The Chinese shipping industry opens up

The key criteria for foreign shipping companies seeking to establish a WFOE in China can now be found in Article 5 of the new Measures.

Measures for the Administration of the Examination and Approval of Wholly Foreign-owned Shipping Companies (Revised)

Article 5: An applicant for the establishment of a wholly-owned shipping company must meet the following conditions: (1) having at least 15 years of experience in shipping; (2) having a stable source of cargoes or passengers in the Chinese open port city where it proposes to establish its wholly-owned shipping company; and (3) not having violated Chinese laws, administrative regulations or rules during the course of its business activities in China for a consecutive period of two years.

Permitted structures

The PRC International Maritime Transport Regulations (中华人民共和国国际海运条例) (Maritime Regulations), which was issued by the State Council on December 11 2001 and took effect on January 1 2002), and the Provisions for the Administration of Foreign Investment in the International Maritime Transport Industry (外商投资国际海运业管理规定), published by the MOT and MOFCOM in 2004 and amended in 2014, provide that a foreign company may take the form of either a Sino-foreign joint venture (JV) company with a majority Chinese ownership (no less than 51%) or a WFOE.

A JV may engage in a much wider scope of business than a WFOE, including, but not limited to, international marine transportation. By contrast, a WOFE is restricted to providing international marine cargo warehouse services and daily services for vessels owned or operated by foreign parent companies, such as cargo canvassing and bills of lading issuances.

FDI regulations in shipping

The Foreign Investment Industrial Guidance Catalogue (外商投资产业指导目录) (Catalogue) shows foreign investors which industries they are permitted, encouraged, restricted or prohibited to invest in. With regards to the shipping industry, “Companies engaged in transportation by water” has been restricted from the first version of the Catalogue published in 1995 to the current 2015 edition; while “Scheduled and tramp international maritime transport services”, with the restriction of the “controlling interest” held by a Chinese party, has been encouraged since the 2002 Catalogue. With the continued de-regulation at different levels and in different industry groups, the government continues to adjust its attitude towards foreign investment in the Chinese shipping industry as well.

This is demonstrated in the latest version of the Catalogue which, for the first time, deletes the Chinese majority ownership requirement to allow “equity and cooperative joint ventures” for “Scheduled and tramp international maritime transport services”.

Favorable policies in the Free Trade Zones

Following the trail blazed by the Shanghai FTZ, which was established on September 29 2013, the State Council approved three new FTZs in Tianjin, Fujian and Guangdong, respectively, as well as the expansion of the Shanghai zone, at the end of 2014. After four months' preparation, these new zones were declared open in April this year and many of the favourable policies available to foreign investors in the Shanghai FTZ have also been adopted by the three new zones.

The Negative List

China has long adopted the “Catalogue” approach for approving foreign-invested projects nationwide until a pilot reform by the Shanghai FTZ created a “negative list” approach. Other than those listed as prohibited or restricted in the Special Administrative Measures for Foreign Investment Access in Pilot Free Trade Zones (Negative List) (自由贸易试验区外商投资准入特别管理措施（负面清单）) (Negative List), all other industries are open to foreign investment. The 2015 Negative List was implemented in all four FTZs.

The Negative List requires JVs as “water transport companies” (except for those companies engaged in the shipping business set up in the Shanghai FTZs) to be controlled by Chinese parties, and are refrained from engaging in domestic water transportation and domestic vessel management, as well as agency services for domestic passengers and cargo transport. This is in line with the strict protection of Chinese cabotage.

WOFEs and JVs in the FTZs

The restriction on the shareholding of foreign parties in JVs engaging in the international shipping business has remained for decades. However, the good news is that this has gradually been relaxed in the FTZs. This will invariably provide new opportunities to foreign investors and for foreign capital.

This opening stemmed from the Announcement on the Implementation on a Trial Basis in the China (Shanghai) Pilot Free Trade Zone of Implementing Measures for Increasing the Foreign Investment Percentage in the International Shipping and International Shipping Management Businesses (交通运输部关于中国（上海）自由贸易试验区试行扩大国际船舶运输和国际船舶管理业务外商投资比例实施办法的公告), issued by the MOT on January 27 2014, which allowed the shareholding of foreign investors of a JV in the international shipping business incorporated within the Shanghai FTZ to exceed 49%.

