Trading WFOEs in Waigaoqiao: End of the Road or New Opportunities?

With the implementation of the PRC Administrative Licensing Law, the minimum capital required for a trading WFOE in the WFTZ has been reduced to US$60,000 in accordance with the PRC Company Law(中华人民共和国公司法). 15% of this amount should be paid within 90 days, and the remaining 85% should be paid within 12 months of the issue of the business licence of the trading WFOE.

In order to simplify examination and approval procedures, a "one-stop service" is available for the registration of trading WFOEs. Foreign investors may handle the application formalities for the incorporation of a trading WFOE in the WFTZ only with the WFTZ Industry and Commerce Bureau, which is responsible for processing the relevant documentation with the economic and trade section of the WFTZ Administrative Commission. Upon submission of the required documents, the approval certificate and business licence will be issued after about 20 business days. Once the approval certificate and business licence are obtained, then a trading WFOE may open a bank account, handle tax formalities and customs registration. The one-stop service is also available to existing trading WFOEs who wish to apply to the WFTZ Administrative Commission for import and export rights (without distribution rights).

Grant of Unrestricted Foreign Trade Rights

Given that historically no trading WFOEs were permitted to incorporate in China outside the free trade zones, and given the rigid registered capital requirements imposed on Sino-foreign joint venture trading companies, many foreign investors chose to incorporate a trading WFOE in the WFTZ. Many such trading WFOEs have actually acted as a distribution hub to import and provide components, accessories and supporting goods of domestically manufactured products for clients of foreign investors in China. Trading WFOEs in the WFTZ, however, are not permitted to enjoy complete foreign trade rights. Their scope of activity is limited to trade with foreign entities, and without the help of an import and export agency, they are generally not permitted to sell and purchase goods outside of free trade zones within China.

With the implementation of the PRC Foreign Trade Law (中华人民共和国对外贸易法)and the Registration for the Record of Foreign Trade Operators Procedures in July 2004, both the Shanghai Foreign Economic Relations and Trade Commission and the Industry and Commerce Bureau released provisions relating to regulatory procedures for foreign trade operators. These appear to permit FIEs to conduct an independent import and export business that includes, after approval has been granted and the appropriate formalities have been satisfied, import and export of goods and technology within their business scope. Therefore, some foreign investors have seen this as a means of easy access to unrestricted foreign trade rights for FIEs. In practice however, only the Ministry of Commerce in Beijing has the power to approve such an expansion of business scope of FIEs under the Administration of Foreign Investment in the Commercial Sector Procedures (the Commercial Sector Procedures, effective June 1 2004. This means that no trading WFOE in the WFTZ is able to obtain such unrestricted foreign trade rights until the MOC approves its application. But according to the situation as we have seen it unfold so far, gaining the MOC's approval takes a long time and is difficult to obtain. Furthermore the MOC hasn't disclosed publicly the reasons that some applications have been rejected.

Grant of Restricted Foreign Trade Rights

The Waigaoqiao Administration began to accept applications beginning in September 2004 for expansion of the business scope of trading WFOEs to include rights relating to the import and export of goods and technology (excluding the distribution business). However, following from our discussions with officials of the Waigaoqiao Administration, it would appear that such an expansion still does not permit a trading WFOE to carry out an import business directly. A trading WFOE will, however, possess the capability to procure any goods from China (other than prohibited commodities) without relying on a PRC agency on the condition that the Waigaoqiao Administration has approved its application for this business scope.

Based on China's Protocol on the Accession to the WTO, distribution services comprise four main sub-sections: commission agents services; wholesaling; retailing; and franchising. Therefore a trading WFOE that doesn't have distribution rights is to a great extent denied the right to import anything into China under the current legal system. Such a trading WFOE certainly can't sell goods from foreign countries to most potential domestic purchasers legally without possessing the requisite distribution rights. In the event that goods are delivered to those domestic purchasers without import and export rights by one of the abovementioned distribution means, the operation of such a trading WFOE would be regarded as engaging in activities beyond its business scope and therefore would be in violation of the relevant laws and regulations. Therefore, the latest amendments that have led to an expansion in the permitted business scope of a trading WFOE in the WFTZ are limited to conducting an export business without the need for a qualified agency. It would also appear that a further application for import rights must be submitted to the MOC via the competent Administration of Commerce at the provincial level.

