The CEPA Hong Kong Agreement

CEPA, the bilateral free trade agreement between Hong Kong and mainland China, became effective on 1 January 2004. The agreement offers early market access to local and international companies with qualified Hong-Kong-based companies, regardless of nationality or size. Even after China complies with its World Trade Organization (WTO) commitments, many Hong Kong companies will maintain a sustainable advantage as the CEPA offers even greater concessions beyond China's commitments in its WTO accession.

The CEPA covers three broad areas, namely trade in goods, trade in services, and trade and investment facilitation. Firms that do not yet have a foothold in Hong Kong should consider partnering with or acquiring eligible companies based in Hong Kong to take advantage of CEPA and gain ‘first mover advantage’ into the mainland markets.

Broadly speaking, the liberalization allows early access to Hong Kong companies and service providers to the mainland market, ahead of China's WTO timetable. In some sectors, like construction and real estate services, logistics services, transport services, distribution services, legal services, and audio-visual services, the concessions extend beyond China's WTO commitments. Unless positively exceeded by the concessions stipulated in the CEPA, China's WTO commitments, including both concessions and limitations, for each individual services sector continue to apply.

To be eligible for this enhanced ‘first mover advantage’, Hong Kong companies must meet certain criteria.

Trade in goods

273 classes of Hong-Kong-made goods can be exported to the mainland free of tariff. For other categories of ‘made in Hong Kong’ products, the mainland also agreed to apply a zero-import tariff from 1 January 2006, upon applications by local manufacturers for other product codes maintained on China's tariff system and meeting the CEPA rules of origin. The HKSAR agrees to bind its existing zero-import tariff regime with respect to all goods of mainland origin and not to impose restrictive regulations on trade for these goods.

Rules of origin: A product is qualified as ‘made in Hong Kong’ if it fulfils the rules of origin under CEPA. Local Hong Kong, mainland China, and overseas investors may set up new manufacturing operations in Hong Kong so that products subject to high mainland tariffs may qualify for the CEPA origin rules and enjoy zero tariffs in the mainland market. Investors may manufacture goods with high intellectual property content in Hong Kong, taking advantage of its legal system and the protection of the intellectual property regime.

A Hong Kong manufacturer should apply for a certificate of Hong Kong origin — CEPA — and pass the approved certificate to the mainland importer. To qualify under CEPA, the goods must meet the rules of origin (ROO) under CEPA so that the product can be claimed to be of Hong Kong origin to enjoy tariff preference. The ROO set out the criteria and standards for a product to claim itself of a particular country of origin. For the 273 mainland product codes covered in the initial phase, the following CEPA origin rules are adopted:

• 68% (187) of the products will adopt Hong Kong's existing origin rules for CEPA, which follows the principal process rule that looks to the location where the major production process takes place in defining the origin of a product. These items include textiles and clothing, jewelry, cosmetics, pharmaceutical products, and plastic and paper articles.
• For 17% (46) of the products, including some chemical and metal products and some electronic products and components, a change in tariff heading (CTH) approach will be used as the CEPA origin rules. The CTH approach is used by most WTO members.
• A 30% value-added requirement will meet the CEPA origin rules for 15% (40) of the products, such as some electronic and optical components, watches and clocks, and watch movements. Under the CEPA ROO, only raw materials and component parts originated in Hong Kong, costs of local labor, and product development costs incurred in Hong Kong could be counted towards the value content calculation. A provision that allows product development costs of design, development, and intellectual property to count towards the 30% value-added requirement is expected to stimulate the development of creative industries and high value-added activities in Hong Kong. The value-added requirement includes skilled processes performed before, during, or after a product's manufacture that increase its selling price.

A manufacturer can continue to use an outward processing arrangement to subcontract outside its Hong Kong subsidiary or use minor finishing processes for goods intended for export to the mainland. After outward processing, the finished goods must be returned to Hong Kong and exported to the mainland under the CEPA in order to claim the zero-import tariff concession. Semi-finished goods do not qualify under the CEPA.

Trade in services

CEPA provisions on market access cover a total of 18 services industries, including management consultant services, exhibitions and conventions, advertising, accountancy, construction and real estate, medical and dental services, distribution services, logistics services, freight forwarding and agency services, storage and warehousing services, transport services, tourism, audiovisual, legal services, banking, securities and insurance. To be entitled to the benefits of CEPA, a service company must have substantive business activity in Hong Kong by fulfilling all of the following criteria:

• The company must be incorporated under the laws of Hong Kong.
• The company must be liable to pay profits tax in Hong Kong.
• The company must employ 50% or more of its total staff in Hong Kong.

The minimum period of the company's substantive business operations in Hong Kong is three years, but for construction and real estate, banking, and insurance, the requirement is five years. Although the exact requirements for a company to be qualified vary by industries, the assessment will be on a non-discriminatory and objective basis.

Similar to trade in goods, the HKSAR agrees to bind its existing services regime for, and undertake not to introduce new discriminatory measures against, services and service suppliers of the mainland for those sectors covered in the CEPA.

Definition of ‘Hong Kong companies’ for services: To be eligible to enjoy the benefits offered by the mainland under the CEPA, a company must have ‘substantive business operations’ in the HKSAR, as assessed on the basis of the following criteria:

• The company must be incorporated under the laws of the HKSAR
• The company must pay profits tax in the HKSAR (or be exempted by law from paying such tax)
• The length of the company's substantive business operations in the HKSAR
• The size and nature of business activity of the company's office in the HKSAR
• The proportion of the company's staff force employed in the HKSAR

The two sides agree to adopt a ‘sectoral’ approach to take into account the unique characteristics of each individual service sector.

Trade and investment facilitation

Both sides agree to promote cooperation in the following eight areas: customs clearance facilitation, quarantine and inspection of commodities, quality assurance and food safety, cooperation of small- and medium-sized enterprises, cooperation in Chinese medicine and medical products, electronic commerce, trade and investment promotion, and transparency in laws and regulations.