of directors with their biographies. If the authority preliminarily approves the application, it will forward these application materials along with their preliminary opinion to MOFCOM. The latter will be in charge of final examination and will decide whether to approve the establishment of the FIEPC and to issue an approval certificate to the applicant. When the applicant obtains the approval certificate, it may apply for a business licence evidencing the establishment of the FIEPC.

Operation of an FIEPC

Scope of Business

As its name indicates, the main business of an FIEPC should be the procurement and exportation of domestic products. Specifically, an FIEPC may conduct the following activities: (i) sourcing products in the domestic market and exporting these products; (ii) providing storage, information consulting and technical services related to export; (iii) importing raw and auxiliary materials, engaging local manufacturers to process such materials and exporting the processed materials; and (iv) importing sample goods to be used for export processing. It appears that an FIEPC may enjoy a wide scope of business in connection with exportation. The key factor regarding the scope of business of an FIEPC is that all products of such FIEPC, either sourced from the Chinese market or manufactured by local enterprises subject to the FIEPC¡¦s engagement, must be sold overseas.

In principle, an FIEPC may not sell its products domestically. However, in special circumstances when products manufactured with imported materials by a local enterprise (under the FIEPC¡¦s engagement) are not exported, the FIEPC may apply to the authority in charge of foreign trade for an approval letter. Only with the approval letter may the FIEPC sell domestically the abovementioned products.

Tax Issues

Generally speaking, an FIEPC, like any ordinary foreign-invested enterprise (FIE), is subject to income tax at the rate of 33% (of which 30% is state tax and 3% is regional tax). Unlike a manufacturing FIE, an FIEPC will not enjoy a preferential income tax rate of 15% if located in an economic and technology development zone or a high-tech development zone, nor is it entitled to preferential income tax treatment in the usual form of a two-year exemption and a 50% tax reduction for three years thereafter. However, if an FIEPC is located in a special economic zone or in the Pudong area of the Shanghai municipality, it will enjoy a tax rate of 15%. It appears that the income tax rate is not very beneficial for FIEPCs.

With respect to export tax rebates, an FIEPC may enjoy the same rebate status as a purely domestically owned trading company. If an FIEPC is registered outside of a free trade zone, it may obtain an export tax rebate as if it were a foreign-invested holding company. In other words, if an FIEPC procures domestically manufactured products and exports these products abroad, it should first reimburse the seller for the value-added tax arising from sale of the products. After the products are exported, the FIEPC may obtain a tax rebate by submitting export declaration documents to the tax bureau where the FIEPC is located. If an FIEPC is located in a free trade zone, it will be treated as a normal trading company in a free trade zone for the purposes of tax rebates. In other words, an FIEPC in a free trade zone may choose, upon negotiation with its supplier, either of the following arrangements: (i) the FIEPC acts as exporter, i.e., the FIEPC reimburses the supplier for value-added tax and obtains a tax rebate when the products are exported; or (ii) the supplier acts as the exporter, i.e., no value-added tax is paid by the supplier nor is it reimbursed by the FIEPC. Consequently, the FIEPC receives no tax rebate.

Comparison of an FIEPC with Other Trading Vehicles

Prior to the promulgation of the FIEPC Procedures, there existed under the PRC legal system certain types of foreign-invested vehicles that could, to a certain extent, conduct a trading business. Each type of foreign-invested vehicle has its advantages and disadvantages. The following is a summary comparison of FIEPCs and these other types of trading vehicles.

FIEPCs and Trading JVs

Under the current legal system, a foreign investor may establish, with a Chinese partner, a Sino-foreign trading joint venture (a Trading JV). A Trading JV, upon approval, may conduct foreign trade or domestic trade business.

