Today the China Australia Free Trade Agreement (ChAFTA) was signed and tabled in the Australian Parliament following a decade of negotiations and seven months of document review and finalisation. Good things come to those who wait (and persevere). This historic milestone will boost trade and economic growth in both countries for years to come.

The formal agreement and ancillary arrangements are consistent with the summary material released by DFAT in November. The key issues are now well-traversed: investment protections and facilitation, reduction or removal of tariffs, and increased access for services businesses. We're excited about this historic next chapter in the Australia-China relationship and we think you should be too. We've spent the past seven months thinking about and engaging with our clients on what this means for them. We set out below some headline thoughts on where the biggest opportunities are.

Key benefits

A number of fundamental investment protection mechanisms have been included which will safeguard and facilitate cross-border investment between Australia and China, including changes to:

FIRB

Chinese investors into Australia can be confident they will be placed on a level playing field with investors from USA, Japan and Korea through the increase of the general FIRB monetary threshold from A$252m to A$1,094m.

Lower investment thresholds for agricultural land and agribusiness will be applied. An A$15m threshold for rural land (calculated on a cumulative basis including existing rural landholdings) was already in force from 1 March 2015 and an A$55m threshold for agribusiness is expected to come into force from 1 December 2015.

Australia will also consider further the position of Chinese government investors - State Owned Enterprises (SOEs) and Sovereign Wealth Funds (SWFs) in the initial 3 year revision period. The Australian business community has suggested options for reform to encourage foreign investment.

Workforce mobility

Under ChAFTA, certain infrastructure development projects which are majority or substantially owned by a Chinese enterprise will be able to operate under an Investment Facilitation Agreement (IFA). IFA’s streamline and relax Australia’s immigration law requirements. IFA’s will be permitted where a project has expected capital expenditure of A$150m (lower than the A$2bn and 1500 worker threshold for the Enterprise Migration Agreements allowed in the resources sector (including Roy Hill)).

IFAs will also apply to projects in a broader range of sectors including food and agribusiness, resources and energy, transport, telecommunications, power supply and generation, environment and tourism sectors.

IFAs will operate within the framework of Australia’s existing 457 visas and applicable laws, including work health and safety law and relevant Australian licensing, regulation and certification standards.  However, the IFA will allow a departure from skill requirements (to allow lower skilled workers foreign workers to work in Australia) and labour market testing requirements. IFA’s are designed to make it easier for foreign labour to be utilised on Chinese sponsored infrastructure projects while maintaining compliance with the safety net of minimum employment conditions provided for Australian employees.

ChAFTA commitments to reduce labour mobility barriers between China and Australia will also provide improved access for a range of Chinese and Australian skilled service providers, investors and business visitors. In turn, this is intended to facilitate Chinese investment into Australia and contribute to economic opportunities for Australian communities. In particular, China will guarantee access to Australian citizens and permanent residents who are categorised as intra-corporate transferees, contractual service suppliers, installers and maintainers, and business visitors (including, if over 12 months, accompanying spouses and dependents). In return, Australia will provide guaranteed access to Chinese citizens who fall into the same categories.

ISDS

The Investor-State Dispute Settlement (ISDS) mechanism will allow investors to bring a claim in an international tribunal if a change in regulation unduly disrupts the FTA's promises to investors. This protects both Chinese and Australian investors against perceived sovereign risk. The receiving government promises to ensure the investment will be treated at least as well as domestic investors.

The ISDS regime already exists in some of Australia’s other FTAs and treaties, but to date only one case has been brought against Australia. As more countries adopt ISDS (for example, it is planned to be part of the Trans Pacific Partnership) it may become a more mainstream way of protecting investments.

The inclusion of the ISDS is expected to be debated in the Senate because these provisions have permitted claims against the Australian government for its tobacco plain paper packaging legislation, and would have permitted claims in response to the mooted carbon tax reforms.  For the Australian public, this is controversial because it could restrict regulation in the public interest.  However, the ISDS provisions will not impact legitimate government regulation (for example, necessary to protect human life or health, and conservation of the environment).

The ISDS doesn’t substitute the need for clients to take sensible precautions to mitigate for ordinary trade risks, which will be the lion’s share of capital flows between both nations.  Traders must think about whether their contracts protect them against recovery risk if disputes arise, usually through the use of international arbitration.

MFN

A “most favoured nation” provision is included. This is intended to ensure that Australia’s competitive position is future-proofed against more beneficial treatment granted to other trade partners for certain services. We think that beneficial treatment is more likely to follow from China’s rapid pace of deregulation, particularly in relation to foreign investment. For example, since ChAFTA was announced in November, a number of the key “concessions” in the financial services and telecommunications sectors have already been superseded.

