The Hainan Free Trade Port (1): Policy Update
13 December 2021
C H Poon
The CPC Central Committee and the State Council’s objective is to develop Hainan into a free trade port. The Guiding Opinions on Supporting Hainan’s Comprehensive Deepening of Reform and Opening Up (Chinese only), promulgated in April 2018, calls for a pilot free trade zone and a free trade port with Chinese characteristics, a project to be completed in stages.
The CPC Central Committee and the State Council released the Overall Plan for the Construction of the Hainan Free Trade Port (Overall Plan) in June 2020 after about two years of free trade zone construction between 2018 and 2020. Subsequently, the Hainan Free Trade Port Law of the People’s Republic of China took effect on 10 June 2021. Hainan is taking bold steps towards the free trade port era within the Overall Plan framework and the Hainan Free Trade Port Law legal safeguards.
According to the Overall Plan, the Hainan Free Trade Port covers the entire island, with a total area of about 33,900 sq km. This vast size provides ample room for the development of many industries.
The HKTDC Research Greater China Research Team has launched the “Hainan Free Trade Port” series in order to update Hong Kong companies on the latest developments following the release of the “Hainan Free Trade Zone” series in 2019. The Team hopes to help Hong Kong companies grasp the emerging business opportunities in Hainan through policy updates, key sectors analysis and case studies. In this first article of the series, the free trade port development framework is presented by analysing the major policies promulgated.
‘First Line, Second Line’
Key policies: Overall Plan, Hainan Free Trade Port Law, and Interim Measures of the Customs for the Collection and Administration of the Taxes on the Domestic Sales of Goods with Added Value from Processing in the Yangpu Bonded Port Area
Free entry and exit of goods is a distinctive feature of free trade ports. For the customs arrangements in Hainan and other mainland cities the Overall Plan and the Hainan Free Trade Port Law put forward a management model featuring island-wide independent customs operation, zero tariffs, and “free flow through the first line, control at the second line”. The “first line” refers to the boundary between the Hainan Free Trade Port and other countries and regions outside the People’s Republic of China customs territory, while the “second line” refers to the boundary between the Hainan Free Trade Port and other areas within China’s customs territory (other parts of the mainland).
Within the “first line”, items not included in the catalogue of goods subject to import tariffs are exempt when they enter or leave the Hainan Free Trade Port, after island-wide independent customs operation takes effect. Customs will also exempt transhipments from taxes and inspection under through bill of lading (TBL). Goods leaving the Hainan Free Trade Port for other countries and regions outside China’s customs territory will be subject to export control. There is no maximum storage time for goods entering Hainan and enterprises are free to choose where to store their goods.
Since most goods entering Hainan are exempt from time-consuming duty levying procedures and can be dispatched freely within the island under this management model, trading and circulation are more efficient than in other provinces, municipalities and autonomous regions. This is what is meant by “free flow through the first line”.
For the “second line”, goods leaving Hainan for other parts of the mainland are required to go through customs clearance. This means that enterprises must conduct the relevant procedures, paying customs duties and import-related taxes (value-added tax and consumption tax) according to regulations. Postal articles sent from the Hainan Free Trade Port to other parts of the mainland will also be levied taxes.
However, if the goods are produced by industries encouraged in Hainan (‘encouraged industries’ is explained below) and do not contain imported materials, or if the value-added by local processing is 30% or more, then goods are exempt from import tariffs on entering other parts of the mainland via the “second line”, but are still subject to import value-added tax and consumption tax.
Since goods entering other parts of the mainland are subject to supervision procedures, there is “control”. Goods entering Hainan from other parts of the mainland are entitled to refunds of value-added tax and consumption tax paid, in accordance with State Council regulations, as well as being subject to domestic circulation control measures.
As of October 2021, zero-tariff and “free flow through the first line, control at the second line” have not yet been implemented in Hainan because island-wide independent customs operation has not yet launched. At a State Council press conference on 8 June 2020 the National Development and Reform Commission indicated that island-wide independent customs operation will be launched at a suitable time before 2025. When Hainan’s then acting Governor Feng Fei delivered the Government Work Report in January 2021, he said Hainan would strive to have the hardware for independent customs operation ready by the end of 2023 and have all preparations completed before the end of 2024.
