China tax: Local content rule for import of auto parts abolished

The Chinese General Administration of Customs recently announced that the higher taxes imposed on the import of certain automobile parts is abolished effective 1 September 2009.

The World Trade Organization (WTO) ruled on 15 December 2008 that the Chinese rules (Administrative Measures for the Import of Automobile Components and Parts for the Assembly of Finished Vehicles (Localization Policy)) violated global trade policies and gave China 15 months to implement changes. Issued in February 2005, the rules imposed higher duties on the import of parts used in the manufacture of automobiles that did not meet the domestic content requirement of 60%.


Background

The Localization Policy generally provided that, when parts were imported into China for assembly into vehicles, they would be subject to Customs duty as a finished vehicle where the total value of the imported parts and components was not less than 60% of the total value of the finished vehicle. Given that the tariff on a finished vehicle is 25% and that on imported vehicle parts is 10%, the additional 15% duty was a significant cost component.

The Localization Policy has been the subject of considerable debate and criticism because the additional duty disadvantaged certain vehicle manufacturers that needed to import components into China. Hence, in 2006, the U.S., Canada and the EU joined forces to take the matter to the WTO, claiming that China's policy was not in line with WTO principles. The WTO issued its final ruling in December 2008, concluding that China failed to comply with the WTO accession agreement by levying the same tariff on imported vehicle parts and assembled finished vehicles. As noted above, the WTO decision requires China to change its policy on the import of spare parts for vehicles.


Comments

The recent change in policy will not affect auto manufacturers that have localized most of their supplies of vehicle components in China – the benefit clearly is for luxury automobile manufacturers that import parts.

While the abolition of the Localization Policy clearly has benefits, some uncertainties remain. On the positive side, the previous requirement to pay a deposit on parts considered to have the essential characteristics of a finished vehicle is eliminated, which can improve cash flow and simplify import procedures. However, it is important to note that the main change in policy is that China will no longer classify the taxation of spare parts as a complete vehicle using the 60% rule.

Chinese Customs authorities still can argue that spare parts should be taxed as a finished vehicle where the parts have the essential characteristics of a finished vehicle because, under the General Classification Rules set by the World Customs Organization, "any reference in a heading to an article shall be taken to include a reference to that article incomplete or unfinished, provided that, as presented, the incomplete or unfinished article has the essential character of the complete or finished article."

In a broader context, determining whether imported parts have the essential characteristics of a whole machine requires an in-depth examination of various aspects of the goods imported, an area in which there are often differences of opinion between importers and the Customs authorities.

Abolition of the Localization Policy does not necessarily provide certainty against the taxation of the import of spare parts. However, it will be interesting to see whether the Customs authorities adopt a more flexible approach in light of the mandate that China amend its policy in accordance with WTO guidelines. Viewed in the context of the current practices of the tax authorities and Customs – both of which are tightening their approach to audits – it is likely that Customs may not make any concessions, especially at a time when China is reported to be the number one sales market for automobiles. Nevertheless, there are possibilities for taxpayers in the auto sector to reduce the dutiable value of goods imported into China. Companies can consider the following:
- Using the supply chain and Processing Trade Relief to mitigate import duties and VAT for the export market;
- Utilizing the provisions under free trade agreements; and/or
- Reducing the base value of imports by stripping out various components.