Common Question: I am setting up a HK LLC because I hear I can operate tax free, do I need to file my taxes each year in HK? I’m also thinking of setting up a company in China to help w sourcing. At what volume does it make sense to set up my own company there and do a PRC Business Formation?

HK law is bit outside the scope of the PRC law we practice at ABL, but as have owned a few HK and PRC companies, I am happy to share my experience in this blog post for your general reference.

Part 1: PRC Business Formation

Let’s first look at the PRC business formation, then we’ll turn our attention to the HK side of things. If you considering setting up a China WFOE, here are some things to remember.

First off, for those readers who are not yet familiar with the term, “WFOE” stands for “Wholly Foreign Owned Entity”. There are many variations to the WFOE, such as “trading WFOE” or “manufacturing WFOE”. But what makes the WFOE special is that this type of business structure does not require any Chinese partners, yet the business is on a level playing field with Chinese owned businesses (at least in theory, from a legal perspective).

Over the years in China, I have had an ownership or a director level position in 8 WFOE’s and 2 JV’s. I don’t claim to be a PRC business formation guru as I still take advice from the experts when it comes to legal and accounting issues. But at http://www.chinasourcinginfo.org/2013/04/09/setting-up-in-china-a-behind-the-scenes-look-wfoes-and-other-options/ I share some of the key lessons I have learned from my particular experience in PRC business formation. In that article I cover:

  • WFOE’s for consulting and services
  • WFOE’s for manufacturers
  • WFOE’s for traders/importers
  • Time frame for setting up a WFOE
  • How the PRC government uses the registered capital requirements to get what they want, not necessarily what you need
  • Options for setting up the WOFE
    • DIY
    • Let your Landlord or Local Government do it for you
    • Engage a Registration Agent
  • All in costs for a WFOE (Set up & Operations)
  • 8 Critical Items for WFOE set up
  • Alternative options to the WFOE
    • Representative Office
    • Outsource the sourcing to China-based service provider
    • Rent a serviced virtual office
    • Hire freelancers

For businesses currently importing from China that are thinking about PRC business formation and setting up their own operation in China, they should consider this rule of thumb:

  • If the annual order size is less than 2 million USD at BOM level it probably wouldn’t make economic sense to set up your own WOFE.
  • If over 20million USD, you probably want to have your own WFOE.
  • Over 2 but under 20 could be good fit for the virtual factory/ virtual sourcing office. More on Virtual Factories and Virtual Sourcing Offices at www.PSSchina.com

Part 2: Setting up a company in Hong Kong

Why consider a HK holding company when doing business with China?

Excerpts from http://www.chinasourcinginfo.org/2014/07/01/4-amazing-advantages-of-using-a-hong-kong-holding-company-when-investing-in-mainland-china/

Ease of Business Formation

HK has returned to the mainland, yet under the 1 country 2 systems approach, HK invested mainland companies are considered foreign invested companies. But HK investors (even if the investor is HK company owned by a foreign individual or corporation) receive preferential treatment over foreign companies that invest direct. For example, the amount of paperwork and lead time to set up a HK owned company in Mainland China is less than if a USA company set up shop in China.

Ownership Flexibility

Once a WFOE (wholly foreign owned enterprise) is set up in China, changing directors and ownership is complex and time consuming. If that WFOE is owned 100% by a HK holding company, there is a lot more flexibility. Say you want to bring in a new investor and give them 40% ownership in your China business. Assuming the HK company owns 100% of the PRC company, selling 40% of the HK company has the same effect as the investor owning 40% of the WFOE.

Another advantage of HK is the rule of law and professional accounting standards. Say someday you want to sell your China operations. Everybody knows most Chinese owned PRC companies run multiple sets of books. So nobody trusts the numbers. But if those PRC accounts are rolled up into a set of consolidated books audited in HK and made official in HK, this carries real weight with international investors because HK accounting is respected and there are strict penalties if somebody “cooks the books” .

Limited Liability and Exposure

Crazy things can happen at your factory in China. Say one of your employees doesn’t follow your policy regarding environmental protections and dumps a tank of chemicals out the back door. If you directly own the WFOE your parent company could be dragged into a lawsuit. Having a HK holding company keeps the exposure at arm’s length.

If structured correctly, business conducted outside of HK is TAX FREE!

If your HK company buys product in PRC and ships those goods to your home country, this can be considered “offshoring” and there is no profits tax applied in HK. Depending on your home country’s tax codes and the tax authorities views on transfer pricing, having a HK holding company can be a very effective and fully legal tax shelter. At the very least, having a HK company can help you defer global tax without breaking any laws in PRC, HK or back home.

Key Question On HK Taxes, Annual Book Beeping and Reporting

Omar, a reader from Jordan, asks “We are setting up a limited liability company in HK, do we need to make any financial auditing to the HK government for tax reasons, keeping in mind none of our income in HK is from businesses done in HK? From my understanding, HK LLC doesn’t need to report to the HK government.

It’s my understanding that if your HK company is considered “offshoring” in the eyes of the HK government, then yes, you may not have to pay profits taxes. BUT, you have to be real careful about keeping your offshore status. For example, if you hire staff in HK, sign deals in HK, exhibit at trade shows in HK or have clients in HK, then there is a chance the tax man will say you are “local” not “offshore”. And profits tax would apply. For example, you may issue invoices to clients overseas who pay you to your HK account, but if you don’t have a contract and invoice that says the client is overseas, the HK government could assume that those clients are in HK and you owe profits tax as the transaction is no “offshore”. I learned that 10 years ago when I got a bill from HK tax authority for 50,000 USD worth of back taxes. Luckily, my clients were overseas and I got a letter from them and the HK government returned the funds to me. So the HK tax authority is professional, if you play by their rules. I learned my lesson and not put the clients’ full address on each invoice, contract, and bank transfer.

Also, it is my understanding that all active HK companies need to do their annual tax filings regardless if you pay taxes or not. So to answer your question, based on my experience, you do have to file your annual accounting reports, but if you meet the criteria of “offshore” business, you may be able to avoid paying HK profits taxes. If you need more info, I can put you in touch w my HK accountant who does a great job for me.

BTW, here is an interview I did about how to use the HK holding company for global tax advantage. You may find it of interest.

Sincerely,

Mike Bellamy

Business Advisor at AsiaBridge Law