The relevant preparations are already underway. The General Administration of Customs released the Interim Measures of the Customs for the Collection and Administration of the Taxes on the Domestic Sales of Goods with Added Value from Processing in the Yangpu Bonded Port Area on 8 July 2021. According to these measures, goods containing imported materials produced by enterprises in encouraged sectors registered in the Yangpu Bonded Port Area and filed with the Yangpu Economic Development Zone Administrative Committee with value-added by local processing exceeding 30% will be exempt from import tariffs on leaving the Yangpu Bonded Port Area for sale in other parts of the mainland before 31 December 2024. Import value-added tax and consumption tax will still be levied.
This shows that the Yangpu Bonded Port Area is conducting trial implementation for island-wide independent customs operation. After the launch of independent customs operation, Hainan will become another zero-tariff zone within China, just like the Hong Kong Special Administrative Region, Macao Special Administrative Region and the Hengqin Guangdong‑Macao In‑depth Co‑operation Zone.
Negative lists and Investment facilitation
Key policies: Hainan Free Trade Port Law, Special Administrative Measures for Foreign Investment Access to Hainan Free Trade Port (Negative List) (2020 Edition), Catalogue of Prohibited/Restricted Industries in Hainan Province (2019 Edition) (Chinese only), Ecological Environment Access List of Hainan Province (2021 Edition) (Chinese only), and Special Administrative Measures for Cross-Border Trade in Services in Hainan Free Trade Port (2021 Edition) (Chinese only)
Investment liberalisation and facilitation is another feature of free trade ports. The Hainan Free Trade Port Law stipulates that the Hainan Free Trade Port will implement a policy of investment liberalisation and facilitation, a system featuring minimal approval procedures for investment, and pre-access national treatment with negative list management, as well as easing market access in the free trade port (Articles 18, 19 and 20 of Hainan Free Trade Port Law). The negative list management system is an important tool for striking a balance between investment liberalisation and facilitation alongside secure development. Businesses should note that the negative list will be updated from time to time.
The Special Administrative Measures (Negative List) for Foreign Investment Access to Hainan Free Trade Port (Negative List) (2020 Edition) contains a list of 27 control measures applicable to foreign investment in the Hainan Free Trade Port. The principle of equality between domestic and foreign investment applies to sectors outside the negative list.
Compared with the Special Administrative Measures (Negative List) for Foreign Investment Access (2020 Edition) in the whole country (33 items) and the Special Administrative Measures (Negative List) for Foreign Investment Access in Pilot Free Trade Zones (2020 Edition) (30 items), Hainan’s negative list is the shortest. It also entails greater measures for opening up. For example, there are no access restrictions for online data processing and transaction processing business in the value-added telecommunications sector. In the legal services sector, foreign investment is allowed in some non-litigation legal services involving commercial matters in Hainan.
The Catalogue of Prohibited/Restricted Industries in Hainan Province (2019 Edition) lists items prohibited from additional fixed asset investment, as well as restrictions for the geographical location, scale, industrial links and technological processes of some industries. For example, the negative list specifies the time that relevant production capacity must exit. There are 24 such items in this catalogue, covering such sectors as agriculture, forestry, animal husbandry and fishery, mining, manufacturing and real estate. Prohibitions and restrictions are imposed mainly to protect Hainan’s environment. These measures are stricter than most other parts of the mainland. For example, the production of disposable and non-biodegradable plastic bags and tableware is prohibited in Hainan.
The Ecological Environment Access List of Hainan Province (2021 Edition) released in October 2021 details the overall ecological environment access and control requirements for different parts of Hainan. Enterprises intending to make fixed asset investment in Hainan are advised to study these carefully. This shows that economic development and environmental protection will proceed side by side in the Hainan Free Trade Port.
The Special Administrative Measures for Cross-Border Trade in Services in Hainan Free Trade Port (2021 Edition) is applicable to overseas service providers that offer services to market entities and individuals in the Hainan Free Trade Port and includes 70 items. The principle of equality between domestic and foreign services and service providers applies to sectors outside the negative list.
It is worth noting that if the central government has already offered more preferential terms to overseas service providers under different agreements and treaties (such as the Mainland and Hong Kong Closer Economic Partnership Arrangement, i.e., CEPA), the provisions of the more preferential agreements and treaties shall apply. Thus, Hong Kong companies need to keep the content of CEPA in mind when studying the negative list. The fact that this negative list is the first of its kind released by the Chinese government for cross-border trade in services suggests that Hainan is the front-runner in the opening up of the service sector to cross-border trade.
