Shanghai Launches Pilot Free Trade Zone

On September 29, 2013, China officially inaugurated the establishment of the Shanghai Pilot Free Trade Zone (SPFTZ) with the awarding of more than 30 new business licenses to companies and financial institutions registered in the zone. Covering an area of 28.78 square kilometers, the zone comprises four existing bonded areas in Shanghai: the Waigaoqiao Free Trade Area (established in 1990), the Waigaoqiao Free Trade Logistics Park (established in 2004), the Yangshan Free Trade Port (established in 2005) and the Pudong Airport Comprehensive Free Trade Area (established in 2010).

The State Council (China's cabinet) approved the establishment of the SPFTZ in early July 2013 and released a policy document entitled General Plan for China (Shanghai) Pilot Free Trade Zone ( "General Plan") on September 27, 2013.

FDI Reforms

The parts of the General Plan which have received the most attention in foreign business circles to date are those that relate to foreign direct investment (FDI).

For several decades, FDI in China has been regulated by a group of laws, regulations and policies enacted specifically for this purpose. These include three laws that deal with different types of foreign investment enterprises (FIEs), namely, the Sino-foreign Equity Joint Venture Law, the Sino-foreign Cooperative Joint Venture Law and the Wholly Foreign-invested Enterprise Law and their respective implementing regulations, and a foreign investment catalogue which classifies FDI projects into three categories—encouraged, restricted and prohibited—with FDI projects which are not listed presumed to be in a permitted category by default.

During this period, the establishment of all FIEs has been subject to approval by the Ministry of Commerce (MOFCOM) or its local commission counterparts (COFCOMs) or their central or local government predecessors. This MOFCOM/COFCOM approval requirement, which only applies to FIEs and not to Chinese companies without foreign investment, has been regarded by foreign investors and foreign governments as a form of discriminatory non-national treatment which makes it difficult for them to make investments in China.

In an apparent effort to give more national treatment to FDI projects in the SPFTZ, the National People's Congress has suspended the MOFCOM/COFCOM approval requirement for some FDI projects in the zone. Complementing this action by the National People's Congress, the General Plan provides that a "negative list" of prohibited or restricted projects will be used in the zone in place of the foreign investment catalogue, with the implication being that any projects which are not on the negative list will not be subject to a MOFCOM/COFCOM approval requirement.

The Shanghai Municipal Government issued the initial negative list on the day that the SPFTZ was established. Contrary to some expectations, it is a long list which retains virtually all of the projects listed in the restricted and prohibited categories of the current Foreign Investment Catalogue. However, officials representing the SPFTZ have intimated that they are hopeful that the list will get shorter over time.

On the same day, the Shanghai Municipal Government issued regulations for the registration of FDI projects which are not on the negative list. They establish a simplified registration process which permits foreign investors to fill out forms to apply for registration of FIEs using an online platform administered by the SPFTZ Administration for Industry and Commerce (SPFTZ AIC).

After the forms have been filled out online, they can be printed and submitted with other documents such as a feasibility study report, articles of association and a joint venture contract, if applicable, to the SPFTZ AIC for the issuance of a business license, which will in turn forward them to the SPFTZ Administrative Commission (which plays the role of a COFCOM in the zone) for the issuance of a filing certificate. Other documents are forwarded to other local authorities for entity code and tax registration.

Under these regulations, it should only take about four business days for a foreign investor to obtain a business license, filing certificate, entity code certificate and tax registration certificate, provided that all the application documents are satisfactory and complete. This is much faster than the one to two months that is ordinarily needed to obtain all of the government documents required to make a new FIE fully operational.

In addition, it appears that the SPFTZ will not be giving documents like articles of association or joint venture contracts which are submitted to them the sort of detailed substantive review ordinarily given by MOFCOM or COFCOM. Consequently, foreign investors may be able to exercise somewhat more discretion in relation to their content.

FDI projects that are covered by the negative list are treated differently. In the case of such projects, foreign investors are required to apply for approval from the SPFTZ Administrative Commission before applying for registration from the SPFTZ AIC. It seems likely that this approval will be similar to the MOFCOM/COFCOM approval which has historically been required. However, the time period for this approval is limited to around five working days, which is much faster than the two to four weeks or longer time periods needed to obtain most MOFCOM/COFCOM approvals.

Registration Reforms

The General Plan calls for the Administration for Industry and Commerce (AIC) registration system to be liberalized. In keeping with this call, the State Administration for Industry and Commerce and the Shanghai Municipal AIC have promulgated rules which relax some requirements for enterprises to be established in the SPFTZ, as follows:

• Registered capital: No minimum registered capital is required for most enterprises in the SPFTZ, and the forms of capital and the timing of their contribution can be freely decided by their investors, so long as they are identified in the articles of association and made available to the public. In addition, the business license will only show the amount of subscribed capital and not the amount of capital that has been paid in. (These rules do not apply to enterprises in certain special industries, including banks, insurance companies, securities companies, futures companies, fund management companies, direct sale companies, foreign human resources (HR) service cooperation enterprises and joint stock companies.)
• Operational permits: Except when there is an express requirement for an operational permit to be issued prior to the issuance of a business license, the application for a business license may be made before the application for an operational permit in the SPFTZ.
• Annual reports: In place of the annual inspection process that enterprises in China normally undergo, enterprises in the SPFTZ will submit an online "annual report" which will be made available to the public. Any enterprises that fail to file the annual report will be named on a "blacklist" which will also be made available to the public.

