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Signed on 29
June 2003, the Closer Economic Partnership Arrangement (CEPA) has provoked
vigorous discussions and debates in the Hong Kong community.
The agreement is the first bilateral Free Trade Agreement (FTA) signed
between Hong Kong and the Chinese Mainland. Formulated within the ambit
of the World Trade Organisation (WTO), the agreement aims to remove
substantial trade and investment barriers between Hong Kong and the
Chinese Mainland without affecting other countries’ access to
the two markets. As CEPA unleashes new opportunities for various industries
and service sectors in Hong Kong, many local and overseas investors
are eager to learn how they can capitalise on and to reap the benefits
of the agreement.
The content of CEPA has been enhanced with the signing of six annexes
on 29 September 2003. Although details of the agreement will be updated
continuously via ongoing talks between the governments, the general
framework and some major terms have already been set and can be leveraged
on by investors.
CEPA covers three broad areas, namely trade in goods, trade in services
and investment facilitation.
Leveraging
on the opportunities in Trade in Goods
The Chinese Mainland will adopt a zero tariff policy for 273 types of
imported goods of Hong Kong origin from 1 January 2004. These include
electrical and electronic products, plastic articles, paper articles,
textiles and clothing, chemical products, pharmaceutical products, clocks
and watches, jewellery, cosmetics, meal products and other miscellaneous
goods. The zero tariff policy will be extended to cover other products
made in Hong Kong upon application by manufacturers and is subject to
agreement on rules of origin no later than 1 January 2006.
In order to enjoy zero tariff, a Hong Kong manufacturer should apply
for a Certificate of Hong Kong origin — CEPA, either from the
Trade and Industry Department (TID) or one of the Government Approved
Certification Organisations.
The certificate should be passed to the Mainland importer, who will
then present the certificate to the customs authorities upon lodgement
of the import declaration.
Manufacturers who wish to take advantage of the
zero tariff policy should make sure that their goods fulfil the rules
of origin requirements. Among the 273 product codes, 68% will
adopt Hong Kong’s existing origin rules as CEPA origin rules.
These include products such as textiles and clothing, jewellery, cosmetics,
pharmaceutical products, and plastic and paper articles. 17% of the
products, such as chemicals, metal products, some electronic products
and electronic components, will use the “Change in Tariff Heading”
approach as CEPA origin rules. 15% of the products, such as some electronic
and optical components, watches and clocks, etc, will adopt a 30% value
added requirement as CEPA origin rules. Product development costs, such
as design, development, intellectual property rights, etc, will be taken
into account in calculating the value-added percentage.
The zero tariff policy will not only enhance the
price competitiveness of the products made in Hong Kong for export to
the Mainland, but will also provide an option for manufacturers to expand
their existing facilities or set up new production lines in Hong Kong.
In order to justify new production in Hong Kong or the reengineering
of existing production structures, manufacturers need to consider the
following factors carefully:
-
Whether
the value added components of the company’s goods (such as brand,
design, technology, etc) are higher than the labour input —
given the higher average wage and rent in Hong Kong, manufacturers
of goods that involve a higher labour input component may not benefit
from the savings in tariffs;
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Whether
the goods are produced in limited quantity rather than mass production
— setting up a mass production line in Hong Kong may not be
feasible or profitable for large scale manufacturing activities due
to the high land cost and scarcity of space in Hong Kong; an alternative
for certain industries is to have research, design, development and
production of the core and most high value-added components performed
in Hong Kong, with mass production of the final products subcontracted
to Mainland factories;
As Hong Kong’s
advantages may offset lower cost levels in China, it will be worthwhile
for certain niche and high value-added industries, such as pharmaceutical
industries, high-end fashion, jewellery, watch and electronic industries,
to consider using Hong Kong as their production or product development
base for OBM (original brand manufacturing). Manufacturers who have
already established distribution networks on the Mainland may also find
new opportunities of forming partnerships or negotiating licensing agreements
with international brands to produce and distribute for the Mainland
market.
Some manufacturers
may consider changing their inter-company pricing strategy to take
advantage of the benefits offered by CEPA. They may try to reduce
the inbound transfer prices of materials or intermediate goods sourced
from overseas associates and increase the relative value of inputs
sourced in Hong Kong. Before adjusting their
inter-company pricing strategy, however, manufacturers should make
sure that the change in strategy will not give rise to any transfer
pricing problems. They are recommended to seek professional
advice if necessary.