Preferential enterprise income tax
Key policies: Circular of the Ministry of Finance and State Taxation Administration on Preferential Enterprise Income Tax Policies in the Hainan Free Trade Port, Catalogue of Encouraged Industries for Foreign Investment (2020 Edition) (Chinese only), and Announcement of the Ministry of Finance, General Administration of Customs and State Taxation Administration on the Duty-Free Shopping Policy for Travellers Departing Hainan
The Overall Plan clearly states that the Hainan Free Trade Port will focus on the development of tourism, modern services and high-tech industries. The Hainan Free Trade Port Law adds high-efficiency agriculture with tropical characteristics to these three industries (Article 38). The central government has adopted a number of policies to encourage the development of these industries, the most eye-grabbing of which are preferential enterprise income tax policies. On 23 June 2020, the Ministry of Finance and the State Taxation Administration jointly issued the Circular on Preferential Enterprise Income Tax Policies in the Hainan Free Trade Port, stating that enterprises in encouraged industries registered in the Hainan Free Trade Port and engaging in substantive operations are entitled to enterprise income tax at a reduced rate of 15% between 1 January 2021 and 31 December 2024.
The list of encouraged industries is included in the Catalogue for Guiding Industrial Restructuring, Catalogue of Encouraged Industries for Foreign Investment and Catalogue of Encouraged Industries in the Hainan Free Trade Port. Hong Kong and foreign companies should refer to the Catalogue of Encouraged Industries for Foreign Investment (which is updated from time to time) to find out whether they are classified as encouraged industries, while domestic companies should refer to the Catalogue for Guiding Industrial Restructuring and the Catalogue of Encouraged Industries in the Hainan Free Trade Port. The following are some of the sectors listed in the Catalogue of Encouraged Industries for Foreign Investment (2020 Edition):
The government has clear specifications as to whether an enterprise is “an enterprise in encouraged industries engaging in substantive operation”. According to the Circular on Preferential Enterprise Income Tax Policies in the Hainan Free Trade Port, an enterprise will only be classified as being in encouraged industries if its primary activity is listed in the three catalogues mentioned above and the revenue from such activity accounts for 60% or more of the total. At the same time, its effective management location must be in the Hainan Free Trade Port and have substantial and complete control over matters of production and operation, personnel, accounts, assets, etc. in order to be regarded as being engaged in “substantive operation”. Otherwise, it will not be entitled to the preferential enterprise income tax policies. If an enterprise in Hainan is just a branch, then only the revenue of the qualified branch set up in the Hainan Free Trade Port is entitled to preferential enterprise income tax at a reduced rate of 15%.
The Circular on Preferential Enterprise Income Tax Policies in the Hainan Free Trade Port also puts forward two other policies. First, income from new overseas direct investment derived by enterprises in the tourism, modern services and high-tech industries may be exempt from enterprise income tax. Overseas direct investment is defined as operating profits derived from branches established overseas, or dividend income from an overseas subsidiary with a 20% or more equity interest that is a result of a direct investment in such company. The country (region) where the investment is made must have a minimum statutory enterprise income tax rate of 5%.
Second, fixed assets or intangible assets newly acquired (built or developed) by enterprises established in the Hainan Free Trade Port can be included in the current calculation of taxable income in one go if the unit price is RMB5 million or less, instead of being depreciated or amortised annually. For assets valued at more than RMB5 million, the depreciation or amortisation period may be shortened, or an accelerated depreciation or amortisation approach may be adopted. Fixed assets here refer to assets other than buildings and structures.
In order to promote the development of tourism in Hainan, the central government has also updated the duty-free shopping policy for travellers departing the island, in addition to the preferential enterprise income tax policies mentioned above. On 29 June 2020, the Ministry of Finance, the General Administration of Customs and State Taxation Administration jointly issued the Announcement on the Duty-Free Shopping Policy for Travellers Departing Hainan. It states that for travellers over 16 years old who made purchases at franchised duty-free stores with air tickets, train tickets or ship tickets and valid identity documents on their departure from Hainan (not including travelers leaving Mainland China through Hainan), the duty-free purchase limit has been lifted from RMB30,000 to RMB100,000 per year.
In addition to limits on value, there are also limits on quantity for some products. For example, each person may only purchase 30 items of cosmetics each time. Purchases exceeding the limits on value and quantity are subject to duties for personal imports according to regulations.
