China has traditionally restricted foreign investment in the retail and wholesale sectors with the aim of nurturing strong domestic players before their foreign counterparts would be allowed to enter the country. Since becoming a member of the World Trade Organisation, China has gradually opened up its distribution sector to foreign investment. The revised policy is implemented through a number of regulations of which the key ones are the Measures for the Administration of Foreign Investment in the Commercial Sector (Commercial Measures) (effective from 1 June 2004) and its various subsequent supplements, the Notice of the Ministry of Commerce on Entrusting Local Authorities with the Examination and Approval of Commercial Enterprises with Foreign Investment, effective from 1 March 2006, and the Circular on Delegating Matters Concerning the Examination and Approval of Foreign Investment Commercial Enterprises, effective from 12 September 2008. These developments in the distribution sector go hand in hand with other policy changes which have given foreign investors greater access to the PRC domestic market.
This article discusses the key elements of the regulatory framework for foreign investment in the distribution sector in China.
Foreign Investment Commercial Enterprise (FICE)
Foreign investors are generally permitted to engage in four forms of distribution activities:
commission agents’ services;
A foreign investor is required to establish a FICE if it wishes to engage in these distribution activities. The investors in FICE can be foreign companies, enterprises or other economic organisations as well as foreign individuals.
Foreign investors may establish a FICE with a Chinese party as a joint venture or on their own as a wholly foreign-owned enterprise. However, not all FICEs may be wholly owned by a foreign investor. A FICE with more than 30 outlets dealing in certain specified products of different brands that are sourced from different suppliers shall generally take the form of a joint venture in which the maximum share of the foreign investor is limited to 49%. The specified products include books, newspapers, periodicals, pharmaceutical products, pesticides, mulching films, chemical fertilizers, processed oil, staple food, vegetable oil, edible sugar and cotton etc.
Also, FICEs are prohibited from engaging in the wholesale of salt and tobacco and in the retail of tobacco.
The foreign investor should have a good reputation and comply with PRC law. Whereas the statutory requirement is that a FICE has a minimum registered capital of only RMB30,000, the authority in charge of approving the establishment may impose a higher registered capital requirement to match the proposed scale of business of the FICE. The investment must comply with the minimum debt to equity (registered capital) ratios imposed under PRC law. The term of operation should not normally be longer than 30 years but may be extended to 40 years if the FICE is established in the central and western regions of China.
Permitted business activities
A retail FICE may engage in the following business activities:
commodity import for its own account;
sourcing of domestic products for export; and
other relevant ancillary activities.
A wholesale FICE may engage in the following business activities:
commission agents’ services (excluding auctions);
commodity import-export; and
other relevant ancillary activities.
A FICE may engage in one or more of the business activities set forth above and may authorise third parties to open franchise shops.
The Commercial Measures do not contain detailed guidelines regarding the operation of franchising business. According to the Regulations for the Administration of Commercial Franchising Operations, effective from 1 May 2007, a franchisor must have operated two directly owned stores for at least one year before it may lawfully grant franchises. More administrative measures were promulgated recently to strengthen supervision of franchising operations, such as the Administrative Measures for Record-Filing of Commercial Franchises (effective from 1 February 2012) and the Administrative Measures for Information Disclosure of Commercial Franchises (effective from 1 April 2012).
Range of products
A FICE must specify the range of products it distributes in the business scope of its corporate establishment documents. A FICE is only permitted to deal in those types of products listed in its business scope.
The import and distribution of certain categories of products in China are subject to various forms of state control. If the products in which a FICE deals are products subject to special State regulations or are import-export products which are subject to quota or licensing control, the FICE must comply with the relevant licensing requirements.
Whilst the Ministry of Commerce (MOFCOM) is the principal approval authority for FICE, it has delegated its approval powers with respect to most types of FICE to the provincial level departments in charge of commerce (provincial commerce authorities). Within the scope of these delegated powers, the provincial commerce authorities can autonomously approve the establishment of FICE and they are only required to report the matter to MOFCOM for record. A FICE is still subject to MOFCOM approval if:
its mode of operations involves sales, without setting up shops (outlets), such as through television, telephone, mail order, etc; or
it wholesales audiovisual products, or distributes books, newspapers or periodicals.
