First wholly foreign invested hospital in China Pilot Free Trade Zone

On 22 July 2014, a framework agreement relating to the establishment of the first wholly foreign invested hospital in China (Shanghai) Pilot Free Trade Zone (“Shanghai FTZ”) was entered into between German-based Artemed Group, HK-based Silver Mountain Capital, Shanghai Waigaoqiao Free Trade Zone 3U-Development Co., Ltd. (“3U-Development”) and Shanghai Waigaoqiao Medical Centre. It is reported that Artemed Group and Silver Mountain Capital will jointly invest in and establish a comprehensive wholly foreign owned hospital with approximately 300 beds at the premises in Shanghai FTZ provided by 3U-Development (“Artemed Hospital”). It is further reported that this new hospital, will be equipped with approximately 10 foreign doctors as well as a number of therapists. Numerous imported medical devices will also be installed in the new hospital. The new hospital will also share medical resources and patients with the Shanghai Waigaoqiao Medical Centre, which is located nearby.

At present, foreign hospitals cooperate with Chinese hospitals in the following ways:

• Contractual model (know-how and/or resources exchange): a Chinese hospital enters into a cooperation agreement with a foreign hospital relating to technology or know-how transfer, the introduction of hi-tech equipment, education or continuing-education of doctors or the exchange of doctors;
• Contractual model (management standards upgrade): a Chinese hospital enters into a cooperation agreement with a foreign medical service company under which the foreign medical service company introduces modern management standards to the Chinese hospital (or upgrades existing standards), but medical treatment and diagnostics remain the responsibility of the Chinese hospital;
• Joint venture hospital model: The Chinese hospital and a foreign hospital establish a Sino-foreign joint venture hospital (such as Shanghai United Family Hospital);
• Wholly foreign invested hospital model: legally speaking, only wholly Hong Kong, Macau or Taiwan invested hospitals are permitted nation-wide in mainland China (such as Shanghai LandSeed International Hospital). There are no nation-wide laws or regulations which provide for the establishment of wholly foreign owned hospitals funded by investors from other countries.

As a pilot, Shanghai FTZ foreign investors are permitted to establish wholly foreign owned hospitals according to the Notice regarding Publishing the General Scheme of the China (Shanghai) Pilot Free Trade Zone of the State Council on 27 September 2013. Further, the Shanghai Free Trade Zone Negative List 2014 (issued on 30 June 2014) has abolished the total amount of investment requirement (which was previously no less than RMB 20 million) and the maximum 20 years business term of a wholly foreign invested medical institute. However, the Shanghai Free Trade Zone Negative List 2014 still prohibits the establishment of branch offices by a wholly foreign invested medical institute outside Shanghai FTZ.

For the time being, the underlying regulation for the establishment of a wholly foreign owned hospital is the Tentative Administrative Measures on Wholly Foreign Invested Medical Institutes of China (Shanghai) Pilot Free Trade Zones issued on 13 November 2013. This regulation mainly focuses on the procedures and conditions for establishment but does not provide detailed rules for the operation of wholly foreign owned hospitals in Shanghai FTZ. If the experiences of the existing cooperation projects with foreign medical institutes are anything to go by, Artemed Hospital may encounter the following specific challenges:

1. Investment model

According to the conditions for establishment of a wholly foreign owned hospital, foreign investors must have experience of no less than 5 years in directly engaging in the investment and management of medical institutions. Due to this requirement, the frequently used joint investment model may not be possible in Shanghai FTZ, i.e. the model whereby two overseas companies would establish a holding company in Hong Kong, which would then directly invest in and establish a hospital in Shanghai FTZ. Taking this requirement into account, Artemed’s hospitals in Germany may have to be direct shareholders of Artemed Hospital.

2. Practising licence of doctors and therapists in China

At present, foreign doctors can be granted practicing licences in China for only one year after approval of the competent health authority. After this one year licence expires, foreign doctors then have to re-register for a further one year licence. Doctors from Hong Kong, Macau and Taiwan are granted such licences for three years after approval of the competent health authority. It is not clear whether the existing policy regarding the practicing licences of foreign doctors will also apply to foreign doctors in a wholly foreign owned hospital in Shanghai FTZ.

In addition, therapists in China are not considered to be equivalent to doctors. Therefore, clarification will need to be sought by the local health authority as to whether foreign therapists can obtain the above mentioned licences in China and work in Chinese hospitals. If not, what kind of working permit can these therapists obtain to work legally in Chinese hospitals?

3. Hospital charges

The Circular on Further Regulating the Medical Services and Pricing of For-Profit Medical Institutes of Shanghai provides that a foreign invested hospital’s service fee shall be decided by the hospital itself in compliance with the principle of “cost plus reasonable profit”, rather than being subject to cap price control by the local health authority and the pricing bureau (which are only applicable to government-funded hospitals). However, a foreign invested hospital does still have to file its service items and prices with the competent health authority and the pricing bureau. “Reasonable profit” is a negotiable issue with the local health authority and the pricing bureau. It is hard to know whether and to what extent the local health authority and the pricing bureau will refer to the cap price applicable to government-funded hospitals. Pricing would be an important factor to be considered by foreign investors as all high value technology needs to be reflected through a pricing mechanism, and the investment should be able to cover the cost as well as enabling the foreign investors to obtain a satisfactory investment return. This is the third issue that Artemed Group and Silver Mountain Capital have to take into account before investment.