The updating of the duty-free shopping policy for departing travellers has had an immediate effect in boosting Hainan’s tourism. According to Haikou Customs statistics, duty-free purchases by departing travellers between 1 July 2020 and 30 June 2021 reached RMB46.8 billion, a year-on-year increase of 226%.
Preferential individual income tax
Key policies: Circular of the Ministry of Finance and State Taxation Administration on Individual Income Tax Policies for High-End and Urgently-Needed Talent in the Hainan Free Trade Port (Chinese only), Interim Measures of List Management for High-End Talents and Urgently-Needed Talents Enjoying Hainan Free Trade Port‘s Preferential Policies on Personal Income Tax, and Catalogue of Urgently-Needed Talent in Designated Industries in the Hainan Free Trade Port (2020 Edition)
As seen from the policies mentioned above, the Hainan Free Trade Port is committed to developing into one of the world’s leading free trade ports. In order to achieve this objective, it must have the ability to attract talent, in addition to liberal and competitive industrial policies. The central government and the Hainan Provincial People’s Government have released many policies in relation to talent since 2018. Among these, the Circular of the Ministry of Finance and State Taxation Administration on Individual Income Tax Policies for High-End and Urgently-Needed Talent in the Hainan Free Trade Port has triggered a significant reaction in society.
This circular stated that individuals’ income tax in excess of 15% of their actual tax burden will be waived for high-end and urgently-needed talent working in the Hainan Free Trade Port between 1 January 2020 and 31 December 2024. In the nine mainland cities in the Guangdong-Hong Kong-Macao Greater Bay Area, individual income tax in excess of 15% of the actual tax burden are subsidised by the local governments for overseas high-end and urgently-needed talent under existing policies, but these people must apply to the local governments to benefit from the subsidies. By directly waiving individual income tax in excess of 15% of their actual tax burden, Hainan is making it simpler and more convenient for overseas talent to handle tax filing.
According to the provisional measures for list management in relation to high-end and urgently-needed talent entitled to preferential individual income tax policies in the Hainan Free Trade Port released by the Hainan Provincial People’s Government, such individuals must meet the following two criteria to be regarded as working in the Hainan Free Trade Port. First, they must be working in the Port and have paid social insurance, such as basic pension insurance, continuously for more than six months in a single tax year (December of the current year included). Second, they must be bound by job contracts, employment agreements and other documentary proof for more than one year with enterprises or entities registered and substantially operating in the Hainan Free Trade Port.
Hainan adopts the list management approach for high-end and urgently-needed talent. According to the Catalogue of Urgently-Needed Talent in Designated Industries in the Hainan Free Trade Port, talent from Hong Kong, Macao and Taiwan working in the Hainan Free Trade Port are part of the urgently-needed talent pool. In other words, Hong Kong permanent residents going to work in the Hainan Free Trade Zone are entitled to individual income tax benefits without sectoral restrictions. Foreigners who go to work in Hainan must meet the criteria for other foreign personnel (category C) in the Interim Measures for Foreigners to Work in Hainan with Work Permit Management Services (Chinese only). Domestic talent must have an annual income of RMB300,000 or above or belong to one of the 16 professions listed in the Catalogue of Urgently-Needed Talent.
Key policies: Overall Plan, Hainan Free Trade Port Law, Opinions of the National Development and Reform Commission and Ministry of Commerce on Several Special Measures for Relaxing Market Access in Support of the Construction of the Hainan Free Trade Port
Many of the policies mentioned above are effective until the end of 2024. Will there be any overall policy changes when island-wide independent customs operation is launched?
The Overall Plan and the Hainan Free Trade Port Law have provided the initial blueprint for the tax reform. First, with regard to enterprise income tax, all enterprises registered and engaging in substantive operation in the Hainan Free Trade Port are entitled to enterprise income tax at a reduced rate of 15%. For personal income tax, all individuals residing in Hainan for more than 183 days in a tax year are levied individual income tax at progressive rates of 3%, 10% and 15% on their comprehensive income and business income derived from the Hainan Free Trade Port.
For value-added tax, sales tax and other taxes, after the launch of island-wide independent customs operation, the current value-added tax, consumption tax, vehicle purchase tax, urban maintenance and construction tax, education surcharges among other taxes and charges will be streamlined, and sales tax will be collected on the retail sale of goods and services. This means Hainan’s tax system will be simpler and distinctly different from other mainland regions after 2025.