In those instances where approval by MOFCOM is required, an application for the establishment of a FICE must be submitted first to the provincial commerce authority in the proposed investment location. After preliminary examination, the provincial commerce authority will forward the application to MOFCOM within one month. MOFCOM will then have three further months to decide whether or not to approve the application.
In some localities, the approval powers in respect of certain types of FICE have been further delegated to the municipal level department in charge of commerce (municipal commerce authorities). For example, in Guangdong province, according to the Guidance Notes on the Assessment of Foreign-invested Commercial Projects in the Guangdong Province (Guidance Notes of Guangdong) effective from 27 July 2009, the wholesale of general commodities (with certain exceptions), commission agent’s services (excluding auctions), or import and export businesses, may be approved by the municipal commerce authorities. Having said that, the approval powers of the municipal commerce authorities may vary from locality to locality. In this regard, foreign investors are recommended to seek professional advice to ascertain the approval requirements as applicable to the relevant locality from time to time.
If an existing foreign investment enterprise intends to expand its business scope to include distribution rights and become a FICE, it must proceed in accordance with the approval procedure and principles for the establishment of a new FICE set forth above.
Establishment of outlets
FICE may set up shops (outlets) on condition that their establishment complies with the regulations regarding urban development and urban commercial development. An existing FICE may only set up a new outlet if it has passed the annual inspection and has paid up its registered capital in full.
MOFCOM is the approval authority for the opening of new outlets by FICE. Provincial commerce authorities are authorised, however, to approve new outlets in the following three situations:
the area of a single outlet does not exceed 5,000 square meters and there are not more than three outlets in total, and the foreign investor has not opened more than 30 outlets in the same class in China through FICE; or
the area of a single outlet does not exceed 3,000 square meters and there are not more than five outlets in total, and the foreign investor has not opened more than 50 outlets in the same class in China through FICE; or
the area of a single outlet does not exceed 300 square meters.
Under the above circumstances, the provincial commerce authorities are only required to report the approval for the establishment of outlets to MOFCOM.
Some provincial commerce authorities have further delegated such approval powers to the municipal commerce authorities. For example, according to the Guidance Notes of Guangdong, the municipal commerce authorities may approve new outlets in the following two situations:
a Hong Kong/ Macau service supplier opens outlets in the local municipal administrative district with the area of a single outlet not exceeding 300 square meters and there are not more than ten outlets in total in one application; or
the area of a single outlet does not exceed 3,000 square meters (only one outlet is allowed in one application).
As in the case of the establishment of FICEs, the approval powers of the municipal commerce authorities for the establishment of outlets may vary from locality to locality. In this regard, foreign investors are recommended to seek professional advice to ascertain the approval requirements as applicable to the relevant locality from time to time.
Special provisions regarding Hong Kong and Macau service suppliers
Qualified Hong Kong and Macau service suppliers (collectively referred to as SAR suppliers) are granted greater access to the distribution sector than other service suppliers under the provisions of the Closer Economic Partnership Arrangements which Mainland China has concluded with Hong Kong and Macau.
For example, there are preferential treatments for a SAR supplier who/which has opened more than 50 stores accumulatively in Guangdong to engage in distribution of mulching films, chemical fertilizers, vegetable oil, and edible sugar on a wholly owned basis if those goods are of different brands and come from different suppliers; whereas for staple foods, the SAR supplier is only allowed to conduct pilot operation on a wholly-owned basis in Guangdong province.
How Deacons can help with establishing a Foreign Investment Commercial Enterprise
Deacons is a full-service commercial law firm with a strong international presence in most major Asian cities. Our China Practice Group has advised on investments, business activities and trade transactions in Mainland China for more than 25 years. Deacons was the first foreign law firm officially approved to establish three representative offices in the major Chinese cities of Beijing, Shanghai and Guangzhou.
Deacons can assist in the establishment of a FICE, including the establishment of an overseas special purpose vehicle to hold the interest in the FICE and the approval and licensing of the FICE and its outlets inside China.