Hainan's Free Port

On June 1,2020,the Communist Party of China's Central Committee and the State Council jointly released the Master Plan for the Construction of the Hainan Free Trade Port,offering a blueprint for an ambitious project that will be a milestone in the nation's economic development.

General Secretary Xi Jinping stated that the free trade port will embrace new ideas in government management that will stimulate growth and unleash domestic talent. "Innovation of institutional integration shall be prioritized to free people's minds to make bold innovations and ensure enduring progress," he said.

China has set up numerous pilot free trade zones since the 18th National Congress of the Communist Party of China in 2012. Much valuable experience has been gained from these projects and the policies that proved successful in the past can be replicated and promoted throughout the country. However,unlike the Hainan Free Trade Port,these free trade zones were confined to relatively limited areas. They also encountered problems that stemmed from a lack of institutional integration. In order to avoid those types of difficulties,the Hainan Free Trade Port has been designed as an island-wide project that will push forward policies that will ensure a higher degree of economic opening. The Master Plan covers institutional innovations across a number of fields and reflects the collaboration and integration of these institutions.

Although the Master Plan was issued to guide the construction of the free trade port in Hainan,it was developed with a focus on the overall development picture at home and abroad and thus has significance for China's economic and social development. The Master Plan has an explicit guiding ideology and clear basic principle; while drawing on international experience,it also embodies Chinese characteristics,conforms to Hainan's economic positioning,highlights reform and innovation,and calls for preparedness for any potential setbacks.

The Master Plan's institutional system focuses on liberalizing policies in six general areas: trade,investment,cross-border capital flows,and the movement of people,transportation and the secure and orderly flow of data. It also builds a modern industrial system focusing on tourism,modern service industries and high-tech industries. Additionally,it entails a liberalized tax system that will be applied in a phased in manner and features zero tariffs and low tax rates combined with a simplified taxation regime. There will also be strengthened social governance,a comprehensive development of the rule of law as well as a risk prevention system. There are 11 components to the Master Plan and they support each other in outlining the plans for construction of the Hainan Free Trade Port.

A Free Trade Port with Chinese Characteristics

Successful international free trade ports provide guidance for Hainan's project,but there is no ready-made template that fits all situations. We need to make use of those valuable experiences and explore our own development method.

Instead of having a universally recognized legal definition,currently there is only a conventional understanding of a "free trade port." China's Hong Kong,Singapore and Dubai are typically seen as free trade ports. Singapore and Dubai also have free trade zones within their free trade ports,where there are no large-scale commercial consumption facilities or complex processing. Imported commodities are exempted from tariffs when entering these free trade zones,but taxes apply when goods enter areas other than the free trade zone. For instance,there is a 5% tax on general commodities in the United Arab Emirates – where Dubai is located – as it is a member of the Gulf Cooperation Council (GCC). In order to become integrated with the GCC tax system,the United Arab Emirates established its Federal Revenue Service in 2017,and began collecting value-added tax as of January 1,2018 and consumption tax as of October 1,2017. Prior to that there was no federal tax department in the United Arab Emirates and there was no value-added tax or consumption tax. On January 10,2018,the UAE Cabinet passed Resolution 2017 (No. 59),announcing that 20 designated zones would enjoy VAT exemption,including seven free trade zones in Dubai.

Another example is Singapore,which has basically instituted zero tariffs as a free trade port. But Singapore implemented a goods and service tax (GST) system in April 1994,and currently has a tax rate of 7%. This tax is imposed on applicable local manufactured goods and services,as well as imported commodities. However,according to the Free Trade Zone Act of Singapore,seven free trade zones are exempt from GST. That means imported commodities are not subject to tariffs when goods enter these free trade zones but are still subject to tax when entering other parts of Singapore.

Based on the current plan for the Hainan Free Trade Port,the degree of institutional liberalization exceeds that of both Singapore and Dubai. Certain imported goods will be exempt from import duties,value-added tax and consumption tax before the infrastructure is fully in place. Afterwards there will be a simplified tax system with no import duties,except for prohibited and restricted goods,as well as those goods specifically listed in a catalogue of taxable items. Value-added tax and consumption tax are not mentioned in the Master Plan because they are to be consolidated into the import tariff arrangement. In this regard,the Hainan Free Trade Port will possibly follow the practice of China's Hong Kong,where tariffs are only imposed on four types of dutiable goods listed in the tax catalogue,with imports of other items exempted from tariffs. There are no turnover taxes (such as value-added tax or commodity tax) in China's Hong Kong. The Master Plan will also try to reduce indirect taxes. While the Hainan Free Trade Port will simplify the tax system,it should be noted that a "sales tax" is mentioned in the Master Plan in a reference to the tax reform prior to 2035. At present,we are not clear that whether this is a general term or a new type of tax to be established.