A Trend towards Relocation?

Some commentators think that most foreign investors may relocate their enterprises outside the WFTZ as a result of implementation of the Commercial Sector Procedures, which permit an approved WFOE to incorporate anywhere in the PRC and operate with unlimited distribution rights. In the absence of preferential treatment relating to trading rights and access of foreign investment, which have been enjoyed exclusively by FIEs in the WFTZ, it is likely that the motivation and enthusiasm of foreign investors to maintain or establish companies in the WFTZ for the purpose of domestic trade and distribution will be lessened.

In reality though, the grant of import and export rights to all entities in China is likely to, at least in the short term, be restricted and take some time to implement gradually. Although the Commercial Sector Procedures do not on face impose substantial restrictions (for instance on minimum registered capital, in applications for incorporation of foreign-invested commercial enterprises), it should be noted that the Procedures require that all such applications be brought to the MOC itself, regardless of the amount of registered capital of the applicants. Chinese laws and regulations on foreign direct investment generally adopt a mechanism of decentralized examination and approval, which vests authorities at different levels with different examination and approval powers based on the total investment of a FIE. But now, even a trading WFOE or a foreign-invested distribution enterprise with a minimum registered capital of US$60,000 must obtain incorporation approval from the MOC in Beijing. Considering the MOC's strict requirements and heavy workload, it is unrealistic to expect that import and export rights can be obtained particularly quickly.

In addition to the above points, other exclusive preferential treatment enjoyed by FIEs in the WFTZ will enable trading companies to consider the commercial feasibility of relocation. On the one hand, foreign exchange earnings under current accounts of trading WFOEs can be fully retained, while enterprises outside free trade zones are only permitted to retain an approved amount. Thus, the commission for selling and purchasing of foreign exchange is spared and the foreign exchange rate risk is greatly reduced. On the other hand, in the Pudong district (including the WFTZ), the applicable FIE income tax is 15%. Moreover, trading WFOEs in the WFTZ enjoy annual financial subsidies at a different rate after paying income tax. As a result, in the past five years the average income tax paid by those trading WFOEs was about 10%. Any foreign-invested trading companies incorporated in China with the exception of a limited number of places such as the Pudong district and special economic regions are not permitted to enjoy such preferential tax treatment.

Pending Issues

In current circumstances, it would appear that the effect of lifting the restrictions on import and export rights of trading WFOEs in the WFTZ is quite limited in the short term. The MOC has demonstrated that it is taking a strict attitude towards applications for expansion of business licences of trading WFOEs, some of which were refused on the basis of feasibility study reports. This is significant as a feasibility study report has usually been regarded as a relatively insignificant document when the local authority was processing similar applications.

China is notionally fulfilling its commitment to the WTO by passing laws to enable foreign-invested trading or distribution enterprises to be granted unrestricted import and export rights under the PRC Foreign Trade Law (中华人民共和国对外贸易法). At the time as the regulatory details of applications for foreign trade rights are released, trading WFOEs in the WFTZ may decide whether remaining in a WFTZ or relocating elsewhere in China is best. It should be noted though, that it will certainly take several months to clarify the regulations relevant to foreign trade rights and to coordinate the rules and formalities of different departments.

Implementation of the Commercial Sector Procedures will require clarification of such issues including the format of feasibility study reports, under which circumstances competent provincial administrations are authorized to approval incorporation of foreign-invested commercial enterprises and the extent of such authorizations. Moreover, it is also hoped that there will be further interpretation of the effectiveness of the Establishment of Sino-foreign Foreign Trading Joint Ventures Tentative Procedures (issued in 2003) and their Supplementary Provisions (also from 2003), and supporting regulations regarding import and export rights of FIEs from the State Administration of Industry and Commerce, the General Administration of Customs, the State Administration of Foreign Exchange and other relevant authorities.

The Ministry of Commerce has already made some progress in this regard. The Networks of Urban Commercial Establishments Plan, a regulation focused on the approval and administrative system for the commercial sector, has been submitted to the Office of Legislative Affairs under the State Council. Obviously, the Ministry of the Commerce will take the Plan as an important tool to control the development of retail enterprises in China, and especially foreign-invested retail enterprises.