Insights into Hainan Free Trade Port Regarding Customs and Trade

On 1 June 2020, the State Council issued the Overall Plan for the Construction of Hainan Free Trade Port (hereinafter referred to as the “Overall Plan”)[1]. Amid the latest domestic and international dynamics, China intends to make Hainan the frontier for its foreign economic development, setting higher requirements for opening-up with the aim to promote the overall construction of Hainan Free Trade Port (hereinafter referred to as the “FTP”).

President Xi Jinping addressed at the Boao Forum for Asia that we should “surmount all obstacles and overcome all difficulties” in the process of reform. Inspired by his speech, we will conclude the Overall Plan and share the following humble opinions to start further discussions on Hainan FTP.

As the overall construction of Hainan FTP is unfolding, the Overall Plan provides for development goals by year 2025 and 2035 respectively and sets forth a new timeline, pointing out the direction for construction at this new stage.

The Overall Plan specifies the “island-wide special customs clearance operation ” mode for Hainan FTP, that is, turning the whole island will be turned into an area under special customs supervision, and relinquishing formerregional special customs supervision on the island will cease to exist. This mode of operation is the basis for implementing policies of “easing control on the first-line” and “having effective and efficient control on the second-line” in Hainan. The “first-line” is set up between the FTP and overseas markets, while the "second-line" is set up between the FTP and other domestic markets in China.

The Overall Plan further specifies the preparations for the island-wide special customs clearance  operation. On the “first line”, Hainan FTP formulates positive lists of imported taxable goods and a negative list of restricted or prohibited goods from import and export, exempts tax and inspection on transshipment cargo shipped by through bill of lading; and establishes a “single window” of high-standard for international trade. On the “second line”, Hainan FTP improves procedures and document format specifications for customs clearance with other domestic markets, exempts import duties for goods produced in the encouraged industries that either contain no imported materials or have a manufactured value added of more than 30% in the FTP; exempts customs declaration formalities for domestic goods transshipped to other domestic markets via Hainan FTP.

By 2025, Hainan conducts an assessment of the preparations for the island-wide special customs clearance operation in a timely and comprehensive manner to check and remedy any security loopholes, and establishes a more matured operation mode of Hainan FTP by 2035.

The Overall Plan has designed special tax arrangements for Hainan FTP.

First, it explicitly and unprecedentedly provides that the “zero tariff” policy will be implemented throughout the island in two steps: prior to the commencement of island-wide special customs clearance operation, the import tariff, import VAT and consumption tax of  certain imported goods will be “reset to zero”; after the island-wide special customs clearance operation, import tariff will be exempted for goods that are not included in the catalogue of imported taxable goods which are allowed to be imported into Hainan FTP.

Second, it provides for a specific taxation plan for consumption: to formulate a positive list for the administration of imported goods consumed by residents on the island, allowing duty-free purchase on the island to spur consumption, to raise the per capita quota for offshore duty-free shopping to RMB 100,000 per year, enrich the categories of duty-free commodities, and further optimize the offshore duty-free policies.

Third, the Overall Plan prescribes internationally competitive tax arrangements for the introduction of talents and enterprises: imposing only 15% CIT on enterprises in the encouraged industries with their registered office and substantial business operation in Hainan FTP, granting CIT exemption for income from additional overseas direct investments made by enterprises in tourism, modern services and high-tech industries established in Hainan Free Trade Port by 2025, allowing permission for enterprises to make one-time pre-tax deduction or accelerated depreciation and amortization of capital expenditures and imposing only 15% PIT on the introduced talents working in Hainan FTP.

The Overall Plan puts forward specific plans to realize the free movement of capital for cross-border transactions, cross-border direct investment and cross-border financing. Based on the free trade account system, the “electronic fence” is established to realize the isolation of financial accounts. For cross-border transactions, bank authenticity verification is changed from pre-audit to post-audit to facilitate cross-border settlement. For cross-border direct investment, the rules of “commitment and enter” for foreign investment is applied. For cross-border financing, the administration of the filing and registration for issuing foreign debts by enterprises is improved to steadily expand the scope of cross-border asset transfer, and better facilitate the capital exchange of foreign debt. For cross-border securities investment and financing, the focus will be on serving the investment and financing needs of the real economy. Such series of new policies embody to a largeextent the high standard set for “opening up” the economy, while stimulatingcapital vitality, in order to provide for a more diversified financing channelsas well as a more accommodating settlement service to the development of HainanFTP.

The construction of Hainan FTP is such a “a gigantic project” that only with the overall planning of the central government and the precise execution on local level can the final success be achieved. In view of Hainan’s “first-mover difficulties” and by taking into account the blueprint in the Overall Plan, we came up with the following thoughts on how to successfully implement the “Hainan Program”:

The operation of pilot zones is for the successful implementation of “Hainan Program” on the whole island. As “incubators” of FTP policies, the pilot zones should also undertake new roles in facilitating on the next stage.

Hainan should vigorously promote emerging businesses and industries in pilot zones, so as to form a sound institutional foundation for exploring high-tech and other sustainable development industries in Hainan FTP. For example, the NPC deputies have recently proposed to explore the commercial aerospace market in Hainan. This can first be piloted in Haikou Integrated Free Trade Zone as a response to the No.16 Announcement on Supporting Enterprises in Integrated Free Trade Zone to Conduct Maintenance Business. It can help to promote the implementation of pertinent policies on aviation bonded maintenance in the Integrated FTZ, and to attract a group of aerospace parts maintenance and manufacturing enterprises. In addition, the existing policies for foreign exchange in Haikou Integrated FTZ can provide access to aerospace R&D and satellite communication for foreign investment.

