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China is and will continue to be one of the most attractive markets for consumer goods. With a population of more than one and a half billion people and a middle class of more than 300 million, that is projected to grow to at least 700 million in the next 20 years. Based upon our experience in China and having been a part of the tremendous growth, we have seen that this emerging middle class, which is already larger than the U.S. population, is spending money like crazy and is not saving like previous generations.

Given that China is one of the only places in the world that has had double digit growth in GDP (except for this year which is still 8%), it has a burgeoning and spend crazy middle class, a developing legal system and excellent infrastructure, everyone should want to bring their products and services into this market. It’s not that easy. For many products, and services there are taxes. China does not have a national sales tax on retail items like other countries and so it imposes import duties, value added taxes and consumption taxes which the importer, wholesaler or retailer must add to the price the consumer pays. It’s all hidden, but, believe me they can be quite steep. For example, the total duty on imported wine, which is the only wine worth drinking in China, is between 41 and 50% which can make many products cost prohibitive when compared to quality – the value is just not there.

And people think China is cheap! I would offer that in the major cities in China, cost of living is higher than most cities in the U.S. and Europe and inflation has not stopped in the 10 years that we have been advising clients in China. China aint cheap anymore, but, the domestic market where they don’t mind paying higher prices on quality items (that aren’t fake) is enormous and growing.

So, until the central government decides to either scrap it’s antiquated and cumbersome Value Added Tax “V.A.T.” system, which we don’t see that happening for a long time as too many people would lose a lot of money ,or they lower the import duties and consumption taxes on imported products – there might be other way to bring in imported products that are in high demand in China.

China and Hong Kong operate under a one country two systems arrangement that has been in place since the turnover in 1999. Despite obvious cultural differences and the fact that there is a border crossing, most of us who do business in South China consider the two as one. In fact, there is a treaty between Hong Kong and China which many people don’t know about that allows for Hong Kong companies and professionals to operate in China and also a few other things such as the duty free import of Hong Kong made products. Below is a summary of the CEPA rules pertaining to importation of Hong Kong products which could provide a solution to the high import duties in China.

In order to enjoy zero tariffs under the Closer Economic Partnership Agreement (CEPA), goods exported from Hong Kong to Mainland China must fulfill the rules of origin and show evidence of being “made in Hong Kong.”

The execution of the rules of origin is detailed in the “Customs Provisions of the People’s Republic of China on Executing the Rules of Origin for Trade in Goods under the Mainland/Hong Kong Closer Economic Partnership Arrangement (haiguanshuling No.106, hereinafter refers as ‘Provisions’),” which was promulgated in December 2003 and came in effect from January 1, 2004. Under the Provisions, “Hong Kong” as the origin of goods shall be determined according to the following principles:

1. Goods entirely obtained in Hong Kong 2.Goods “substantially manufactured” in Hong Kong if not entirely obtained in Hong Kong Goods entirely obtained in Hong Kong According to the Provisions, goods entirely obtained in Hong Kong include:

  • Minerals exploited or extracted in Hong Kong
  • Plants or related products collected in Hong Kong
  • Animals born and raised up in Hong Kong and their related products
  • Animals hunted in Hong Kong
  • Fish and other sea products caught by ships with Hong Kong licenses and regional flags and their related products
  • Waste disposal for recycling from and collected in Hong Kong
  • Waste and scrap for recycling resulting from manufacturing in Hong Kong
  • Products made out of waste disposal or waste and scrap mentioned above Substantial processing, transformation, or manufacturing The criteria of determining whether the products are “substantially manufactured, transformed, or processed” in Hong Kong should include the following:

Manufacturing or processing operations. The goods should be endowed with essential characteristics after principal manufacturing or processing operations in Hong Kong.

Change of tariff number. Change of tariff number refers to a change of the four-digit tariff numbers and taxation categories after the manufacturing or processing operation of non-Hong Kong materials in Hong Kong. Moreover, no further manufacturing or processing should happen outside Hong Kong.

