According to Articles 56 to 581 of the Customs Law of the People's Republic of China ("Customs Law")2, there are three categories where duties may be reduced: statutory duty abatements or exemptions, deductions or exemptions on special goods, and temporary duty reductions or exemptions. "Deductions or exemptions on special goods" refers to goods imported into China that enjoy a reduction or exemption of duties in specified areas and enterprises or for special purposes until the expiration of customs supervision over such goods. Special goods which are subject to reductions or exemptions are divided into many categories according to the region, use of the goods, nature of the trading business and source of funds. According to related regulations, if the imported goods fall within certain product categories encouraged by the government, the foreign investment enterprise can apply for a preferential policy of deduction and/or exemption of duties.
However, in practice, some foreign investment enterprises, being unaware of customs supervision rules, receive penalties from China Customs offices for improper handling of these special goods that are otherwise eligible for reductions or exemptions of duties. Therefore, it is important for foreign investment enterprises to understand the relevant regulations concerning special goods that are eligible for deductions and exemptions.
I. Regulations on Special Goods Eligible for Deductions and Exemptions
Paragraph 2 of Article 57 of the Customs Law provides three "Specific Uses" for special goods eligible for reductions or exemptions:goods used in specified areas, goods used by specified enterprises or goods used for specified purposes. Such special goods must not be utilized otherwise unless relevant parties have obtained the approval of China Customs and duly paid customs duties. In short, the enterprise enjoying the deduction or exemption of duties on special goods shall bear legal liability if the enterprise utilizes the goods outside of the approved areas, enterprises and purposes without first obtaining the approval of China Customs or duly paying the duties.
Article 26 of the Administrative Measures of the Customs of the PRC for Duty Reduction and Exemption for Import and Export Goods ("Administrative Measures")3 clarify that "an applicant applying for a reduction or exemption of duties, without the permission of a customs office, shall not transfer, mortgage, pledge, use for other purposes or dispose in any other way the goods that are the subject of such an application."
The provision that an "applicant...shall not transfer, mortgage, pledge...the goods entitled to duty reduction and exemption" is easy to understand for foreign invested enterprises ("FIEs") under most circumstances. However, the Customs Law, the Administrative Measures and other relevant laws and regulations do not specify at the meaning of "using for other purposes or disposing in any other way"4. Therefore, different enterprises may have different interpretations of this provision. In practice, some FIEs face administrative liabilities for Customs duties because their use of special goods constitutes a "use for other purposes or disposal in any other way". A FIE can even incur criminal penalties in the event that the Customs anti-smuggling departments transfer the case to competent judicial authorities.
II. Analysis of Typical Cases
Based on an analysis of cases handled by the China's customs offices in recently years, acts of "using for other purposes" or "disposing in any other way" are always evidenced by renting, lending, transferring or misappropriating special goods without the approval of customs officials. The following paragraphs will explore the above issue based on a study of typical cases.
A. Using Exempt Equipment for Other Purposes without Approval
A foreign invested beverage enterprise planning to produce juice beverages, tea beverages and drinking water prepared a Feasibility Study Report, which was approved by the Ministry of Commerce (MOFCOM). The enterprise then obtained the Confirmation Letter on Domestic or Foreign-funded Projects Encouraged to Develop by the State ("Confirmation Letter"). In the Confirmation Letter, the "Project Specifications" were written as "fruit processing". Later, the enterprise imported $4 million worth of filling equipment, which enjoyed a special deduction of duties. However, due to the decline of the domestic market, the enterprise, without the approval of customs officials, used the equipment to produce bottled water. The Customs Investigation Department discovered such illegal acts while they were conducting a verification procedure on goods subject to duty reductions and exemptions. Customs officials initiated an investigation over this issue and determined that the production changes by the enterprise were an act of "using the goods for other purposes".The Customs Office imposed a fine of RMB 1.07 million according to the Regulation of the People's Republic of China on the Implementation of Customs Administrative Punishment5, and ordered the enterprise to reimburse the customs duties payable during the period of "using the equipment for other purposes".6
The enterprise applied for administrative reconsideration on grounds that "the feasibility study report approved by MOFCOM contains drinking water, therefore using the equipment to produce bottled water does not constitute the act of using for other purposes". The General Administration of Customs ("GAC") rejected the enterprise's reconsideration request and reaffirmed the administrative sanctions.
Therefore, FIEs must strictly comply with the "Approved Items of Project Industry Policy" and "Project Specifications" provided in the Confirmation Letter. Otherwise, the enterprise may violate the provision for "using for special purpose", and thereby conduct an act of "using for other purposes" as determined by customs officials.