Sector specific opportunities

ChAFTA means that in some sectors, Australia has been granted “best ever access.” This means Australian businesses can either operate wholly owned subsidiaries or operate with fewer restrictions relative to companies from other countries. The agreement facilitates a virtuous circle when trade leads to greater investment and investment leads to increased trade. However this window of opportunity will not remain open indefinitely. Businesses will need to act now to ensure that they are prepared to take advantage of developments in key areas while Australia still holds a competitive advantage.

Agribusiness and Processed Foods

The agribusiness sector is set to be one of the key beneficiaries of ChAFTA. The agreement covers a range of measures in this area which will facilitate opportunities in the sector, including:

  • Significantly reduced tariffs over the next 4–9 years:  Tariff cuts have been agreed for beef, dairy, sheep, live animals, hides, skins and leather, horticulture, wine and seafood.  Reductions have also been agreed for a number of processed foods, including orange juice, natural honey and canned fruits (tomatoes, peaches, pears and apricots).  Most of these tariff cuts will only come into force in the next 4–9 years. These tariff cuts will make relevant Australian products as competitive as, or even more competitive than, equivalent New Zealand and Chilean products.
  • But other major Australian exports have missed out:  There are no tariff reductions for sugar, rice, wool, cotton, wheat, maize or canola.  However, Australia will receive an exclusive Australia-only duty-free annual quota of 30,000 tonnes of clean wool (equivalent to approximately 43,000 tonnes of greasy wool), which will grow by 5% each year, to almost 45,000 tonnes of clean wool (equivalent to approximately 64,300 tonnes of greasy wool) by 2024.
  • Discretionary safeguard measures retained for beef and milk powder products:  If Chinese imports of these products from Australia exceed the specified “trigger” levels for any given calendar year, China may apply additional customs duties. The trigger starts at 170,000 tonnes for beef (10% above the historic peak export levels) and 17,500 tonnes for milk powder products (40% above the amount of whole milk powder exported to China over 2012/13).  There is a review mechanism in place that provides for removal of these safeguards if it is concluded that Chinese imports of these Australian products do not cause serious injury to the corresponding Chinese domestic industry.
  • Incentives for increased investment in Australian agriculture:  Australia's more competitive position will provide incentives for Chinese investors (and Australian and other foreign investors) to invest in Australian agriculture to build capacity. Chinese investors may be preferred by Australian businesses if they can also provide Chinese import and market development assistance.
  • Promise of increased transparency and collaboration:  No specific non-tariff barriers have been eliminated.  However, there are consultative and notification measures, which are aimed at minimising the burden of customs procedures, sanitary and phytosanitary measures and other technical barriers to trade.
  • Don’t forget about Australia’s highly regarded agricultural technology and services:  Australian businesses will be permitted to take a majority stake in joint ventures which provide services incidental to agriculture, forestry, hunting and fishing in China. Australian R&D providers will be allowed to offer R&D services in China through wholly-owned subsidiaries. They will be treated no less favourably than corresponding Chinese service providers.

Energy and Resources

Driven by China’s spectacular demand for energy and raw materials and Australia’s deserved reputation as a reliable, high quality supplier, the energy and resources sector has been at the centre of the China-Australia economic story. The sector has seen some amazing success stories, as well as its fair share of controversies. Regardless, Chinese demand is set to continue for decades to come, albeit at a more measured growth rate. ChAFTA will facilitate Australia servicing that.

China will remove the modest tariffs that are currently imposed on a number of resources imports from Australia. For example, the tariffs on coking coal will drop immediately from 3% to 0%. At these levels, the tariff removal is unlikely to produce a substantial change in supply or demand, particularly for suppliers who sell on a FOB basis. But for importers and traders alike it will be important to update import processes and documentation quickly (for example, to comply with country of origin rules) in order to take advantage of the reduced tariffs.

The investment facilitation measures described above (FIRB, ISDS and IFA) are likely to have their biggest impact in the energy and resources sector.

Healthcare and Pharmaceuticals

Under ChAFTA, wholly Australian-owned hospitals, clinics and aged care facilities will be permitted to be established in China. This offers exciting new opportunities for Australian private health sector providers to invest in or establish medical services businesses in China. This is despite China’s National Development Reform Commission’s (NDRC) draft revisions on foreign investment suggesting tighter control over the establishment of foreign invested medical institutions. Ownership flexibility is therefore a unique benefit accorded to Australian health and aged care suppliers.