The Opinions on Special Measures for Relaxing Control over Market Access to Support the Construction of Hainan Free Trade Port jointly released by the National Development and Reform Commission and the Ministry of Commerce on 7 April 2021 charts the direction for expanding the opening up of industries. With a focus on sectors such as medicine and health, culture and education, this guideline puts forward the following policies to support Hainan’s opening-up:
- Supporting the online sales of prescription drugs. The Boao Lecheng International Medical Tourism Pilot Zone (Lecheng Pilot Zone) will set up an e-prescription centre in Hainan to provide third-party information services for prescription drug sales agencies. All prescription drugs, except for drugs specifically regulated under the national drug administration law, can be sold online through the e-prescription centre without separate approval.
- Supporting the innovative development of China-made high-end medical equipment. The production of the first unit (set) of high-end medical equipment in Hainan is encouraged. China-made large medical equipment produced in Hainan and included in the guiding catalogue for promotion and application of the first unit (set) of major technical equipment or the catalogue for allocation licensing for Category A and Category B large medical equipment shall be subject to the requirements of the relevant document on the first unit (set) of China-made equipment.
- Supporting the development of Hainan’s high-end medical cosmetology industry. Well-known medical cosmetology institutions are encouraged to settle in the Lecheng Pilot Zone. Medical cosmetology institutions in the Lecheng Pilot Zone may use medical cosmetology products in batches marketed in the US, EU, Japan and other countries or regions. Among them, drugs, medical devices and cosmetics that need to be registered or filed in China must follow the law. The Lecheng Pilot Zone may formulate incentive measures. The relevant Hainan Province government departments will research and put forward the list of imported drugs, medical devices, cosmetics companies and products required for the development of the medical cosmetology industry in the Lecheng Pilot Zone, and assist the related companies in handling the registration, under the support of the National Medical Products Administration. Foreign high-level medical cosmetologists are supported in practising medicine in Hainan for a short period of time in accordance with laws and regulations, and promote the development of the medical cosmetology tourism industry.
- Relaxing access restrictions on cultural relics industry. The notification and commitment management system will be implemented in approving the establishment of cultural relics stores. Support will be given to the establishment of market-based cultural relics restoration, protection and authentication research institutions.
- Supporting leading Chinese colleges and universities to establish international schools in Hainan. Support will be given to leading Chinese education institutions to set up international schools in the Hainan Lingshui International Education Innovation Pilot Zone, or in places like Sanya with better conditions for running schools to serve the Belt and Road Initiative.
The above policies suggest that advanced manufacturing and services sectors such as medicine and health, culture and education are pillar industries for long-term development in Hainan. These policies are intended to improve the quality of consumption and services in Hainan and boost the island’s development of tourism and high-tech industries.
Hainan is no doubt unique when its current and future systems are compared with other parts of the mainland, even other pilot free trade zones. Despite Hong Kong’s status as one of the leading free trade ports of the world, Hainan Free Trade Port may still prove to be attractive for Hong Kong companies already accustomed to the free trade port system.
Seen from short-term perspectives, Hainan’s tourism and related services will stand to benefit from the free trade port policy. According to Hainan Provincial Department of Tourism, Culture, Radio, Television and Sports, Hainan’s gross revenue from tourism reached RMB107.1 billion between January and September 2021, soaring by 51.5% from the corresponding period in 2019 before the Covid-19 outbreak. Gross tourism revenue in the province suffered a 17.5% drop in 2020 compared with 2019 due to the pandemic. Hong Kong and overseas investors may actively consider taking advantage of Hainan’s preferential tax policies to venture into Hainan’s tourism market and engage in luxury merchandise sales, jewellery trade, as well as sports, health and leisure services. They may also consider providing services needed by tourism enterprises, such as services of international business consultancy, software design and human resources. Hainan has attracted a lot of people and capital since 2018 and is an ideal place for Hong Kong companies to open up the domestic sales market.
In the long-term Hainan is deepening its connections with countries all over the world through different channels, such as the China International Consumer Products Expo, with the first edition held in May 2021. The province may become another hub for the deepening of China’s opening up in future.
Hong Kong and overseas investors planning to venture into Hainan may leverage the mainland’s “dual circulation development paradigm” and actively make use of Hainan to expand international trade as well as developing domestic sales in order to gain a bigger comparative advantage amid the deepening of regional economic and trade co-operation around the world.
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