What accountants need to know about free-trade zones

A Chinese campaign to attract more foreign business and investment to its shores has put a spotlight on free-trade zones and raised the stakes among competing precincts.

In June 2023, China’s State Council announced it is trialling a range of new international trade rules in five FTZs and in the Hainan Free Trade Port as part of efforts to attract foreign interest, nurture domestic industries and boost the economy. 

In February 2024, the State Council also announced its intent to exempt stamp duty on offshore trade in the Shanghai FTZ and the zone’s Lingang new area from 1 April 2024 to 31 March 2025, “to benefit entities registered in the zone that conduct offshore trade business”. 

The opening-up measures come a decade after Mainland China launched its first FTZ in Shanghai. They underline the competitive nature of a market that has more than 5400 FTZs around the world, including 21 in Mainland China. 

Hailiang Zhang FCPA, business head and regional managing director, Vistra Greater China and CPA Australia east and central committee member, cites Chinese Ministry of Commerce figures revealing that, in 2023, the country’s 21 FTZs covered less than 0.4 per cent of China’s territory, but had achieved more than 18 per cent of foreign investment and more than 17 per cent of foreign trade. 

“Many multinational corporations have found FTZs to be a landing point or an attractive option for setting up business in [Mainland] China, with their sound business environment, investment and trade facilitation, government incentives and strong talent pool,” Zhang says. 

“The zones also serve as a gateway for Chinese companies looking to expand their presence overseas.”

FTZs versus FTAs

In the alphabet soup of free-trade things, it is important to understand the difference between free-trade agreements (FTAs) and FTZs. 

An FTA is an international treaty between two or more economies that reduces or eliminates barriers to trade and investment, which typically translates to benefits to exporters and importers around duties and tariffs.

An FTZ, on the other hand, is a physical place where goods can be imported, stored, manufactured and re-exported under specific customs regulations. These zones usually offer advantageous tariffs and lighter regulation related to financing, labour and taxes. They are also known as “special economic zones”. 

These sprawling precincts – which typically offer manufacturing, warehousing, storage and distribution facilities for trade purposes – are subject to favourable tax and customs regulations, making them conducive to foreign direct investment. 

They also seek to drive domestic economic growth and spark technological and skills advancement.

Race for global investment

FTZs are not new – they have existed in some form for centuries. While the Roman Empire provided safe spaces for traders, some European nations offered “free ports” in the 16th century, allowing foreign ships to dock and conduct trade. 

The Irish city of Shannon, located 200 kilometres south-west of Dublin, is regarded as the home of the first modern FTZ. Set up in 1959, it quickly flourished as a base for the export of manufactured goods and led to similar zones being set up in other jurisdictions, including Taiwan and South Korea. 

In Malaysia, two chief forms of FTZs operate – free industrial zones (FIZs) that primarily cater to manufacturing activities and free commercial zones (FCZs) that target trading activities. 

Semiconductor giant Intel has had a presence at the Bayan Lepas FIZ in the state of Penang for more than 50 years, setting up its first offshore assembly plant there in 1972. The company also has a presence at the Kulim Hi-Tech Park, an FCZ in Malaysia.

Amit Minocha FCPA, senior finance director at Intel Malaysia, says FTZs reduce many of the headaches for international investors. The Penang deal includes government tax exemptions from customs and excise duties for many goods and services, as well as providing a strong industrial ecosystem, well-developed infrastructure such as roads and ports, connectivity and access to a highly skilled workforce.

“Over time, that talent base just keeps building, so you have a really concentrated and skilled talent base in one area,” Minocha says.

Another key benefit of the Bayan Lepas FIZ for Intel is that streamlines import and export activity, so long as the business complies with Malaysia’s Customs Act 1967, which requires foreign companies in FTZs to export at least 80 per cent of their production. 

“For us, it helps with a simplified and swift customs-clearance process,” Minocha explains. “We bring in raw materials, tools or machinery for the factories and do not have any challenges with customs. It simplifies the whole process, and it is very convenient in terms of transporting goods and machinery in and out.”

Getting the FTZ fit right

Foreign companies are spoilt for choice when selecting FTZs in which to operate. 

In Mainland China, the Dalian FTZ in Liaoning province and the Waigaoqiao precinct in Shanghai are considered world class, while other acclaimed zones around the globe include the Dubai Multi Commodities Centre (United Arab Emirates), the Katowice Special Economic Zone (Poland), the Incheon Free Economic Zone (South Korea) and FTZ 124 in South Louisiana and FTZ 18 in California (US). Numerous other options exist across many other jurisdictions.

CPA Australia’s business investment and international lead Gavan Ord says there are many factors that may lead a business to choose one FTZ over another. 

“It could be lower cost, easier access to markets, the availability of skilled labour, favourable tax treatment, the strong presence of their industry, or just the overall business environment, to name a few,” he says. 