When the infrastructure construction is completed,the Hainan Free Trade Port will become a huge special customs zone,but it also will be different from other existing special customs zones. Traditional bonded areas (around 15) have a departure tax refund policy. There are only a few commercial consumption facilities serving products purchased from the mainland market. A bonded port area and integrated free trade zone have an entry tax refund policy. Commercial consumption facilities are not allowed in these areas. In contrast,the Hainan free trade is an international tourist center,which means there will be a large number of commercial consumption facilities that will provide consumers plenty of imported tax-free goods. The Hainan Free Trade Port is similar to China's Hong Kong in this regard.

However,China's Hong Kong is an independent customs territory. Unless Hainan is also defined as an independent customs territory under the planned Free Trade Port Act,it will still be a special area under the customs supervision of China. And there are only a few special customs supervision areas in the world where manufacturing and commercial/retail operations are permitted. The Manaus Free Trade Zone in Brazil may provide some similarities to Hainan. Manaus was only a bonded warehouse in the Port of Manaus on the Amazon River in 1951. It was legally recognized as the Manaus Free Trade Zone in 1967. At present,the Manaus FTZ covers an area of approximately 10,000 square kilometers and includes commercial and industrial areas as well as agriculture zones. Except for weapons,alcoholic beverages,tobacco,certain perfumes and cosmetics,and passenger cars,goods imported into the FTZ are all exempt from tariffs regardless of their usage. All are exempt regardless of whether they are for local consumption,to be reassembled or stored for re-export. Industrial products manufactured within the FTZ,as well as their imported inputs can enjoy up to 88% of the import tax exemption when they are moved to other regions of Brazil. Computers,automobiles,tractors and similar finished products also enjoy reduced taxes. Brazilians can also purchase tax-free goods in the free trade zone though there are limits on quantity. Yet,Manaus is an inland river port located far away from the sea and high transportation costs hinder its development. Therefore,this taxation system does not entirely suit Hainan.

The Hainan Free Trade Port is much larger in area than above mentioned free trade ports. China's Hong Kong is about 1,107 square kilometers,Singapore 724 square kilometers,Dubai 4,114 square kilometers,and Manaus –which is the biggest of the four -- with around 10,000 square kilometers. Hainan island is 34,000 square kilometers. It gives us sufficient space to build a natural ecological system where man and nature can develop in a coordinated way while we maintain a social economic system which highlights freedom and openness.

Hainan must make full use of the huge mainland market while it maintains a high degree of openness and freedom. It should become a bridge connecting the home market with the international market rather than be seen as an independent island. Moreover,in order to prevent smuggling,the Master Plan stipulates that goods produced by enterprises in encouraged industries that do not contain imported materials or that contain imported materials processed in Hainan with an added-value of more than 30% will be exempt from import duties and will only be subject to value-added tax and consumption tax. This will help Hainan utilize the huge mainland market to develop high value-added manufacturing,including in hi-tech industries. Policies will require more details in the future,but these are the main characteristics of a free trade port that is part of a much larger country and rules of origin apply.

The rule of origin standard has been widely applied in many other free trade agreements. The 30% standard is also used in the Closer Economic Partnership Arrangement of China's Hong Kong/China's Macao and the Mainland (CEPA). It is similar to a free trade agreement that has been included in the institutional design of the Master Plan. Perhaps someday in the future,the Hainan Free Trade Port will be able to implement a unified value-added rule-of-origin system with China's Macao and China's Hong Kong,making use of a cumulative added-value of 30% covering these three areas so that goods can be exempt from import duties when entering the mainland market. If this comes true,enterprises will be able to enjoy more convenience,while Hainan,China's Hong Kong and China's Macao can benefit from greater cross-regional cooperation and development.

But we also must be aware that the Hainan Free Trade Port is constructed under a socialist system with Chinese characteristics. This is an important feature that distinguishes the Hainan Free Trade Port from other free trade ports.

Conclusion

The Master Plan is a brand-new type of development blueprint. Inevitably there will be new situations and fresh difficulties that will require adjustments. Nonetheless,we are confident that under the joint efforts of the designer and builders,we will see a free trade port that is highly attractive to a wide range of businesses. It will become an important portal for opening up the economy and provide an important link between the domestic and global markets.

The author is the dean,professor,and doctoral supervisor of Hainan Research Institute,University of International Business and Economics