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On The Relevance Of Hong Kong To China.

By Dan Harris on Posted in China Business, Legal News

A couple days ago, one of my firm’s legal assistants, Stephanie Henry, wrote an excellent post on a Harvard Business Review article she had read on whether it is too late for businesses to be going to China. That post, entitled, “Are You Too Late for China?“ made no mention of Hong Kong. 

Despite that, a reader named Elizabeth, who is with a company that appears to focus on Hong Kong entity formation, left the following comment:

Hong Kong remains the critical Gateway to Doing Business in China . Hong Kong’s unparalleled legal system as well as its world class banking provide stability and tremendous advantages for foreign businesses who want to succeed in China . Furthermore, the ability of a company to have a zero based tax system is simply too strong a pull to ignore . Many companies are also now taking advantage of the low 5% witholding tax on dividends paid from a China operation to a Hong Kong parent . No matter how you look at Hong Kong , it is an important corporate strategy for international business … whether it is to Do Business in China or for Chinese businesses who are Doing Business in the West.

Reader John Wu then responded to Elizabeth’s comment with the following:

Hong Kong is not necessary given the relative ease at which one can register their company on the mainland these days. Having to maintain an office and staff in Hong Kong while doing little to no business in HK is a waste of money and resources. I considered a HK holding company initially then quickly decided against it.

I then chimed in with my own comment, agreeing with John’s:

@John Wu, I completely agree with you and I note that Ms. Thomson works for a company whose business appears to involve forming HK companies. There are times when forming an HK company to go into China makes sense from a tax perspective, but I would say those times (at least for my firm’s clients) are few and far between (maybe 25% of the time). Most of the time, it does make sense for our clients to form a new company to own their new China WFOE or to own a portion of a JV, but in most of those cases, forming a new company in the home country (typically the US) makes more sense than forming a company in HK.

Tim Lamb then left the following comment, providing a very good analysis of why the tax benefits of having a Hong Kong company own your mainland China entity are not always all they are cracked up to be:

A few clarifications on Ms. Thomson’s post: If you establish a HK holding company you will most likely enjoy little to no tax advantages in China: – reduced witholding tax on profit reparation for HK parent companies only applies to those with a substantive business in HK; holding companies will still be charged 10%. – if you are funneling revenues through the HK holding company and the effective management of the HK entity is on the Mainland, you could be subject to taxes on profits captured in HK. – Indirect transfer of mainland assets (i.e. selling your HK holding structure to escape approvals and capital gains taxes on the Mainland) may also be liable for taxes on the Mainland. Effectively, if you are looking to use a HK holding structure for tax reduction/evasion purposes, it may no longer be a viable option. That being said, a HK holding company may still hold certain advantages over other jurisdictions: favorable local tax rates and easy to restructure/sell. As for the relative ease of setting up a company in China; the process has not really gotten any easier in the past 5 years (or worse for that matter). The Mainland still runs a highly bureaucratic; opaque and self-centered registration operation.

Then another reader, Mullins, left the following comment siding with Elizabeth:

Elizabeth is correct. Hong Kong is useful as a China parent domicile as profits parked there and redistributed are at a lower rate than being repatriated back to the US. Also the CEPA arrangement favors HK registered businesses. Plus changes at the China subsidiary can be enacted through the HK entity without having to endure mainland China ‘approval’. It’s that simple. Check these issues out properly before dismissing them – or Hong Kong as a jurisdiction please.

So who is right? Everyone is, to a certain extent. Let me explain.

First off, let me make one thing clear. Forming a Hong Kong entity is NOT a substitute for any requirement that you have a PRC entity. A Hong Kong entity is not the same thing as a PRC entity.  

The issue is whether it makes sense to form a Hong Kong entity to own your PRC entity. The short answer to is “sometimes” or “it depends.” There are absolutely some situations where it does make sense to have a Hong Kong entity own your PRC entity, but my experience has been is usually easier and cheaper not to bother.

My stock answer when a client asks how I feel about their forming a Hong Kong company to own their PRC entity is that “I feel really good about it because I get to charge you for doing two things, not just one.”  

A big misconception seems to arise from confusion between the difference between avoiding a tax and delaying a tax. If you set up a Hong Kong entity and pretty much immediately funnel the money from that entity back to your home country (such as the United States), you may end up gleaning little to no tax benefit from having a Hong Kong entity. But if you do not immediately repatriate your money from Hong Kong to your home country, your chances of gaining a tax benefit from your Hong Kong entity increase. This relates to saving on taxes in your home country.

Tim Lamb made some excellent points on how the PRC has really stepped up its taxation of transactions that occur within the PRC, whether or not they are nominally done by a Hong Kong entity or not. This relates to saving on PRC taxes.