Compared to an FIEPC, the requirements for the establishment of a Trading JV are stiff: (i) the Trading JV must be a Sino-foreign equity joint venture; i.e., foreign investors may not wholly own a Trading JV; (ii) a Trading JV is usually required to have registered capital of no less than Rmb50 million, which is higher than the registered capital requirement for an FIEPC; (iii) the average annual value of trade with China of the foreign investor of the Trading JV must be above US$30 million in the previous three years if the Trading JV is to engage in foreign trade and the average annual sales turnover of the foreign investor must be no less US$2 billion if the Trading JV is to engage in domestic trade.

The advantage of a Trading JV is that it may conduct, upon approval, importation as well as domestic trading activities that may not be conducted by an FIEPC.

FIEPCs and FIHCs

A foreign-invested holding company (FIHC) is another type of foreign-invested vehicle that a foreign investor may use to conduct a trading business in China. An FIHC, in the PRC legal system, refers to a foreign-invested limited liability company established in China to carry out direct investment activities. A secondary function of an FIHC is to provide trade-related services to its subsidiaries in China.

The law sets forth stricter requirements for the establishment of an FIHC than for the establishment of an FIEPC. Generally speaking, the requirements for an FIHC include: (i) the total assets of the foreign investor for its fiscal year prior to the application must be at least US$400 million; (ii) the foreign investor must have contributed at least US$10 million in registered capital to its foreign-invested enterprises in China; (iii) the foreign investor has already obtained approval for at least three proposals for foreign-invested projects; and (iv) the registered capital of the FIHC must be at least US$30 million.

An FIHC may conduct both importation and exportation as well as domestic sales. Unlike an FIEPC, which may procure and export products manufactured by any supplier, however, trading businesses conducted by an FIHC must be conducted on behalf of, for the benefit of, or related to, the foreign investor of the FIHC or to its subsidiaries in which the FIHC holds at least 10% equity. Many foreign investors choose FIHCs as the vehicle to exploit the trading functions of their subsidiaries.

FIEPCs and Expanded FIEs

Generally speaking, a manufacturing foreign-invested enterprise (Manufacturing FIE) may only sell self-manufactured products. However, a qualified Manufacturing FIE may, upon approval, convert itself into a Manufacturing FIE with expanded import/export rights (Expanded FIE) so that it can export products that are sourced from other domestic enterprises.

The requirement for the conversion to an Expanded FIE is not very strict. The main condition for the conversion is that the annual value of exportation of the Manufacturing FIE should be no less than US$10 million.

However, it should be pointed out that an Expanded FIE is, by nature, a manufacturing enterprise (while an FIEPC is a trading enterprise). In other words, an Expanded FIE must conduct certain manufacturing activities in addition to its trading business. Further, unlike an FIEPC, an Expanded FIE is not entitled to an export tax rebate, which materially weakens the economic feasibility of Expanded FIEs¡¦ engagement in exportation.

FIEPC and FTZ WFOEs

In spite of national law and the central government¡¦s desire to control and direct foreign investment in certain industries (e.g., trading), some local governments have enacted regional rules and developed infrastructures to allow the establishment of wholly foreign-owned trading companies in free trade zones (FTZ WFOEs) to attract foreign investment.

The requirement for the establishment of an FTZ WFOE is even less strict than for the establishment of an FIEPC. An FIE WFOE is required to have a minimum registered capital of US$200,000, which is much lower than that for an FIEPC. In addition, the business scope of an FTZ WFOE may cover import and export as well as domestic trade.

The disadvantages of an FTZ WFOE, compared to an FIEPC, include the fact that an FTZ WFOE must be located in free trade zones, while an FIEPC may be set up in any city in China. Further, the legality of utilizing an FTZ WFOE in order to engage in domestic trade is highly questionable. Although authorities of the free trade zone where an FTZ locates will never challenge the domestic trading activities of an FTZ WFOE, as a practical matter, domestic trade will not be stated in the scope of business of the business license of an FTZ WFOE. Therefore, an authority outside such a free trade zone may regard the domestic trading activities as being beyond the approved scope of business and may impose a penalty on the FTZ WFOE.