Business related to the people’s livelihood or of people’s concerns can also be tested in the pilot zone. For example, Hainan may conduct the trial of AI-assisted decision-making products in Boao Pilot Zone, explore and formulate product registration rules, promote supporting policies for developing medical AI products, and establish a sustainable business mode which is conducive to improving the basic medical care standards in Hainan. As what the author mentioned in former articles, Hainan’s existing regulatory rules and policy incentives for imported drugs would attract more pharmaceutical enterprises and medical institutions to settle in Hainan[4], and approval policies regarding the import of new drugs would further solve the dilemma faced by patients in the movie “Dying to Survive”[5].

Loosening measures  should also be commenced inside cross-border e-commerce industrial park in Haikou Integrated Free Trade Zone, such as replacing the “White List of Duty-free Imports in Cross-border E-commerce” with a negative list. Such policy adjustments will be a strong response to people’s concern on consumption.

The rule of law is the prerequisite for free trade. Now the legislation process is accelerating for Hainan FTP with international economy and trade rules as the general guidelines by the central government. Meanwhile, Hainan will also formulate supporting policies for preventing and controlling risks in finance, taxation, personnel and data flow, people’s livelihood and public health. Hainan should also accelerate the formulation of supporting measures, such as introducing the Pilot Measures for the Administration of Cross-border Data Flow in Haikou Integrated FTZ, formulating a negative list and tax incentives for data flow, as well as penalties. It should also accelerate the application of Securities Law and Foreign Investment Law in Hainan FTP, improve the regulatory rules on foreign exchange in an effort to solve the foreign exchange and repatriation problems concerning securities investment and dividends. In addition, Hainan should improve its tax administration, specify explicit criteria for determining the actual places of business and residence, enhance the identification of risks in tax evasion under the loosened tax rules of the FTP, and prevent tax base erosion and illegal profit transfer under a more loosened tax arrangement so as to prevent the FTP from becoming a “tax haven”.

To “ease control on the first-line” is to relax control on the cross-border inflow of goods, capital, personnel and data. Whether Hainan FTP can be effectively connected to the global markets and realize the free movements of elements of production are subject to the design of the "first-line" rules. We believe that differentiated standards should be applied to the opening-up policies in different areas of the island at different stages. To be specific, at the present stage, the opening-up policies in the pilot zones should conform to the highest standards of a free trade port, while areas outside the pilot zones should have the same level of openness as other pilot free trade zones and special customs supervision areas in China. Prior to the establishment of island-wide special customs clearance operation on the whole island by 2025, it is expected that as the pilot zones develop, they will help to gradually eliminate policy discrepancies within and outside the pilot zones, so that the opening-up policies of the whole island can eventually conform to the standards of a free trade port.

Pursuant to the instructions of the Overall Plan, Hainan should accelerate the formulation of positive lists of imports into Hainan FTZ, introduce a negative list of goods restricted or prohibited from import and export. Hainan should also accelerate the implementation of “zero tariff” policy and construct Hainan FTP in accordance with the standards of Hong Kong Separate Customs Territory. In this regard, the central government should consider delegating more power to Hainan, granting greater autonomy in its formulation of such lists of goods, and promoting the simplification of the cycle and procedures for goods crossing borders at the ministerial level. 

For example, as Hainan intends to further develop seed trade, the authority to approve the import & export of seed resources can be delegated to Hainan’s provincial departments. Meanwhile, Hainan should accelerate the formulation of supporting measures to isolate and supervise the introduced germplasm resources, prevent biological invasion, improve regulatory measures and enhance its ability to undertake policies.

To “have effective and efficient control over the second-line” is to administer the interaction between Hainan and other domestic markets on the movements of elements. Hainan FTP is not built to separate Hainan from other domestic markets in terms of economy and trade, but to serve as a platform to connect global markets and utilize global resources. We believe that the “second-line” rules should be designed to fully utilize domestic markets, effectively isolate the potential policy risks of the FTP and maintain the stability of domestic markets.

Pursuant to the Overall Plan, Hainan should develop into a free trade area which is “within the national territory but outside the customs territory”, with independent and well-designed rules on tax and special customs supervision governing its connection with domestic markets. As for taxes on goods departing from the island, our advice is to further loosen the duty-free policies for the departing goods which enter the domestic markets. In this way, such policies can benefit more consumers, making the massive domestic markets a driving force for the development of FTP. Other feasible measures include periodically lowering the tax rate or raising the threshold of postal tax of personal articles, exempting certain commodities with higher unit price from postal tax of personal articles, or even entirely abolishing such tax on commodities. For customs supervision on goods and articles leaving the island, it is necessary for Hainan to establish well-developed supporting measures for risk prevention and control. For example, anti-smuggling regulations and detailed rules on relevant penalties can be issued for areas under special customs supervision such as the integrated FTZ. A joint prevention and control mechanism for smuggling can be established with neighboring provinces such as Guangdong and Guangxi to prevent the FTP from becoming the hotbed of smuggling.