“The relative importance of these and other factors will vary from business to business.”

For Minocha and Intel, proximity to an airport near the Bayan Lepas precinct has been an important factor, along with a geographical location that puts it on the doorstep of other Asian trading strongholds. 

Minocha advises other companies weighing up the choice of an FTZ to do their homework, because setting up in such a zone can be expensive, and companies do not want to switch FTZs without good reason.

“In the semiconductor industry, similar to many other industries, there is a lot of co-dependency among core travelling partners through the supply chain, so it is important to have the same ease of access to those core travelling partners as well. That is why you want to get it right.”

Zhang agrees that it is especially important for foreign investors to make the right FTZ choice when beginning the incorporation and setup of a business. Matching an FTZ with a business’s particular sector and characteristics make sense. 

“For example, Shanghai is an excellent location for a financial company because of its status as an international financial hub that attracts many global asset management institutions,” he says. 

In addition, Zhang says elements such as geographic location, surrounding facilities, industry clusters, supply chains and urban development planning should be considered. 

While government subsidies and tax incentives will inevitably play a critical role in site selection, Zhang suggests that companies should conduct a cost-benefit analysis between different FTZs to ensure the numbers stack up. 

“Most importantly, these preferential policies may vary from FTZ to FTZ, from company to company, and are subject to negotiation with the local government.”

He adds that there can be challenges associated with FTZs, which include compliance requirements when changing a company’s registered address within Mainland China. Also, in order to receive government subsidies, Zhang says foreign-invested enterprises may need to make a commitment with the local government to operate for a certain period. 

“There is a chance that, if they close down or move to another location ahead of schedule, part of the establishment and operation bonus, tax savings and other benefits will be returned,” he says. 

Such challenges mean it is critical for foreign investors to consider whether it is appropriate for their business to be in an FTZ in the first place. 

“It may not be worthwhile for investors to force their business into an FTZ if the business activities do not have good synergy with those of the zone, or if extra effort is required to comply with the additional requirements,” Zhang says.

“In addition to FTZs, you can find an excellent foreign investment location throughout the country to suit your future company’s business needs and objectives, supported by China’s mature infrastructure, adequate supply chain, skilled workforce and huge consumer market.”

Mutual benefits of FTZs

In Mainland China, there is no doubt that the economy – not just foreign companies – have benefited from the establishment of the nation’s FTZs in the past decade. 

In the first quarter of 2023 alone, the import and export value of the 21 FTZs hit 1.8 trillion yuan (about US$247 billion or A$383 billion), a year-on-year increase of 6.6 per cent, according to official government data. Many other countries have benefited economically and through better infrastructure, technology and skills development through their FTZs.

For companies, Minocha says that while the tax breaks associated with FTZs “definitely help the bottom line”, it is important for all parties – including businesses, governments and local communities – to benefit from the partnership.

He recommends treating an FTZ as an opportunity to work closely with local governments, customs and other institutions, including having regular dialogue on what is working well in a precinct, and what is not.

In Intel’s case, it has given back to Malaysia in the form of initiatives such as funding scholarships and programs for under-privileged students, providing funding for crisis-relief efforts, and playing a key role as a good corporate citizen.

“Just be really open to the concept of engaging with the local ecosystem for a win-win for both sides,” Minocha says.

Big benefits

Vistra Greater China’s Hailiang Zhang FCPA outlines some of the government benefits that FTZs can deliver in Mainland China for foreign-invested enterprises.

1. Ease of doing business

FTZs offer greater access to foreign investment, a faster turnaround time for setting up business in the area, fewer restrictions on the movement of capital and simplified customs clearance. 

2. Preferential tax and duties policies

Eligible enterprises pay a 15 per cent corporate income tax rate for the first five years, compared with the standard 25 per cent rate for enterprises in Mainland China, if they are registered in the Shanghai FTZ and engage in substantial production and R&D activities in industries such as integrated circuits, artificial intelligence, biomedical and civil aviation. 

Foreign companies and their subsidiaries in the “promoted industries” category are also entitled to refunds related to value-added tax (VAT), income tax, import tax and customs duties.

3. Government subsidies

Qualified companies and their subsidiaries in promoted industries can also receive a range of subsidies, such as settlement bonuses, contribution bonuses, rent subsidies and purchase subsidies, if they meet certain conditions. 

“These subsidies vary from company to company and are granted on a case-by-case basis,” Zhang says.

4. Deep talent pool

Over time, FTZs in tier-one Chinese cities or on the east coast have developed a strong pipeline of qualified workers. To attract people from different industry backgrounds, the government has eased restrictions on bringing in overseas talent and introduced incentives to encourage more overseas workers to enter FTZs. 

“Other measures include utilising the resources of local universities and cooperating with universities to nurture talent,” Zhang says. 

Various FTZs are also introducing special benefits for domestic and overseas workers, including tax rebates, allowances, and housing and transportation subsidies.