Australian companies will be permitted to carry out R&D and to provide R&D services through Australian owned subsidiaries based in China.

ChAFTA will result in a reduction in tariffs on pharmaceuticals (including vitamins), health products and medical devices. This is a boost to the Australian pharmaceutical industry given that China will become the world’s largest pharmaceutical market by 2020 with an estimated value of US$250 bn. Orthopaedic appliances currently comprise A$56m of Australian exports and centrifuges account for more than A$9m. ChAFTA offers increased competitiveness for these products, which currently attract tariffs of up to 10%.

Financial Services

Australian financial services businesses have been granted unprecedented access to the fastest growing markets in the world, unlocking an enormous potential export base. Key changes we can look forward to include:

  • Significantly enhanced opportunities for Australian fund managers both in providing asset management services to Chinese clients and in accessing Chinese investments (including through Australia’s recently launched RQFII program);
  • Additional opportunities for Australian insurers including the ability to fully access China’s statutory third-party compulsory motor vehicle insurance market;
  • Removal of working capital requirements for Australian bank subsidiaries in China, and opportunities to participate in credit asset securitisation; and
  • Relaxation of Chinese regulatory barriers to Australian investments in China.

This comes at a time when these industries are undergoing significant reform and liberalisation, presenting opportunity for foreign financial services providers. For the moment, this access is not able to be matched by competitors from other sophisticated financial markets such as those of the United States, Europe or Japan.  This creates a window for Australian businesses to find a foothold in the home marketplace of the worlds’ fastest growing middle class.

Property

ChAFTA is expected to lead to even higher levels of property investment by Chinese investors in Australia because of the broader investment opportunities in the education and the tourism sectors. Specifically, in the education sector, ChAFTA allows for improved mutual recognition of educational qualifications and improved mobility of students across the two countries. Australian institutions will have the opportunity for increased marketing and exposure to the Chinese market, with China committing to listing an increased number of higher education institutions on its Ministry of Education website. There is potential for investment in the student accommodation area to accommodate an increased flow of Chinese students into Australia. For example, already there are more than 18,000 international Chinese students currently enrolled to study in Queensland.

Telecommunications

China has made specific commitments in ChAFTA, these go beyond the WTO commitments that are currently in place.  Although these additional commitments have largely been superseded by liberalisation of certain Chinese telecommunications markets as part of the establishment and development of the Shanghai Free Trade Zone (SFTZ), these measures are now locked in for Australians so that ChAFTA provides Australian investors with greater certainty.

Next steps

Next steps are for the Joint Standing Committee on Treaties to conduct an inquiry, Parliament pass enabling legislation and regulations amended. Although not yet clear, we are optimistic that ChAFTA will take effect on 1 January 2016.

With negotiations settled, consideration will now turn to the measures needed to ensure that the agreement is able to meet its desired objectives in practice. A key part of this is a review of how tax between the two countries will operate in the ChAFTA world.

In ChAFTA Australia and China have agreed to review bilateral taxation arrangements to improve trade and investment conditions following implementation of the agreement. The review will take into consideration mutual economic objectives and international taxation standards and will cover existing double taxation and prevention of tax evasion.

The current long standing double tax agreement (DTA) does not extend to Hong Kong, and does not yet reflect the (more favourable) terms of agreements that both countries have negotiated with others in recent years.

While there is no certainty as to what the specific areas for negotiation will be, based on recently negotiated agreements, some of the areas for discussion may include:

  • Reducing the rate of dividend withholding tax on unfranked dividends from 15% to either 10%, 5% or even zero in specific circumstances;
  • Reducing the rate of interest withholding tax to nil where it is paid to a resident financial institution in the other contracting state;
  • Providing for an exemption from capital gains tax where the interest being disposed of is a non-controlling interest in a company (an exemption from tax where the ownership interest in a non-land rich company is less than 25% has been negotiated elsewhere); and
  • Possible negotiation of a DTA with Hong Kong.

Across the spectrum, the work is clearly not yet complete. However today’s signing of ChAFTA means that businesses can assess with certainty what the opportunities are for them. Across a range of sectors, this planning can and should begin now. ChAFTA means that Australian businesses will be a better position than any of their competitor nations when they enter or do business with one of the world’s fastest growing economies. However, China is currently negotiating FTAs with a number other countries and the concessions given to Australian businesses under ChAFTA will likely very soon become the norm under China’s other agreement. It will be important for Australian businesses to quickly and effectively take their first mover advantage before it is eroded.