How do Free Trade Zones in China differ from those in other countries?
Free trade zones (FTZs) are a type of special economic zone used by the Chinese government to pilot preferential trade and investment policies. As of 2017, there are 11 FTZs in China. Each FTZ has its own strategic positioning within the larger economic plan of the Chinese government.
The first and largest FTZ, the Shanghai Pilot Free Trade Zone, was introduced in 2013. The government first piloted streamlined registration processes for businesses in the Shanghai Pilot FTZ before expanding the policy nationwide through the 5-in-1 business license.
FTZs in China differ from other countries because they are almost exclusively used for piloting programs and “testing” them before expanding nationwide. As such, preferential policies in FTZs must be replicable on a national scale.
In contrast, other countries use FTZs as customs-friendly zones to encourage exports or imports with preferential tax policies playing a major role. For example, in the United States, FTZs (known there as foreign trade zones) offer exemptions from state and local inventory taxes.
How did free trade zones in China evolve over time?
Founded in 2013, the first and largest FTZ is the Shanghai Pilot Free Trade Zone, which holds strategic importance as a financial and logistics hub.
Two years later, in 2015, the government announced a second batch of FTZs, including Fujian, Guangdong and Tianjin. The second batch focuses on regional economic integration. The Fujian FTZ encourages closer economic integration with Macao and Taiwan, while the Guangdong FTZ does the same for Hong Kong. The Tianjin FTZ seeks to support the economic growth of the Beijing-Tianjin-Hebei region, as well as encourage offshore financial markets.
The third and latest batch was announced in 2016. This third batch of seven FTZs highlights the government’s intention to aggressively industrialize inland China and support the “Belt and Road” initiative. The FTZs include Chongqing, Liaoning, Henan, Hubei, Shaanxi, Sichuan and Zhejiang.
Free Trade Zone (FTZ) vs. Free Trade Area (FTA)
A free trade zone (FTZ) is a type of special economic zone designated by the government. Like most FTZs in the world, it is an area where goods can be imported into the zone and handled with minimal intervention from the Customs authority. In China, FTZs serve as pilot zones where the government can first “test” different reforms before expanding the application of such reforms. The China Shanghai Pilot Free Trade Zone (Shanghai FTZ) was the first FTZ in China, and it was a place for the government to test streamlined setup applications and procedures, which were then nationalized.
As of 2017, there are 11 official FTZs in China. Each FTZ in China has a strategic purpose depending on its location and focus industries.
A free trade area (FTA) describes the trade bloc formed by country members who sign a free trade agreement to lower import duties, quotas and other national preferential treatment. China’s free trade agreement with the Association of Southeast Asian Nations (ASEAN) would be considered a free trade area.
Which industries are encouraged in the free trade zones?
The Chinese government releases and regularly updates a list of encouraged, restricted and prohibited industries for foreign investors to follow through the Catalogue for the Guidance of Foreign Investment Industries. Implemented on July 28, 2017, the latest amendments to the Catalogue follow through on the government’s statements to further open the economy to foreign investment.
Currently, there are 348 “encouraged” industries, largely focusing specific needs for innovation and new technologies within traditional major sectors. Additionally, specific FTZs are assigned an industry focus to develop the area and attract foreign investment within that sector. These industries also correspond to the government’s long term economic policy. For example, the latest batch of FTZs are distributed along key areas of the “One Belt One Road” trail, and encourage logistics and commerce, along with advanced manufacturing and modern services.
Which industries are restricted or prohibited in the free trade zones?
China has a Negative List which outlines the industries for which foreign investment is either restricted or prohibited. “Restricted” means that foreign investment into that industry will be subject to limitations, such as shareholder requirements, typically in favor of the domestic market. “Prohibited” means that foreign investment is not allowed into that industry.
The Negative List
The Negative List dictates which sectors in China are restricted for foreign investment in the free trade zones (FTZs). It is updated about every two years with the latest measures taking effect on July 10, 2017.
The number of industries specified under the Negative List has decreased over time with each amendment. The latest amendment in 2017 decreased total special administrative measures controlling foreign investment from 93 to 63. Restricted industries include road passenger transport, ocean shipping tally, rating services, performance management agencies, large-scale theme park operators, mineral smelting and calendaring, and more.
The 2017 Negative List covers 15 sectors, 40 categories and 95 special management measures. As the 2017 edition covered 10 less categories than the 2015 edition, and cut 27 measures, it is largely seen as an improvement and a proven effort by the government to ease limitations on foreign investment in China.
The sectors included mining, manufacturing, wholesale and retail, leasing and commercial services, as well as financing. For sectors that are not included within the list, other existing regulations will prevail, and foreign investors receive equal treatment as domestic companies within the FTZs.
Prohibited industries largely include those that would depend on data collection, news dissemination, institutional establishment and those that would create industries of high risk, such as GMO crops, tobacco and tobacco products, rare earth and more.
