China has always been a country with a long history and rich culture. Today, thanks to a booming economy, a huge population and an abundance of disposable income, it has become a consumer market with great potential and promise. But the country has its own way of conducting business, and becoming familiar with its rules and practices — and following them — are the first steps in doing diamond business safely and successfully in China.
To foreigners, the vastly different culture, as well as language difficulties, can often result in misunderstandings. Although many Chinese, especially the younger generation, speak and write basic English, most of them still find it challenging to communicate in English with foreign suppliers. Local regulations are difficult for foreigners to comprehend and all documents are published in Chinese, the only official language in Mainland China. Another problem is business and financial systems, especially credit systems, the most important issue for the Chinese diamond industry right now. Because the industry is so young, and dealers want to keep their customers’ identities secret, a credit/payment infrastructure, such as exists on 47th Street in New York City, is not yet developed to facilitate sales transactions. In light of all these obstacles, foreign investors who want to succeed in China learn to hire local Chinese as part of their management team and rely on them to explain the intricacies and resolve the confusions of the China market.
China’s rapidly expanding economy in the midst of so much global recession makes it a very attractive market. With the intense interest in China has come intense competition and, at this early stage of its development, many companies are pursuing rapid expansion, choosing to sacrifice short-term profit in order to lock up market share. The fierce competition is among traditional retailers and between traditional retailers and website-based retailers, as well as among website-based retailers themselves. There is also competition between legitimate businesses and those dealing in smuggled goods.
Cracking Down on Smuggling
In principle, Mainland China has very strict laws and regulations, and a foreign company registered anywhere outside Mainland China cannot conduct business directly within its boundaries. While Macau and Hong Kong have been designated special administrative regions (SAR) of China, companies registered in Hong Kong, Macau and Taiwan are still considered foreign companies. It is illegal to bring diamonds into China and sell them for cash without proper customs declarations and official invoicing. Smuggling goods and evading the required value-added tax (VAT) is a felony in China; violators are subject to criminal prosecution and the crimes are punishable by imprisonment.
The smuggling of diamonds into the country has been a serious, widespread problem since the very beginning of diamond trade in China. Diamonds are easy to conceal, the borders are hard to secure and smuggling routes were well-developed. Over time, many diamond dealers flaunted the laws and carried their goods into the country illegally. Legitimate dealers were at a competitive disadvantage with the smugglers, who pay no taxes or fees.
In January 2010, the government busted a major smuggling ring in Shenzhen, detaining and arresting dozens of foreign diamond dealers, most of whom are still in custody. The government was sending a message that it intended to enforce the law, but an end to all diamond smuggling in China will not come easily or quickly.
SDE and Taxes
The Shanghai Diamond Exchange (SDE) plays a critical, high-profile role in the China diamond industry. As China’s only diamond bourse and a member of the World Federation of Diamond Bourses (WFDB), the SDE is the only legal channel for importing diamonds into China. As such, it enjoys a favorable tax policy for those goods. In effect, those who wish to import diamonds to China must do so through a company registered with the SDE. The bourse does not deal with jewelry, with or without diamonds, nor with colored gemstones. It deals only with diamonds.
There is no government tariff on polished and rough diamonds imported into China. In 2006, the VAT for imported polished diamonds was reduced from 17 percent to 4 percent. The diamonds can be imported temporarily without paying the 4 percent VAT — if they do not leave the SDE premises— for as long as three months, with a one-month extension. After that time, the diamonds must be officially imported into the country and the tax paid or they must leave the country. If sellers pay a 4 percent refundable deposit, they can take the diamonds outside the exchange to show them to potential buyers.
SDE is a free-trade zone so selling among members within SDE does not incur VAT; the tax is incurred only when the goods are sold to companies outside SDE. There is no VAT imposed on rough diamonds imported via the SDE, although the exchange does impose a 0.3 percent transaction fee on all imports. Rough diamonds destined for processing in China are not considered normal trade and do not have to go through SDE as long as the finished, cut products are exported.
Business Channels
There are several methods for meeting clients and selling diamonds in China. Many companies exhibit at the country’s popular international jewelry shows and many also work with local agents as partners. Some actually establish their own companies in the country.
Trade shows. Foreign companies participate and exhibit their diamonds in the popular international gem and jewelry trade shows in Mainland China. The shows usually have a temporary tax-free import system, but very often they require the exhibitors to export all goods out of the country after the show closes. The shows do not allow foreign exhibitors to sell directly to local buyers, but exhibitors sometimes are able to contract with local importing agents to close transactions after the show. Exhibitors generally don’t expect to generate many sales at the shows, but rather use them to make new contacts and “test the water” before penetrating further into the market.
Importing agents. Before establishing a company in China, many foreign suppliers choose to work with an importing agent, who is a member company of SDE that does not manufacture and sell its own diamonds. The agent company handles imports into the country, provides official VAT invoices to the Chinese buyers, collects payment from the buyers and then wires the payment to the foreign suppliers.
Establishing a foreign-invested company. The most independent way to do diamond business in China is to invest in and establish a separate company. In order to import and wholesale diamonds in China, two requirements must be fulfilled at the same time: The company must be a member of SDE and registered within the exchange.
China law allows foreign companies and foreign citizens to invest in and establish companies that are known as a wholly owned foreign enterprise (WOFE). The Diamond Administration of China (DAC) must approve the establishment of the companies, which are required to become SDE members. Each WOFE must have a $200,000 fund of registered capital physically wired into China that the company can use to purchase diamonds and pay for operating expenses. The WOFE must pay a SDE membership entry fee of $20,000, as well as a $3,000 annual membership fee, and must rent a physical office within SDE, which must be personally staffed, usually by a Chinese national. The staff of at least one on-site person, who should be fluent in speaking and writing Mandarin Chinese, takes care of daily administration work for the company. That individual also handles the SDE-issued VAT invoices that many Chinese buyers require as legal proof that the diamonds were imported legally. Currently, there is nothing like an unstaffed “letter box company” in SDE, where companies simply receive mail.
SDE member companies enjoy high status in the China diamond industry because there are only about 280 of them. Therefore, setting up an SDE diamond company is the best choice for most foreign suppliers who are committed to doing business in China.
The companies in SDE are approved to trade diamonds only — but not jewelry— on an import, export and wholesale basis, and are not approved for retail business. As a result, many foreign investors decide to establish a second company outside SDE in order to conduct retail jewelry business. Such a company, which can be registered outside Shanghai, does not have an import license for diamonds and can only buy diamonds domestically. The capital investment requirement varies from city to city. This approach is most practical when the investor plans to sell jewelry, especially on the retail level.
Although doing diamond business in China can be frustrating and challenging for companies unfamiliar with the country’s culture, language and legal system, many diamond dealers are finding that the potential for new sales in a growing market is hard to resist.
Article from the Rapaport Magazine - February 2011. To subscribe click here.