Grand Opening: New Rules for Foreign Investment Break Open China's Commercial Sector

¡P WFOEs will now be permitted in the sector as of December 11 2004, subject to certain restrictions;

¡P the high threshold registration requirements have been eliminated;

¡P investors will benefit from a wider scope of permissible retail and wholesale activities, including previously off-limits franchising, and commissioned sales for wholesalers;

¡P wholesalers are no longer subject to geographical limitations, and retailers will no longer be subject to geographical limitations as of December 11 2004; and

¡P the approval process has been simplified.

Nevertheless, certain restrictions remain with respect to equity share and product lines.

Investor Qualifications

The 1999 Procedures imposed high qualification requirements for investors. The foreign party in a retail joint venture had to have average annual sales of US$2 billion in the three years prior to application and net assets in the year before application of US$200 million. For wholesale enterprises, the foreign party needed US$2.5 billion in annual sales and US$300 million in net assets. The Chinese party also needed to meet high annual sales thresholds, as well as high import and export values if it was a foreign trade company. These requirements effectively kept out many of the smaller, more entrepreneurial foreign companies, and impeded the development of private sector PRC distributors and commercial entities.

The new Procedures eliminate all such requirements, although they "encourage" foreign parties with strong economic means, advanced distribution skills and management experience, and broad overseas marketing networks to apply. Foreign applicants need only have a good reputation and a clean record. This provision may hurt those companies that have already entered China, and in their rush to penetrate the market have broken the rules.

In addition, the Procedures now permit foreign individuals and "other organizations" as well as foreign companies to establish retail and wholesale companies in China.

Registered Capital Requirements and Term

Prior to the issuance of the Procedures, retail joint ventures needed Rmb50 million in minimum registered capital (Rmb30 million in the western and central regions). The minimum registered capital for wholesale joint ventures was Rmb80 million, and Rmb60 million for operations in central or western China. The new Procedures require only that the parties meet the minimum amount to establish a company under the PRC Company Law(中华人民共和国公司法), which is currently Rmb300,000 for retailers and Rmb500,000 for wholesalers. Commercial FIEs must also comply with the generally applicable registered capital and total investment rules for FIEs, including registered capital to total investment ratios and deadlines for contributions that vary depending on the amount of investment.

Whereas in the past, the term was limited to 30 years (40 years in the western and central regions), the Procedures suggest there may be some flexibility by providing that the term "in general" shall not exceed 30 years and 40 years, respectively. Although exceptions may be difficult to obtain from MOFCOM, they may be more readily available if MOFCOM delegates approval authority to provincial branches.

Equity Ratios

Before the issuance of the Procedures, the Chinese party was required to hold at least 51% in joint ventures in the wholesale business, or in retail ventures having three or more stores (excluding convenience stores, professional stores (zhuanye dian) and special brand stores (zhuan mai dian)).

In general, foreign parties are no longer limited to a minority share. However, foreign investors are still limited to 49% where the foreign investor has opened more than 30 outlets that engage in distribution of books, newspapers, magazines, motor vehicles (until December 11 2006), pharmaceutical products, pesticide and mulching films, chemical fertilizers, processed oil and crude oil, cereals, vegetable oil, sugar and cotton, and where the products are from multiple suppliers and have different brand names.

Scope of Business

The currently allowed scope of business for a retail company includes sales of products, import of products for its own business, purchase and export of domestic products, and related services, including after-sales services. Wholesale companies may sell products on a wholesale basis, act as a commissioned agent (excluding auctions), import and export products, and provide related services. Previously, only retailers could sell goods on a commission basis. Upon approval, a company may combine retail and wholesale activities.

Commercial FIEs may also authorize third parties to operate franchises, which was not possible previously.

Restrictions and Prohibitions

As noted, WFOEs are still off limits until December 11 2004, except for Hong Kong and Macao companies, which may establish WFOEs as of January 1 2004.

Wholesalers may not distribute pharmaceuticals, pesticides and mulching film before December 11 2004, and may not distribute chemical fertilizers, processed oil and crude oil before December 11 2006. Retailers may not distribute pharmaceuticals, pesticides, mulching film and processed oil before December 11 2004, and may not distribute chemical fertilizers before December 11 2006. Neither wholesale nor retail FIEs may distribute tobacco, and wholesalers may not distribute salt.

Until December 11 2004, retailers and their stores are still limited to provincial capitals, cities under the direct control of the central government, and cities under the direct planning of the central government and SEZs. Hong Kong and Macao retailers may immediately do business in cities at the district level, and in county level cities in Guangdong.

Investors will also welcome the removal of a cap on royalties to 0.3% of the joint venture's net sales annually for a maximum of ten years under trademark, trade name or technology licence agreements.

A Simplified Approval Process

Before the Procedures, approval involved a rather cumbersome and inefficient two-step process. First, the Chinese party submitted the feasibility study report (including the project proposal) to the local Economic and Trade Commission, which in turn would submit it to the SETC. The SETC would then consult with MOFTEC and decide whether to approve the feasibility study report. In the second step, once the feasibility study report was approved, the local COFTEC would submit the joint venture contract and articles of association to MOFTEC for approval.

Now, the feasibility study report, joint venture contract and articles of association shall all be submitted to the provincial-level branch of MOFCOM for preliminary investigation. Assuming all is in order, the provincial branch of MOFCOM shall submit the documents to MOFCOM within one month. MOFCOM shall decide whether to approve the company within three months. The Procedures also expressly authorize MOFCOM to delegate approval authority to provincial branches.

Conclusion

The Procedures are the fruit of long fought WTO negotiations in which foreign investors sought to pry open the tightly controlled commercial sector. The elimination of most restrictions, the permission of franchising and the authorization of WFOEs will greatly expand the opportunities for foreign investors.

As always, we will need to wait to see how the Procedures are implemented, and wait for additional rules to further clarify outstanding issues. Detailed rules for franchising would be welcome. Delegation of approval authority to provincial branches of MOFCOM would also expedite matters, although MOFCOM is likely to wait and see what issues turn up before it relinquishes control over approvals.