B. Changing Entities and Areas without Approval
An overseas enterprise established ten FIEs in Shanghai, Ningbo and other cities. From July 2001 to August 2003, four of the ten enterprises, according to the foreign parent's arrangement, allocated to six other subsidiaries 79 sets of duty-exempt food processing equipment without the approval of customs officials. The four enterprises also issued a Group Fixed Assets Relocation Sheet, and claimed that the ownership of fixed assets did not transfer, and took no fees from the other 6 enterprises. Customs officials determined the four enterprises' behavior constituted an act of using special goods subject to duty reduction and exemption "for other purposes", imposed a fine on the four enterprises and ordered them to fulfill the goods transfer procedure and fully remit relevant customs duties.
Similar cases occur frequently between parent enterprises and their branch offices. For example, a FIE, without customs approval, uses duty-exempt special goods in other branches (usually processing plants) that are located outside of the approved areas for use of the special goods by customs officials.
In the customs enforcement practice, the enterprise's transfer or misappropriation of duty-exempt special goods are usually alleged to be a violation of the principle of "Three Specific Uses", especially the principles ofusing the goods "in specific areas" and "for specific enterprises". Certain aspects of enterprise's behavior may be determined to be an act of "using" the special goods and thus warrant customs penalties.
C. Circumstances of "Disposing in Any Other Way"
From practice experience in customs cases, the modifying, dismantling, or destroying of special goods subject to duty deduction and exemption without customs approval may be deemed as an act of "disposing in any other way". In addition, there are some specific circumstances in practice that may potentially be deemed as an act of "disposing in any other way".
For example, a joint venture ("JV") imported several sets of duty–exempt equipment within the amount of investment, and such equipment was within the customs supervision period. The JV then applied to reduce the amount of investment and registered capital, which had been approved by relevant administrative authorities. The JV subsequently modified its registered capital with the local Industry and Commerce Administration. However, customs officials found that the value of duty-free equipment owned by the JV exceeded the total amount of investment after this reduction of registered capital, and the excess portion did not qualify under the duty reduction and exemption policy. Therefore, the enterprise had to duly remit the customs duties for the excess portions (the depreciation value before the date the administrative authority approves the investment fund reduction shall be deducted from the taxable base of customs duties), and apply to terminate customs supervision over the excess portions.7
In summary, parties enjoying a reduction or exemption of duties for special goods must strictly comply with the customs supervision principle of "Three Specific Uses" when they use and manage such goods within the customs supervision period. Any improper disposition of the goods without customs approval may be determined as an illegal activity in violation of customs supervision rules, and the non-compliant parties will bear corresponding legal liabilities.
1Article 56 of the Customs Law:
Duty reduction or exemption shall be granted for import or export of the goods and inbound or outbound articles listed below:
(1) advertising items and trade samples of no commercial value;(2) materials presented free of charge by foreign governments or international organizations;(3) goods to which damage or loss has occurred prior to Customs release;(4) articles of a quantity or value within the fixed limit;(5) other goods and articles specified by law as items for duty reduction or exemption;
Paragraph 1 of Article 40 of the Customs Law:
Duty reduction or exemption may be granted for import and export goods of the Special Economic Zones and other specially designated areas. The State Council shall define the scope and formulate the rules for such reduction and exemption. Article 58 of the Customs Law:
The State Council shall decide the temporary reduction or exemption of Customs duties which fall under Articles 56 and Paragraph 1 of Article 57 of this Law.
2 The Customs Law of the People's Republic of China ("Customs Law") was adopted at the 19th session of the Standing Committee of the 6th National People's Congress on January 22, 1987, and became effective on July 1, 1987. The Customs Law was revised at the 16th Meeting of the Standing Committee of the Ninth National People's Congress on July 8, 2000,and become effective on July 8, 2000.
3The Administrative Measures of the Customs of the PRC for Duty Reduction and Exemption for Import and Export Goods was issued on December 29, 2008, and became effective on February 1, 2009.
4 Some Customs officials and experts consider Paragraph 2 of Article 30 of the Administrative Measures as specifying three circumstances of using the goods subject to deduction and exemption as approved by the Customs offices "for any other purposes", though there needs to be clarification of the circumstances of using the goods "for other purposes or dispose in any other way" without the approval of China Customs or paying the customs duties as provided in the Customs Law. However, this regulation only reiterates the three "Specific Uses" from the opposite view point. How to determine the circumstances of "using for other purposes" or "disposing in any other way" is still a myth. Paragraph 2 of Article 30 of the Administrative Measures provide as follows:
(1) Where goods entitled to duty reduction or exemption are delivered for use to any entity other than the duty reduction or exemption applicant;(2)Where goods entitled to duty reduction or exemption are not used for the originally intended purposes and at the originally intended regions;(3) Any other circumstances in which goods entitled to duty reduction or exemption are not used at the specific regions, by the specific enterprises or for the specific purposes.
5 The Regulation of the People's Republic of China on the Implementation of Customs Administrative Punishment was promulgated on September 19, 2004, and was effective since November 1, 2004.
6 See"Reading Customs case" published by General Administration of Customs of the People's Republic of China, the 2007 edition, page 117 to Page 118.
7 See "Customs Supervision", edited by Xu qiuyan, China Customs Press, 2007 edition, page 208.
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