4. Liability for medical accidents

Liability for medical accidents is an inevitable topic for any hospital, and would also be a key concern for foreign invested hospitals. This issue will be further complicated when Shanghai Waigaoqiao Medical Centre shares its patients with Artemed Hospital, and it will be particularly hard to identify who will be liable for medical accidents when Shanghai Waigaoqiao Medical Centre transfers its patients to Artemed Hospital in emergency situations.

5. Imported medical treatment and diagnostic equipment

Since Artemed Hospital will be established in Shanghai FTZ which is a bonded area, it is questionable whether Artemed Hospital can enjoy tax exempt treatment or bonded tax treatment for its numerous imported medical treatments and items of diagnostic equipment.

According to the Measures on Customs Supervision in Bonded Areas, generally speaking, customs duties and VAT can be exempted in the case of importing manufacturing, management or office-use equipment and their necessary spare parts for own use. The bonded tax treatment is applicable to importation of raw materials or spare parts by enterprises in Shanghai FTZ for processing exported products or importation of products stored by enterprises in Shanghai FTZ which will ultimately be exported again. It seems that Artemed Hospital might not enjoy tax exemption or bonded tax treatment even if it is located in Shanghai FTZ. Therefore, without a new policy being issued for wholly foreign owned hospitals, Artemed Hospital may be no more competitive than other privately-funded hospitals outside the Shanghai FTZ from a pricing perspective.

6. Imported drugs

In addition to imported medical treatment and diagnostic equipment, imported drugs are also important for Artemed Hospital. As mentioned above in Item 5, bonded tax treatment is applicable to imported products stored by enterprises in Shanghai FTZ which will ultimately be exported again. For those unsold imported drugs, Artemed Hospital should enjoy such treatment. But it is not easy for local customs to carry out supervision on these imported drugs which might become stored products if they fail to be sold on. This issue should be noted for the future in case an application for bonded tax treatment is made.

7. Medical management service

What will make Artemed Hospital stand out among other privately–funded or government-funded hospitals in Shanghai with foreign cooperation or investment outside of the FTZ? Top-level doctors and sophisticated medical devices are also available in other privately-funded and government-funded hospitals. Below are different views from some of their Chinese peers:

“We clearly go for the joint venture model. It has been demonstrated in a number of cases in China including the Bourn Clinic and TC Medical case in which the domestic partner is responsible for the operation and development and the foreign partner brings in the brand, process and knowledge. We believe it is the model that can resolve those above-mentioned issues and maximize the values of both parties.” Dr Yi HONG, Vice President of TC Medical

*TC Medical is a Chinese privately-funded medical investment group listed on Shenzhen Stock Exchange Market. It has invested in more than 16 private hospitals in China with foreign cooperation. Construction will finish on TC Medical’s newly-built International Medical Centre in the Lujiazui area of the Shanghai Pudong New District by the end of this year, which will have similar joint venture platforms with several international hospitals.

“Cooperation between the Chinese and foreign hospitals could be very interesting for the two partners not only in China but also in France or in other European countries. However, each time, it should be based upon the demands of the population in order to avoid risks arising from the different issues, such as regulation, tax, real estate and health, which sometimes very much influences the realization of the structure of hospital investments.” Mr Jean-Loup Durousset, President of Noalys Group

**Noalys Group is the second French private maternity hospital group headquartered in Lyon with 4,500 accouchements and 1,200 FIV (fecundation in vitro) and a neonatology division. It cooperates with a first tier government-funded hospital in Shanghai and private hospitals in other regions in China. Construction of a new mother and baby care centre is being carried on in a first tier government-funded hospital in Pudong New District to support the Sino-French gynecology and obstetrics department of that hospital.

Shanghai FTZ Administrative Committee has stated that it thinks highly of the value of Artemed Group in Germany as a leading standards-maker in the areas of image diagnosis and treatment of sport injury. Its standardized technology and management in these two areas can not only improve the relevant technology in China but also standardize the management of other Chinese hospitals in the relevant areas. The standardized management itself is the highly valued know-how of Artemed Group.

Possible next steps

Based on the current practice, to operate a hospital, a series of auxiliary services must be provided to patients in the hospital. To outsource such services to a third party provider would apparently not be suitable if the high value standards of Artemed Group are to be maintained. Therefore, a medical management company, wholly invested by Artemed Group and Silver Mountain Capital, or jointly invested with 3U-Development, could instead be established to provide such standardized management services.

As the first wholly foreign invested hospital in Shanghai FTZ, foreign investors may inevitably face regulatory, legal and tax implications. We are confident that with the support and coordination of Shanghai FTZ and Shanghai Government, Shanghai FTZ will help Artemed Group to resolve all these issues in cooperation with the various levels of the administrative authorities. We are also eager to see more innovative legislative measures that may be enacted by the Shanghai Government to move forward the reform of wholly foreign invested hospitals, so that foreign investors may bring more high value technology for medical treatment and diagnostics to China, and even more importantly, patient-centered healthcare concept to Chinese hospitals.