A sampling of prohibited industries includes the following:
- Manufacturing of GMO crops and livestock breeds
- Exploring and mining of rare earth
- Smelting and processing of radioactive minerals
- Processing technology for Chinese herbal medicine
- Manufacturing, wholesale, retail, import and export of tobacco and tobacco products
- Operating of air traffic control
- Operating of postal enterprises and domestic express mail
- Investing Internet news service, publishing, information dissemination service
- Formulating Internet maps
- Investing in geodetic surveying, ocean mapping, topography, etc.
- Developing human stem cell research
- Establishing humanities and social science research institutions
Advantages inside FTZ
What are some general advantages for setting up a business within a free trade zone?
Given the variety of regions promoting industry in China, an FTZ is not a firm’s only choice – there are also industrial parks, technology parks, special economic zones and more. Prior, FTZs stood out because of the one-stop application process and a faster turnaround on registration. However, with the national expansion of the 5-in-1 business license, FTZs are no longer unique in this respect.
What FTZs do offer is a highly flexible Customs and logistics process. Firms are allowed to import goods into the FTZ directly to a warehouse without having to first pass Customs. This is particularly important for goods that require temperature control and whose quality would suffer otherwise.
Additionally, if eligible, firms can benefit from preferential tax policies, such as a reduced corporate income tax (CIT) rate of 15 percent in some FTZs.
FTZs in China are regions for the government to test policies before expanding nationwide. As such, entities within the FTZ are able to enjoy benefits first. However, this also means the firm would undergo any difficulties due to policy confusion or rollout disorganization.
What are the logistics advantages of setting up in a free trade zone?
There are two main logistics advantages to setting up in an free trade zone (FTZ) in China: customs and proximity to existing infrastructure.
First of all, items that are shipped into the FTZ can be directly sent to a warehouse; it does not need to first pass customs clearance. This can be a major boon especially to the food and beverage industry as it allows them to better control the quality of the product. Before, goods entering the FTZ would have to pass customs before going onto the warehouse, which could mean weeks of waiting. Shipments out of the FTZ has to clear customs first, but the clearance process can take 2 to 3 days.
Furthermore, there are administrative logistics advantages to the FTZ. If it has provided guarantees to the government, the company can pay its taxes in a lump sum payment within a certain period of time for good already imported. The government maintains checks of these operations through tax audits. Additionally, firms can make a collective declaration on a single form for imports and exports on a single form.
Secondly, FTZs are built to encourage and house international trade and transactions. As such, the government has invested into the infrastructure in order to make trading as easy as possible. As China’s FTZs are all relatively new (Shanghai was the first FTZ, having been implemented in 2013), the infrastructure for warehouses and ports, etc. are current.
What are some tax advantages for setting up in a free trade zone?
As FTZs in China are pilot regions for the government to test new policies, lower corporate and individual income tax rates (CIT and IIT respectively) are generally not been included in the preferential policies. However, three FTZs currently offer a reduced CIT of 15 percent. They include the Qianhai Shenzhen-Hong Kong Modern Service Industry Cooperation Zone (“Qianhai FTZ”), the Hengqing New Area (“Hengqing FTZ”), and the Pingtan Comprehensive Experimental Area (“Pingtan FTZ”).
Firms that establish within these FTZs are not immediately eligible for the reduced CIT. They must also fulfil a series of requirements set down by the FTZ’s administration. These requirements vary by zone. In the case of the Qianhai FTZ, the firm’s primary business must be one listed within the “Preferential Corporate Income Tax Catalogue” for the area. Moreover, the firm’s revenue from its primary business must make up more than 70 percent of total revenue. The policy on reduced CIT is effective until December 31, 2020.
Additionally, unless specified, any equipment and machinery intended for the firm’s own usage that is imported into the FTZ are exempt from import duties.
Various FTZs continue to experiment with preferential tax policies. For example, the Shanghai Pilot Free Trade Zone allows qualified firms to pay CIT in installments over a maximum period of five years.
Pilot Free Trade Zones in China
Shanghai
Approved by the State Council in 2013, the China (Shanghai) Pilot Free Trade Zone, or the Shanghai FTZ (SHFTZ) was the first pilot free trade zone. In total, the SHFTZ spans 120.72 square kilometers.
All FTZs are approved by the Chinese government for the development of specific industries and to further strategic focuses. The SHFTZ has numerous purposes, all focusing on liberalization and modernization. This includes:
- Updating investment management systems using the FTZ Negative List.
- Liberalizing financial services.
- Serving as a pilot zone for further FTZ management innovations.
The SHFTZ includes four special customs areas: the Waigaoqiao Bonded Area, the Waigaoqiao Bonded Logistics Park, the Yangshan Bonded Port Area and the Pudong Airport Comprehensive Bonded Area.
The bonded areas feature free trade, export processing, and logistics warehousing. Waigaoqiao Bonded Logistics Park and Yangshan Bonded Area are both integrated FTZ-ports, and are key areas for international logistics. The Pudong Airport Comprehensive Bonded Area is specialized for the development of the airport service industry.