Further Opening-up of Certain Industry Sectors

Consistent with the efforts of the Chinese government to transform China's economy to rely less on infrastructure construction and exports and more on consumer spending and services, the General Plan calls for the further opening up to foreign investment of more than a dozen services and other industry sectors by suspending certain restrictions imposed by various laws and regulations, the foreign investment catalogue and regulatory practice. Some examples are:

• Commercial banks: Qualified foreign commercial banks and other financial institutions are allowed to establish wholly foreign-invested banks in the SPFTZ. Suspended restrictions: Under current law, foreign investment in this sector is limited to foreign financial institutions which have had representative offices for two years before applying for the establishment of a wholly foreign-owned bank.
• Health insurance: Foreign insurance companies are allowed to establish wholly foreign-owned health insurance companies in the SPFTZ. Suspended restrictions: Under current practice, foreign investment in this sector is limited to joint ventures (JVs) with Chinese insurance companies.
• Medical institutions: Foreign investors are allowed to establish wholly foreign-owned hospitals in the SPFTZ. Suspended restrictions: Under current law, foreign investment in this sector is limited to 70 percent (maximum) equity participation in JV medical institutions.
• Ship management: Foreign investors are allowed to establish wholly foreign-owned ship management enterprises in the SPFTZ. Suspended restrictions: Under current law, foreign investment in this sector is limited to participation in JV ship management enterprises.
• Value-added telecommunications services: Foreign investors are allowed to establish wholly foreign-owned value-added telecommunications enterprises in the SPFTZ. Suspended restrictions: Under current law, foreign investment in this sector is limited to 50 percent (maximum) equity participation in JV value-added telecommunications enterprises.
• Foreign-invested investment companies: Foreign investors are allowed to establish foreign-invested investment companies as joint stock companies (with shares of stock) in the SPFTZ. Suspended restrictions: Under current law, foreign-invested investment companies can only be established in the form of limited liability companies.
• Entertainment equipment: Foreign investors are allowed to establish FIEs in the SPFTZ to manufacture and sell entertainment equipment (such as the Microsoft Xbox) subject to review and approval by the local bureau of culture. Suspended restrictions: Under current regulatory practices, foreign investment has not been allowed in this sector. (Note: A JV established by Microsoft and BesTV was one of the first batch of enterprises to receive a business license in the SPFTZ.)
• Credit investigation: Foreign investors are allowed to establish wholly foreign-owned credit investigation enterprises in the SPFTZ. Suspended restrictions: Under current practice, foreign investment is not permitted in this sector.
• Engineering design: Foreign investors are allowed to establish wholly foreign-owned engineering design firms in the SPFTZ which may apply for an engineering design qualification without the foreign investors having prior design experience outside China. Suspended restrictions: Under current regulations, the parent company of a foreign-invested engineering design firm must have prior design experience outside China.
• Construction: Foreign investors are allowed to establish wholly foreign-owned construction enterprises for all foreign-invested construction projects in Shanghai. Suspended restrictions: Under current regulations, wholly foreign-owned construction enterprises can only undertake construction projects which either have 50 percent or more foreign investment or cannot be performed by Chinese domestic construction companies for technical reasons.
• For-profit educational training: Foreign investors are allowed to establish for-profit cooperative joint venture educational training institutions in the SPFTZ. Suspended restrictions: Under current law, foreign investment in this sector is limited to non-profit cooperative JV educational training institutions.
• HR agency services: Foreign investors are allowed to hold up to 70 percent of the equity of cooperative JV HR agency services enterprises which have minimum registered capital of US$125,000. Suspended restrictions: Under current law, foreign investment in this sector has been limited to 49 percent (maximum) equity participation in cooperative JV HR agency services enterprises which have minimum registered capital of US$ 300,000.
• Entertainment venues: Foreign investors are allowed to establish wholly foreign-owned enterprises to operate entertainment venues in the SPFTZ. Suspended restrictions: Under current law, foreign investment in this sector is limited to participation in an equity or cooperative JV.

Other Reforms

The General Plan also sets out plans for financial, customs and tax reforms. It provides that the SPFTZ will experiment with Chinese yuan convertibility for capital account transactions, market-oriented interest rates and cross-border use of the Chinese yuan. It also provides that foreign-invested companies will be gradually permitted to participate in commodities futures trading in the SPFTZ.

With respect to customs and quarantine procedures, it is planned that the SPFTZ will loosen these procedures in relation to the movement of goods between the zone and areas outside Chinese territory but maintain secure and effective controls between the zone and other areas in China. Commodities shipped from overseas to the SPFTZ will be able to directly enter the zone before customs declarations are made and customs and quarantine supervision will be streamlined. For commodities transported from the zone to other areas in China, the existing customs and quarantine supervision will apply, but the supervision measures will be improved.

Although there was speculation that the SPFTZ would have a preferential 15 percent enterprise income tax (EIT) rate instead of the normal 25 percent rate, the General Plan is silent on any general reduction in the EIT rate. However, it does outline some measures in support of a "pro-investment and pro-trading" preferential tax policy, including installment payment of EIT resulting from outbound non-currency investments, installment payment of individual income tax of qualified individuals who receive bonuses, export VAT refund and preferential import VAT rates for finance leasing companies and adjusted tariffs on goods sold into the domestic market by manufacturers or processors in the SPFTZ based on their imported materials and parts and their actual conditions on a trial basis.

It is important to note, however, that the General Plan is by nature a policy document and lacks many of the details that will be needed to implement its provisions. We understand that the State Council will designate various authorities to work together with the Shanghai Municipal Government to formulate implementing regulations for their implementation.

The SPFTZ is obviously still evolving. It is widely speculated, especially in Shanghai, that the SPFTZ will become an important testing ground for major government and economic reforms that may eventually be rolled out for the entire country. Time will tell.