China has traditionally restricted foreign investment in the retail and wholesale sectors with the aim of nurturing strong domestic players before their foreign counterparts would be allowed to enter the country. Since becoming a member of the World Trade Organisation, China has gradually opened up its distribution sector to foreign investment. The revised policy is implemented through a number of regulations of which the key ones are the Measures for the Administration of Foreign Investment in the Commercial Sector (the "Commercial Measures"), effective from 1 June 2004, and the Notice of the Ministry of Commerce on Entrusting Local Authorities with the Examination and Approval of Commercial Enterprises with Foreign Investment, effective from 1 March 2006. These developments in the distribution sector go hand in hand with other policy changes which have given foreign investors greater access to the PRC domestic market.

This leaflet discusses the key elements of the regulatory framework for foreign investment in the distribution sector in China.

Foreign Investment Commercial Enterprise ("FICE")
Foreign investors are permitted to engage in four forms of distribution activities:

• commission agents' services; 

• wholesaling;

• retailing; and 

• franchising.

A foreign investor is required to establish a FICE if it wishes to engage in these distribution activities. The investors in FICE can be foreign companies, enterprises or other economic organisations as well as foreign individuals.

Foreign investors may establish a FICE in partnership with a Chinese party as a joint venture or on their own as a wholly foreign-owned enterprise. However, not all FICE may be wholly owned by a foreign investor. A FICE with more than 30 outlets dealing in certain specified products of different brands that are sourced from different suppliers must take the form of a joint venture in which the maximum share of the foreign investor is limited to 49%. The specified products are pharmaceutical products, pesticides, mulching films, chemical fertilizers, processed oil, staple food, vegetable oil, edible sugar and cotton.

Also, FICE are prohibited from engaging in the wholesale of salt and tobacco and in the retail of tobacco.

Conditions
The foreign investor should have a good reputation and comply with PRC law. Whereas the statutory requirement is that a FICE has a minimum registered capital of only RMB30,000 (about US$4,390), the authority in charge of approving the establishment may impose a higher registered capital requirement to match the proposed scale of business of the FICE.The investment must comply with the minimum debt to equity (registered capital) ratios imposed under PRC law. The term of operation should not normally be longer than 30 years but may be extended to 40 years if the FICE is established in the central and western regions of China.

Permitted Business Activities
A retail FICE may engage in the following business activities:

• commodity retailing;

• commodity import for its own account;

• sourcing of domestic products for export; and

• other relevant ancillary activities.

A wholesale FICE may engage in the following business activities:

• commodity wholesale;

• commission agents' services (except for auctions);

• commodity import-export; and

• other relevant ancillary activities.

A FICE may engage in one or more of the business activities set forth above and may authorise third parties to open franchise shops.

Franchising
The Commercial Measures do not contain detailed guidelines regarding the operation of franchising business. According to the Regulations for the Administration of Commercial Franchising Operations ("Franchising Regulations"), effective from 1 May 2007, a franchisor must have operated two directly owned stores for at least one year before it may lawfully grant franchises. The franchisor can be a foreign entity.

Range of Products
A FICE must specify the range of products it distributes in the business scope of its corporate establishment documents. A FICE is only permitted to deal in those types of products listed in its business scope.

The import and distribution of certain categories of products in China are subject to various forms of state control. If the products in which a FICE deals are products subject to special State regulations or are import-export products which are subject to quota or licensing control, the FICE must comply with the relevant licensing requirements.

Establishment Procedure
Whilst the Ministry of Commerce ("MOFCOM") is the principal approval authority for FICE, it has delegated its approval powers with respect to most types of FICE to the provincial level departments in charge of commerce ("provincial commerce authorities").Within the scope of these delegated powers, the provincial commerce authorities can autonomously approve the establishment of FICE and they are only required to report the matter to MOFCOM for record.A FICE is still subject to MOFCOM approval if:

• its mode of operations involves sales through television, telephone, mail order, internet or automatic vending machines, etc; or

• it distributes important industrial raw materials such as steel, precious metals, ironstone, fuel oil, natural rubber or products such as books, newspapers, periodicals, processed oil, pharmaceutical products, motor vehicles, pesticides, mulching films, chemical fertilizers, staple food, vegetable oil, edible sugar and cotton.

In those instances where approval by MOFCOM is required, an application for the establishment of a FICE must be submitted first to the provincial commerce authority in the proposed investment location. After preliminary examination, the provincial commerce authority will forward the application to MOFCOM within one month. MOFCOM will then have three further months to decide whether or not to approve the application.

If an existing foreign investment enterprise intends to expand its business scope to include distribution rights and become a FICE, it must proceed in accordance with the approval procedure and principles for the establishment of a new FICE set forth above.

Establishment of Outlets
FICE may set up shops (outlets) on condition that their establishment complies with the regulations regarding urban development and urban commercial development. An existing FICE may only set up a new outlet if it has passed the annual inspection and has paid up its registered capital in full.

MOFCOM is the approval authority for the opening of new outlets by FICE. Provincial commerce authorities are authorised, however, to approve new outlets in the following three situations:

• the area of a single outlet does not exceed 5,000 square meters and there are not more than three outlets in total, and the foreign investor has not opened more than 30 outlets in the same class in China through FICE; or

• the area of a single outlet does not exceed 3,000 square meters and there are not more than five outlets in total, and the foreign investor has not opened more than 50 outlets in the same class in China through FICE; or

• the area of a single outlet does not exceed 300 square meters. 

Under the above circumstances, the provincial commerce authorities are only required to report the approval for the establishment of outlets to MOFCOM. 

Special Provisions Regarding Hong Kong and Macau Service Suppliers 
Qualified Hong Kong and Macau service suppliers (collectively referred to as "SAR suppliers") are granted greater access to the distribution sector than other service suppliers under the provisions of the Closer Economic Partnership Arrangements which Mainland China has concluded with Hong Kong and Macau. For example, SAR suppliers are permitted to establish wholly-owned car retailers.

There are also preferential treatments for a Hong Kong service supplier who/which has opened more than 30 stores accumulatively on the Mainland to engage in distribution of pharmaceutical products, pesticides, mulching films, chemical fertilizers, vegetable oil, edible sugar and cotton on a wholly owned basis if those goods are of different brands and come from different suppliers.

How Deacons can help with establishing a Foreign Investment Commercial Enterprise
Deacons is a full-service commercial law firm with a strong international presence in most major Asian cities. Our China Practice Group has advised on investments, business activities and trade transactions in Mainland China for more than 25 years. Deacons was the first foreign law firm officially approved to establish three representative offices in the major Chinese cities of Beijing, Shanghai and Guangzhou.

Deacons can assist in the establishment of a FICE, including the establishment of an overseas special purpose vehicle to hold the interest in the FICE and the approval and licensing of the FICE and its outlets inside China.

For more information on how Deacons can help, please contact one of the China Practice Group members.