  • Ad valorem percentage. Ad valorem percentage is the ratio between the total value of raw materials, components, labor and product development that are fully acquired in Hong Kong, and the FOB value of the finished product for export.
    Ad valorem percentage = (Value of raw materials + value of components + labor costs + product development costs) ÷ (FOB value of finished product for export) Products with an ad valorem percentage equal to or greater than 30 percent, and with the last manufacturing or processing procedures completed in Hong Kong, shall be regarded as “substantial processing.” The following stipulations apply:
  • Calculation of the above “ad valorem percentage” should be consistent with generally accepted accounting standards and with the “Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994.”
  • “Product development” refers to product development conducted in Hong Kong for the purposes of producing or processing the exporting goods. Incurred expenses for development shall be related to the exporting goods, including the costs for self-developing of the producers and processors, as well as the costs for the developing of consigned natural or legal person. The expenses also includes fees for purchasing designs, patents, patented technologies, trademarks or copyrights processed by a natural or legal person in Hong Kong. The concerned value should be clearly identifiable under generally accepted accounting standards and the provisions of “Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994.”
  • If raw materials or components originating from Mainland China are used and they constitute part of the export products in Hong Kong, when calculating the ad valorem percentage of the export product, the raw materials or components from Mainland China should be deemed to be originating from Hong Kong. The ad valorem percentage of the export product should be greater than or equal to 30 percent, and greater than or equal to 15 percent excluding the price of the raw materials or components from mainland. Other criteria The “other criteria” refer to other criteria agreed by authorities of both Mainland China and Hong Kong in determining the origin of the products, besides the three above-mentioned criteria.

Mixed criteria. The “mixed criteria” means that two or more of the above-mentioned criteria are used in determining the origin of the products.

Manufacturing or processing for the purpose of transporting or storing the goods, facilitating the packaging of the goods, or better packaging and displaying the goods is not considered as “substantial processing, transformation, or manufacturing.”

Simple diluting, blending, packaging, bottling, desiccation, assembling, sorting or decorating will not be regarded as “substantial processing, transformation, or manufacturing.”

Package, packaging materials, containers and accessories, spare parts, tools and explanatory materials accompanying the goods should be ignored in determining the origin of the goods.

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China recently made sweeping changes to its Consumer Protection law. The changes mark the first time that the law was modified in two decades – brought on by what the Chinese government calls “changes in the makeup and challenges of the consumer sector.”

According to an article by Reuters, the new laws “increase consumer powers, add rules for the booming internet shopping sector and stiffen punishments for businesses that mislead shoppers.”

The true purpose of the revisions, according to the article, is so that China can further move its economy away from one that is built on investment-driven growth, and transform it into one that’s led by domestic consumption.

Consumption contributed to just 45% of China’s economy during the beginning of 2013, which is down from about 60% during the same period last year. The Chinese government hopes that these new law is going to allow consumers to purchase Chinese products with increased confidence.

The new revisions will also strengthen the role of the China Consumers’ Association, which sometimes acts as a representative for plaintiffs in class action suits brought against retailers.

To read more, you can read the article from Reuters here: China Overhauls Consumer Protection Laws

Check out some related articles by IPG Legal here:

  • Import Duties & Taxes in China: The Wine Example
  • How to Succeed in Business in China
  • Another Reason for Establishing a Company in Hong Kong for Entering the Chinese Market
  • China May be Deep into a Bubble According to the Financial Times

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Chinese delegation visited the port city of Gwadar, Pakistan. The Chinese government has invested USD 250 million over the past decade to develop the port, which it will eventually control through a government consortium called the China Harbour Engineering Company. The port isn’t fully operational yet, but Chinese media’s willingness to report on the issue may be a signal that the port may finally transfer to Chinese control soon. Pakistan’s government has also publicly made it clear that it would like to hand control of the port over to China within one month.

The port is of extreme geographical significance to the Chinese, who have over the past ten years begun to flex their muscles and expand their influence far beyond their own borders. China is developing ports throughout South Asia – something often referred to as China’s ‘String of Pearls.’