This new policy was further extended to the three other FTZs in China through the MOT's Announcement on Several Maritime Transport Policies for China Pilot Free Trade Zones (关于在国家自由贸易试验区试点若干海运政策的公告) (FTZ Announcement) issued on June 5 2015. This completely lifted all shareholding restrictions on international shipping JVs established within the four FTZs. It also allows a foreign company to set up a WFOE within the Shanghai FTZ to engage in the international shipping business. Moreover, investors from Hong Kong and Macau are now allowed to set up wholly-owned companies in the Guangdong FTZ to conduct international shipping activities.

When a foreign investor intends to set up a JV in the FTZs, the requirements set out in the 2001 Maritime Regulations remain relevant and must be satisfied in order for the company to be qualified to engage in the international marine transportation (shipping) business. One of these requirements is that the company must have vessels of Chinese nationality.

However, it appears that there is a conflict under the PRC Vessel Registration Regulations, which state the Chinese shareholding of a JV must at least 50% in order for it to own and register vessels in China and have them fly the Chinese flag.

Various authorities, including the MOT and the Department of the Local Maritime Safety Administration (in charge of vessel registration), have confirmed, in their responses to enquiries, that JVs controlled by foreign parties incorporated in the FTZs can register their ships under the Chinese flag.

Domestic and international cargo relay

In addition to the requirements scattered among different regulations and policy instruments, the general rules in respect of the Chinese cabotage regime are set out in Article 4 of the PRC Maritime Law, which provides that “maritime transport and towage services between Chinese ports shall be undertaken by ships flying the Chinese flag, except as otherwise provided for by laws or administrative rules and regulations”, and in Article 28 of the Maritime Regulations, which provides that “foreign international shipping operators are not permitted to engage in transport services between Chinese ports either directly nor in a disguised form, such as by chartering in Chinese flagged vessels or renting a slot space or exchanging a slot space etc.”

As such, foreign operators and non-Chinese flagged vessels were not permitted to engage in transport services between Chinese ports, including cargo relay businesses, namely:

1. where cargo is loaded at one Chinese port and transhipped at another domestic port and to be delivered outside China; or
2. where cargo is loaded outside China and transhipped at one domestic port and to be delivered at another.

In practice, in order to get round the Chinese cabotage restrictions, some foreign liner operators have adopted a form called “international cargo relay” by carrying cargo from one domestic port with an ultimate destination at another, but calling at a second country's port en route. It should be remembered that this arrangement is in violation of Chinese law and may expose the operators to a penalty imposed by the MOT or its local authorities.

However, this long-term restriction has been eased with the Announcement on the Trial Implementation in Shanghai of Domestic Coastal Shipping by Chinese-invested Foreign-flagged Oceangoing Vessels (关于在上海试行中资非五星旗国际航行船舶沿海捎带的公告), which was issued on September 27 2013. It permits non-Chinese flagged vessels wholly-owned or controlled by domestic shipping companies via shareholding to engage in “container cargo relay business between Shanghai port as the transhipment port and any other Chinese port”. The FTZ Announcement issued this year extends this relaxation to the other three FTZs.

In conjunction with the de-regulation of the establishment of JVs and WFOEs in the FTZs, it seems that a JV with a foreign majority ownership established in any of the zones may be permitted to conduct “container cargo relay business between a port within the FTZs as the transhipment port and any other Chinese port”. This interpretation has been orally endorsed by a senior officer of the Water Transportation Department of the MOT.

It would be prudent for foreign investors to await further written clarification/policies in this regard. It may also take time for the local authorities to fully implement them, although it appears that MOT does not yet have these new policies clearly in mind.

Tax incentives in the Shanghai FTZ

The Ministry of Finance, the General Administration of Customs and the State Administration of Taxation jointly issued the Circular on Expanding the Pilot Areas for Tax Refund Policy on Ports of Embarkation (关于扩大启运港退税政策试点范围的通知). It states that container cargo shipped outside the country from certain designated original loading ports using the Yangshan Bonded Port (south of Shanghai) as the transhipment port, will be treated as successfully exported once the vessel leaves the original loading port, where a tax refund can be applied for.

This will be applied to the additional three FTZs, pending detailed notices or announcements.

Local-level rules coming soon

The four new FTZs came with the roll-out of a series of pilot reforms and opening-up of policies in relation to foreign investment. Although not all are fully formed yet, these reforms signify attractive opportunities in the shipping industry. Foreign investors should keep an eye out for the coming detailed local policies for each of the FTZs.

Lianjun Li and Cheryl Xiaochen Yu, Reed Smith Richards Butler, Hong Kong