The decision on whether to form a Hong Kong entity typically involves complicated legal, administrative, and taxation issues and is always company and case specific. In other words, it sometimes will make sense to have a Hong Kong entity and it sometimes will not. But to call Hong Kong “the critical gateway to Doing Business in China” is an exaggeration when for most companies seeking to do business in the PRC, a Hong Kong company will not make sense. 

To Hong Kong or not to Hong Kong, that is the question.  What do you think?

  • http://www.procurasia.com Etienne

    Interesting topic. It is clear that, as China’s authorities gets increasingly sophisticated regarding tax collection, the tax benefits of HK entityies are also less obvious to activate.
    I was also told another reason why a HK Holding legal entities are a good vehicle to invest in China: any corporate change in China (change of shareholding, …) would requires lengthily and sometimes difficult administrative approvals. When a China entity is mirrored with a HK entity, even though the HK mirror is sold or its shareholding structure is changed, there is no need to go through the PRC administrative process as the China entity corporate structure remains unchanged. There will probably tax impact for such transaction, but no delay or refusal from China’s administration. This is probably even more important when working with partners who might want to use the local administration as a tool to oppose corporate decisions.
    What do you think that that rationale: another HK consultant legend or a reality?
    Regards and thank for the great blog.

  • Graham Thompson

    You look at it solely from the US perspective where the IRS have become more strict at taxing offshore profits held overseas. For other countries its easier to do that. So it depends where the beneficial owner is based and the nature of the corporate tax structure and any applicable treaties.

  • Richard

    Does Hong Kong make sense as a Greater China HQ for an MNC anymore? Depends on the industry, but much less so than it used to. However, Hong Kong still makes sense as an Asia Regional HQ for many multi-nationals: great human capital, transport links, tax structure, reliable legal system, multi-cultural/lingual/ethnic, much more-China focused than Singapore, etc…
    I recognize this is not as to smaller companies, which I believe are the focus of your discussion.

  • http://www.utilitycomputing.com.cn Richard Ford

    The question also boils down to who are your clients inside China. While not the case in the past, a legal HK entity is now needed for banking accounts there as well. If you carry out the activities of a project inside China, however your client is based over seas. The transaction and payments can all be done off shore and avoiding the problems of brining money in and out. That is – if you are able to trade as BOTH a PRC and a HK company – you are offering more avenues to conduct business with your clients.
    Of course payments made in HK don’t allow fapiao to be issued in the PRC – though that is not necessarily a bad thing when with the new VAT system that was recently introduced and the scarcity of the “VAT stamps” issued.
    And finally – legal arrangements with your clients. Why sign a contract under Chinese law and in Chinese when you can do so in HK, in English? Most people would be happier to sign a contract in HK rather than one parties home country or China.
    I guess I am taking the perspective of how does a HK entity relate to your business when you need to factor in how to offer the best/easiest/flexible transaction for your clients – where the money comes from – as opposed to internal ‘selfish’ issues as tax and the like.
    IMHO, HK entity (which itself could be owned again by entities in other jurisdictions) owning the China WFOE seems the rolls royce way to go. All the options that you need. And in China, being flexible and being prepared for the things that you CAN’T think of is often more important than listing the issues that you are aware of.
    Cheers,
    RF.

  • http://www.chinalawblog.com Dan

    @Etienne,
    That is a reality. In fact, I just spoke with someone yesterday who was talking about forming a business with two other people and they want to be able to bring in other investors at some later date. He was concerned about setting up how to set up the WFOE with three people owning it and then bringing in additional investors. I immediately said the way to resolve that issue is to have the WFOE 100% owned by an outside (HK or US company) and then set up the percentage of ownership and resolve the control issues in HK or the US.

  • http://www.chinalawblog.com Dan

    @Graham,
    I am not looking at it solely from the US perspective. As I say, “the decision on whether to form a Hong Kong entity typically involves complicated legal, administrative, and taxation issues and is always company and case specific.” How can you not think this allows for taking into account foreign countries? I do agree with you though that having an HK entity is more likely to make sense for those who come from a high tax, high minimum capital, high administrative cost country, as opposed to the US.

  • http://www.chinalawblog.com Dan

    @Richard,
    I completely agree with you. One of the great things about HK is its banking and legal system. Again though, the US is fine for those things, if you are from a country where those things are not fine, then HK makes much greater sense. And if you are looking for an Asian headquarters you are actually going to staff with people, then there is the whole “nother analysis involved in that. Hong Kong? Shanghai? Singapore? It depends.

  • http://www.chinalawblog.com Dan

    @Richard Ford,
    I agree with all that you say, but again, much (if not all) of what you say would be true if your WFOE is owned by a US company or a Virgin Islands company. HK is not the only way to go and it really does come down to the individual situation.