Leveraging
on the opportunities in Trade in Services
The Chinese Mainland has granted specific market concessions to Hong
Kong enterprises trading in 18 service sectors. These include management
consulting, convention and exhibition, advertising, accounting, real
estate and construction, medical and dental, distribution, logistics,
freight forwarding agency, storage and warehousing, transport, tourism,
audiovisual, legal, banking, securities, insurance and telecommunication
services. To qualify for the benefits guaranteed by CEPA, an enterprise
must have substantive activity in Hong Kong. The general criteria
for determination include:
-
The
nature and scope of its business in Hong Kong — it should
include services it intends to provide on the Mainland;
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The
years of operations in Hong Kong — for most services,
the minimum period of the enterprise’s business operations
in Hong Kong is three years, but for construction, banking and
insurance, the requirement is five years. There is no limitation
in the years of operation for real estate services;
-
Liable
to pay profits tax in Hong Kong;
-
Own
or rent premises in Hong Kong — the scale of the business
premises must be commensurate with the scope and scale of the enterprise’s
business;
-
At
least 50% of employees are residents staying in Hong Kong without
limit of stay and people from the Mainland staying in Hong Kong
on a One Way Permit.
The specific
benefits offered by CEPA vary from industry to industry, but in general,
CEPA offers Hong Kong firms earlier and wider accessibility to the
Mainland market ahead of China’s WTO commitments. For example,
management and consulting firms in Hong Kong may set up wholly owned
companies on the Mainland from January 2004, which is more than three
years ahead of China’s WTO commitment. Companies that engage
in logistics and transport services, construction and related services,
and distribution services may set up wholly owned companies one year
ahead of China’s WTO timetable. CEPA also allows Hong Kong firms
wider access to the various services markets, including construction
and related services, logistics, and transportation services, distribution
services, tourism, legal services and audio-visual services. Five
telecom subsectors, including paging, messaging, Internet access,
content services and data storage will also allow access from Hong
Kong telecom companies.
To
obtain the CEPA treatment, a Hong Kong firm should apply for a Certificate
of Hong Kong Service Supplier (HKSS) from the Trade and Industry
Department in order to establish its status as a “Hong Kong
Service Supplier”. Upon receipt of the certificate,
the supplier can then apply to the relevant Mainland authorities
for permission to supply the relevant services under CEPA.
CEPA also extends benefits to Hong Kong permanent residents, who
as natural persons, may apply to the relevant authorities on the
Mainland for the supply of services under CEPA. Such services include
legal, accounting, medical, insurance and securities. CEPA also
formalises the practice of allowing Hong Kong permanent residents
to set up individually owned retail stores in the Guangdong Province
for the provision of retailing services.
Foreign
investors who intend to acquire a Hong Kong enterprise in order
to capture the benefits offered by CEPA should take note of
the rules on mergers and acquisitions that govern the eligibility
of the enterprise as a “Hong Kong Service Supplier”.
An enterprise being merged or acquired on or after 29 June 2003
will not qualify as a “Hong Kong Service Supplier”
within the first year of the merger or acquisition.
It
should also be noted that a Hong Kong firm that has changed
the nature of its business operation in recent years may
not qualify to enjoy the arrangements under CEPA, as the
arrangement requires most service suppliers to engage in
the same nature of substantive operation for a minimum period
of three years or more. For example, a service supplier
that has been in business operation since 1995 but has changed
its operation from accounting to management consulting in
2002 will not qualify to set up a wholly owned management
consulting operation in China under CEPA. Given the requirements
on substantive business operation and the rules on mergers
and acquisitions, foreign investors who intend to acquire
Hong Kong firms should assess whether their acquisition
target has fulfilled the substantive business operation
requirements, and whether the merger can still enable the
firm to capture the first mover advantages despite a one-year
delay.
Trade
and Investment Facilitation
CEPA includes a range of measures to help facilitate trade
and investment. These include simplifying procedures and
strengthening cooperation between Hong Kong and the Mainland
in seven areas, namely, trade and investment promotion,
customs clearance facilitation, commodity inspection and
quarantine, food safety, quality and standardisation,
electronic business, transparency in laws and regulations,
cooperation of small and medium enterprises and cooperation
in the Chinese medicine industry.
To
conclude, Hong Kong firms have to work hard and act fast in order to
capitalise on the preferential tariff policy and other advantages offered
by CEPA. Given the relative immaturity of the Mainland’s service
sectors and complex regulatory practices, however, Hong Kong firms may
have to take on the risk of early exposure to the myriad of problems
and complications on the Mainland.
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