China has become quite adept at spotting and hunting down foreign companies that are doing business in China without a required Chinese entity. What exactly constitutes doing business in China at a level requiring a Chinese corporate entity ? That is a question far too complicated to answer in a blog post, but suffice it to say that the Chinese government has a very expansive definition of that simply because such a definition increases its tax coffers.
I bring this up because as China continues/accelerates its crackdown on foreign companies doing business in China without a Chinese entity, our China lawyers are seeing a concomitant rise in foreign companies setting up companies in Hong Kong and paying taxes there will bring them into compliance with Chinese law even though 9999 out of 10,000 it doesn’t.
In fact, whenever a client asks whether their setting up a company in Hong Kong will solve the problem of their operating on the Mainland without a company, I respond by saying: “Think of Hong Kong as New York. Having a Hong Kong company will no more help you get legal in China than setting up a new company in New York. When it comes to business law, you need to think of Hong Kong as a completely different country than the PRC.”
We most often see the Hong Kong company problem with foreign companies that have Chinese “employees” in China but no company there. This is 100% illegal in China. Yet this is also very common and it is also very common for the Chinese government to catch foreign companies that do this and then come down on those companies like a ton of bricks. For a more complete explanation of this, check out my Forbes article, China’s Tax Authorities Want You. The reason companies with employees in China so much want to avoid having a China entity is because China employer taxes and required benefit payments are really high and if you have can keep your China employees off the grid, you can avoid paying those taxes and benefits.
Oftentimes, the “Hong Kong excuse” is actually generated by the Chinese employee who very much wants its foreign “employer” to stay off China’s grid as well. The employee likes its foreign employer to operate illegally in China because the employee’s pay can be higher (because there are no employer taxes) and its take home percentage is also higher (because he or she is not paying income taxes). So the employee convinces its foreign employer that forming a Hong Kong company will be both cheaper and equally effective as forming a PRC company.
But it isn’t. Sorry. If you have employees in China or if you are otherwise doing business in China at a level that requires an entity (there’s that vague line again) and you don’t have a registered PRC entity, you have a legal and a tax problem and there are no two ways about it. All of the above is true of Macau and Taiwan as well.
For more on the China-Hong Kong distinction when it comes to corporate entities, check out How to Form a China WFOE: What’s Hong Kong Got to Do with It?
And while we are discussing how Hong Kong entities do not satisfy PRC entity requirements, I might as well remind you that having a trademark in Hong Kong or Taiwan or Macau does not give you any trademark rights in the PRC and vice-versa. Again, you must think of these jurisdictions as being legally separate as that is the case when it comes to trademark rights as well. For more on this, check out China Legal. Not Hong Kong Legal. Not Taiwan Legal. Not Macau Legal and China And Hong Kong Trademarks. Think Puerto Rico.
One last area where we often have to deal with the differences between Hong Kong and China is on all of our contracts relating to manufacturing, such as NNN Agreements and Product Development Agreements. Many Chinese manufacturing companies want their agreements with their foreign customers to be with the manufacturer’s Hong Kong entity, not its China entity. This creates all sorts of complicated ownership and liability and jurisdictional and venue issues that must be resolved correctly to prevent a legally nonsensical or invalid agreement or equally bad, an agreement that makes perfect legal sense, but provides no protections to the foreign buyer. Again the key issue here is that Hong Kong and the PRC are legally separate when it comes to commercial transactions.
Just curious. How many of you were aware of the above and for how many of you is this above a revelation?