Insights into how foreign companies can gain trading and distribution rights.

Moving forward on distribution

After nearly a year's delay, China has opened the way for the expansion of foreign retail and wholesale operations.

December 11, 2004 was supposed to mark the date by which China would fully implement a system to grant trading and distribution rights to foreign investors in accordance with its World Trade Organization (WTO) accession protocol. But it was not until mid-2005 that the PRC government fully clarified application procedures for foreign investors to obtain such rights, thereby paving the way for an increase in the rate and number of approvals issued to foreign companies.

The options

Foreign companies may choose one of two ways to acquire trading and distribution rights. They can set up a new, standalone Foreign Invested Commercial Enterprises (FICE) or apply to expand the business scope of an existing Foreign Invested Enterprise (FIE).

Existing manufacturing FIEs, free-trade zone trading FIEs, investment companies, and regional headquarters FIEs may all apply to expand their business scopes. Companies must specify in their applications the product categories they wish to trade in, based on Customs' Product Catalogue. Manufacturing FIEs may only deal in products that either they or their parent companies produce; trading companies are generally limited to three product categories; investment companies may acquire up to five categories; and firms with regional headquarters status have no category limitations on the products they may import and sell.

Quicker approvals

Until the release of final clarifications, applying to set up a new FICE was the quickest method by which to acquire trading and distribution rights. Recently, however, there was an across-the-board increase in the speed and number of both FICE and expanded-scope FIE application approvals. Manufacturing FIEs, FTZ companies based in Shanghai's Waigaoqiao, and regional headquarters or investment firms have all reported securing approval to expand their scopes of business scopes to include trading and distribution rights. Some companies have reported requests for additional increases in registered capital from local authorities; some firms have found that they can forestall this requirement by clearly explaining in their application's feasibility study report how they expect to finance distribution activities from existing cash flows.

Many of the companies acquiring approvals have used service companies affiliated with local or municipal government bodies, such as the Foreign Enterprise Service Center set up by the Shanghai Municipal Foreign Economic Relations and Trade Commission, to assist in preparing applications. These entities are close to the approval bodies and know what is needed in the application to gain approval quickly. However, companies that have submitted applications prepared on their own are also getting approvals, however. As the application process becomes more defined, it is likely that approvals will continue to accelerate: Waiting times are now estimated at around three months.

Experiencing and handling difficulties

As FIEs acquire approval for trading and distribution within China, their focus is shifting to actually selling imported and third-party goods in China. Because relevant government bodies, particularly the customs and tax authorities, have yet to issue regulations governing the import and sale of products by foreign companies, it will likely take some time to develop routine processes and procedures. Firms trying to use trading and distribution rights will probably face new situations that cause uncertainty among local officials. As a result, municipal and local government bodies may delay processing transactions from FIEs with trading and distribution rights until receiving explicit clarification from their superiors¡ªand until the regulations catch up. Ideally, under WTO national treatment principles, FIEs would follow the same procedures as domestic companies.

It also remains unclear how authorities will enforce the stipulation that manufacturers must earn no more than 30 percent of their revenue from sales of third-party produced goods, including imports, if they are to retain the various tax incentives enjoyed by foreign-invested manufacturers. Whether the loss of tax benefits would be permanent or temporary, and whether the new tax rate would be levied starting the next year or retroactively, are unknown variables.. The regulations also do not specify how the 30 percent would be calculated, an issue of particular concern to manufacturing FIEs that assemble products using a significant amount of imported components. In short, China has come a long way in implementing distribution rights, but on several fronts, questions and uncertainties will be resolved only as companies start to exercise their new rights.

Source: This is an excerpt from an article originally published in the Sept-Oct, 2004 .issue of the China Business Review. Reprinted with the permission of The US-China Business Council, Washington D.C.