In 2104, the SHFTZ expanded to include:
- Lujiazui Financial Area (a hub of finance, high-end services for shipping and trading),
- Jinqiao Development Zone (a center for advanced manufacturing, producer services and strategic emerging industries), and
- Zhangjiang High-Tech Park (a tech park focusing on integrated circuit, software and biomedicine).
Pros:
1. Customs
Imports to the SHFTZ can directly go to the warehouse and clear customs at a later stage when trying to enter the domestic market. This is particularly important for those importing products that need temperature controls, like food and beverage.
2. Logistics
The SHFTZ can take full advantage of the Shanghai Port, which is one of the largest and busiest ports in the world. This offers investors access to a logistics hub and may help streamline their supply chain.
3. Tax policies
Machines, equipments and other goods used by manufacturers and manufacturing services companies in the SHFTZ are subject to tax exemptions. However, after production and process, the goods that are then sold into the domestic market are subject to import and consumption taxes.
Cons:
1. Uncertainty
As the SHFTZ is still developing and the regulations are still being adjusted, there is an element of uncertainty. Information about market-oriented reforms are released piecemeal by the government, and investors have to wait for further liberalizations to occur.
2. Persisting restrictions
Despite the relative ease and freedom of the FTZ, there are still restrictions on which industries foreign investors can enter. Moreover, establishing in the free trade zone does not automatically grant investors complete access to the domestic market. Goods imported domestically will still have to pay import VAT and consumption taxes.
3. Costs
Rental space in the SHFTZ is becoming increasingly expensive. With rising labor costs, many manufacturers find themselves priced out. Additionally, new regulations on encouraged and discouraged industries also push some companies to relocate. For example, high-tech and advanced manufacturing now receive more benefits, while other industries, like furniture-making, find themselves forced out of the SHFTZ.
Tianjin
Launched in 2015, the China (Tianjin) Pilot Free Trade Zone, the Tianjin FTZ (TJFTZ), is part of the second set of FTZs announced by the Chinese government. It covers an area of 119.9 square kilometers.
All FTZs are approved by the Chinese government for the development of specific industries and to further strategic focuses. The TJFTZ has numerous purposes, focusing mainly on regional connections and developing advanced industry services. Specifically, the TJFTZ’s strategic positioning includes:
- Serve as a pilot zone for further FTZ management innovations.
- Further the development of the Beijing-Tianjin-Hebei region.
- Develop high-end industry and services.
The TJFTZ includes three areas:
- Tianjin Port Dongjiang Area (a key port connecting Northeast Asia and Central and West Asia, with focus on developing modern services industries for logistics).
- Tianjin Airport Area (focus on developing advanced manufacturing, research and development, and technology transfer).
- Binhai CBD Area (focus on developing modern service industries and financial innovation).
Guangdong
Launched in 2015, the China (Guangdong) Pilot Free Trade Zone, or the Guangdong FTZ (GDFTZ) is part of the second set of FTZs announced by the Chinese government. It covers an area of 116.2 square kilometers.
All FTZs are approved by the Chinese government for the development of specific industries and to further strategic focuses. The GDFTZ has numerous purposes, focusing mainly on opening up the mainland to international trade. In particular, the GDFTZ’s strategic positioning includes:
- Serve as a demonstration area for collaboration between Guangdong, Hong Kong and Macau.
- Serve as an area for pilot reforms for market-oriented business environment.
- Offer trade and investment facilitation.
The GDFTZ includes three areas:
- Nansha Area of Guangdong (a critical shipbuilding base, including seven subsections consisting of experimental zones and preferential policy areas).
- Qianhai-Shekou Area of Shenzhen (focus on connectivity with Hong Kong, as well as modern services such as finance, modern logistics, and information and technology services).
- Hengqin Area of Zhuhai (focus on tourism; leisure and health; commercial and financial services; culture, science and education; and new and high technology).
Fujian
Launched in 2015, the China (Fujian) Pilot Free Trade Zone, or the Fujian FTZ (FJFTZ) is part of the second set of FTZs announced by the Chinese government. It covers an area of 118.04 square kilometers.
All FTZs are approved by the Chinese government for the development of specific industries and to further strategic focuses. The FJFTZ has two main purposes, focusing largely on developing ties with Taiwan. In particular, the FJFTZ’s strategic positioning includes:
- Adopting innovative cross-strait (mainland with Taiwan) economic cooperation and trade.
- Serve as a core area for the 21st century Maritime Silk Road.
The FJFTZ consists of three areas:
- Fuzhou Area (an experimental region for market-oriented reforms, and leader in promotion of trade and investment with Taiwan).
- Pingtan Area (a key area for the development of a port economic and trade zone, a new and high-tech industrial zone and a tourism and business zone).
- Xiamen Area (focus on development of new and high-tech research and development, information consumption, airport-based industries, emerging industries and other modern industries services).