  • John Croxson

    Dan – Have you ever tried to get a BVI company through the China bureaucracy? It’s not a sovereign state, requires more documentation, has zip transparency and it’s not wise for use for US incorporations – red flag to the IRS. Cheap dirty and not a blue chip professional option and arranging the banking is a nightmare. As was mentioned, HK is the Rolls Royce. It also has CEPA status with China which hasn’t been mentioned and can be additionally be useful. I’m not sure its a good idea you beating up on the HK professionals about China either if you’re not qualified to practice either in HK or in tax. I think you’re skating on thin ice here. I’d like to hear what the original Elizabeth has to say – if she’ll now give you the time of day, that is. You’re talking about the Chairwoman of ICS Trust incidentally and a much revered and experienced professional in this part of the world. I’m not sure you’re so qualified to question her opinon to be frank.

  • Dan

    All Dan is saying is that it is wrong to knee-jerk say that the only right way to go into China is via a Hong Kong company. We all know that to be true and we don’t really need all those with a vested interest in pushing Hong Kong to try to argue otherwise. My company went through a long analysis in deciding how to go into China and we ended up deciding a Hong Kong entity made sense for us because we decided we wanted to make Hong Kong the base of our entire Asian operations. But if all we had been planning to do had been to go into just China, we wouldn’t have even bothered.
    It really does need to be considered on an individual basis each and every time.

  • http://www.chinalawblog.com Dan

    @ Dan (a different Dan)
    Thanks. That is all I am saying.
    @ John Croxson
    Next time, do me a favor and actually read what I wrote before you start trashing me and trying to stir up some sort of brouhaha. All I am saying is that Hong Kong is not always the way to enter China. Would you disagree with that? I am actually a big fan of using Hong Kong to go into China, but only when appropriate.

  • John Croxson

    Dan, perhaps you’d like to explain why in your opinion the Virgin Islands are a better bet? I think I also speak for many here in China when I suggest your manner towards fellow professionals (in this case Elizabeth) and your knowledge at times is not what it should be. Good day to you Sir.

  • http://www.chinalawblog.com Dan

    @John Croxson,
    I admit I get irritated with people who attribute things to be that I never said and you are doing it again. I never said the Virgins Islands were a better bet than HK or the US, I merely said that HK should not be automatic and that there are situations where the Virgin Islands might make better sense. For example, we did a BVI company that was insurance related because our client (who really knows the business) wanted it over HK because he said that investors would be more comfortable with a BVI company than an HK company.
    I keep answering your questions, so why don’t you answer my one question, which is, would you agree that Hong Kong is not always the best way to enter China?

  • Kwok Ting Lee

    One of the key issues that has been emerging recently for quite a few private equity firms is the taxation of intermediate holding companies (“SPVs”) in Hong Kong and Singapore (among other jurisdictions) under the new anti-avoidance rules that may: (a) permit the Chinese tax authorities to deem a transfer of the shares of an SPV as being a direct transfer of the interests in the underlying PRC company; (b) permit the Chinese tax authorities to look through an SPV if the SPV serves no real purpose other than to claim tax treaty benefits.
    I think this makes the decision to go into the PRC via Hong Kong (or Singapore) less of a “certainty” than it was in the past. Certainly, I would expect that such firms would have to reassess: (a) the efficacy of existing Hong Kong transaction specific SPVs; (b) assess the utility (going forward) of continuing to establish the “typical” BVI – Hong Kong – PRC transaction structure.
    In any case, I tend to agree with Dan Harris that it is not necessarily always the case (especially now) that a private equity fund seeking to engage in a transaction in China would necessarily use a Hong Kong intermediate structure, given the new position of the Chinese tax authorities. There may will be justification for using other on-shore structures, especially if one considers the possibility of being able to exit the investment by way of an IPO in Shanghai to be attractive. (I’m of mixed views on that, but it is a valid consideration.)

  • http://www.utilitycomputing.com.cn Richard Ford

    @ John,
    You can still do a BVI. BVI could own the HK entity – which owns the WFOE. You then have options on how you want to trade with your clients and the jurisdictions to issue and executed contracts.
    @ Dan,
    I get what you say- maybe I was not clear. HK presents a neutral zone to do the contracts in. While the USA or Australia or anywhere else (BVI) may be fine – parties entering a business relationship may prefer a neutral zone – no home field advantage to anyone.
    In our business we have successfully screwed the bolts down on bad debtors from all around the world – some from the USA and they signed contracts with us in English in Beijing – thinking I am in the USA – they can’t touch me….. Their local entity that actually chopped and signed on their behalf is in some small shit brick outback town. Did they stand a chance (legalities notwithstanding) of a fair trial in Beijing against a Beijing incorporated WFOE?
    No.
    People may feel that a neutral zone will be more “fair” to both parties in the event of contract frustration. I am not advocating HK per se. I have raised two new angles to look at it that basically revolve around your client(s) feeling more comfortable – for whatever reason.
    Cheers,
    RF.

  • http://www.chinalawblog.com Dan

    @Richard Ford,
    I certainly understand how it is that parties may want a “neutral zone” in which “to do the contracts in,” but one can use HK arbitration, for instance, without necessarily having to have an HK country.