For example, in July of this year, China outbid India to secure the rights to upgrade Chahabar Port, which sits in southeastern Iran along the Strait of Hormuz. And, in early August, Sri Lanka opened a Chinese-developed port at a total cost of USD 500 million. In total, China operates 15 ports in foreign countries, with most of them in Southeast Asia.

Gwadar offers China a chance at quicker oil acquisition from countries exporting through the Persian Gulf. China is the world’s largest consumer of Middle Eastern oil, meeting nearly 60% of its total energy needs from energy exports shipped through the Strait of Hormuz. After clearing the Strait, the oil must then be shipped east through the Indian Ocean, then slowly ferried through the Strait of Malacca (the narrow coastal throughway between Malaysia and Indonesia). Finally, it arrives at its destination through various ports in east China. The oil’s journey, from start to finish, is long and, often, prohibitively expensive.

The port at Gwadar would also give China something it desperately needs – a viable energy conduit that is completely free from a potential American naval blockade. Control of the port would allow the Chinese to ship their oil through the Strait of Hormuz into Gwadar, and then use overland transport to travel northeast through Pakistan. Once at Islamabad, the route will then use the also-Chinese-developed Karakoram Highway, and travel through the K2 mountain range, the second highest in the world, which lies adjacent to the Himilayas. From there, it will travel through the Pakistan-controlled Kashmir province of Gilgit-Baltistan, and will, finally, cross the Chinese border and be sent to Kashgar, a former Silk Road city located in western China’s Xinjiang Province. China has recently spent upwards of USD 18 billion to further develop roads in Gilgit-Baltistan to facilitate this process, and Kashgar is regularly the recipient of Chinese infrastructure investment. This all sounds good on paper, but the reality of transporting high profile soft targets, such as oil, through Pakistan is not as simple as our Chinese friends may think.

Gwadar sits in one of Pakistan’s most unstable provinces – Balochistan. Balochis are a fiercely independent people who are ethnically related to the also-fiercely-independent Kurds. Balochistan sees regular violence against representatives of the Pakistani government and foreigners (often Chinese). Balochis have an extensive list of grievances against the Pakistani government and do not like being ruled from Islamabad. Their situation has even attracted the attention of the U.S. Congress which, in light of China’s attempt to circumvent an American-dominated Pacific Ocean, considered a resolution in 2012 that was to suggest the funding of Balochi separatist groups. News of the resolution led to protests in both China and Pakistan, with the usual complaint that the U.S. was interfering in each country’s internal affairs.

China insists that there is no cause for alarm, and that their ‘String of Pearls’ is designed to support Chinese commercial interests, and nothing more. They have, for some time, maintained the position that India and the United States are locked in a ‘Cold War mentality’ that sees Chinese overseas ports as playing a threatening host to the People’s Liberation Army Navy (PLAN), as opposed to friendly outposts that exist solely to import/export manufactured goods. As we know, China, colonized in its past, increasingly plays the role of an international victim and regularly points its finger at Western countries for what it calls repeated attempts at limiting its outwardly-focused posture.

It’s anybody’s guess, at this point, as to China’s true intentions, but history has shown that great empires need not be built on military conquest alone. The British Empire was founded almost entirely on the establishment of overseas commercial interests – only later, when those interests were threatened, did the soldiers come. China is rising and, therefore, will begin to butt heads with those who have already risen.

But, for the sake of argument, must the Chinese have a martial mindset at the outset to be accused of doing what they are, in fact, doing? When is a counter by India or the United States, thus, warranted? I think that there needn’t be a sinister ‘master plan’ if it leads to the same result as a well-intentioned one. Chinese expansion, hostile or not, arouses great fear in India and well-founded concern in the United States. Throughout history, and in every corner of the world, countries have balanced each other, re-balanced each other, and re-balanced each other yet again. This game of ‘balance and re-balance’ plays out even between allies – how much more so must it play out between rivals? Therefore, just as Chinese expansion may not be inherently hostile, China should not consider other countries’ attempted checks on that expansion as inherently hostile either.

By seeking to avoid a rival’s check on its security through development of an overland energy route, China is acting in its best interests, and therefore doing exactly what it is supposed to do – India and the United States will do likewise, and so the world turns.