We're often asked if Hong Kong company registry is necessary as a prerequisite for setting up a WFOE in China. Many rumours and anecdotes are floating around about if this is a good idea for foreign investors.
Let's explore if this scenario suits you here.
How Can A Hong Kong Shell Company Help With Mainland China WFOE setup?
Hong Kong is a part of China, but it has its own business laws and jurisdiction. It is often said that it's 'better' to open a Hong Kong company to use as a vehicle, or 'shell company,' for then opening your WFOE.
But what makes this 'better' than just opening your Chinese company directly in China using your foreign, say American, parent company as the investment vehicle?
In general, it comes down to maximising profits, with a healthy portion of convenience thrown in for good measure.
Hong Kong is a lower tax environment than the PRC and is also far more open in business terms than the Mainland.
This roughly means that having an HK shell company will allow you to operate more smoothly and simply in Asia, and potentially pay less tax than if you have a Chinese WFOE owned by your home nation's company. For instance, making payments abroad is simple from Hong Kong, but could be troublesome from China (unless you qualify to be able to open an offshore business bank account in Shenzhen).
This is a brief and simple explanation though, and in fact there are a number of benefits and drawbacks to Hong Kong company registry with a view to setting up a WFOE in China, so let's take a look at them now...
Hong Kong Company Registry Benefits
- It's easy and convenient to open an HK company - it's a relatively simple process, and is fast, taking just a matter of days. Whereas a lot of documentation is required to open a China WFOE, to the point where you'll think that it's bureaucracy gone mad, and at best it will still take more than a month to open; this can't be said for HK.
- Hong Kong's official language is English making operating there easier - this is not true of China.
- As mentioned, banking in China is similar to banking in Western countries. Banking processes are as free as you would expect - i.e. it is not difficult to transfer money where it needs to go to from Hong Kong.
China keep tight controls over finances coming and going through its borders, to the point where it is almost prohibitive at times. - HK corporate income tax is relatively low, just 16.5%, compared to the PRC's 25% (and it will be reduced even further in 2018).
Importantly, withholding tax on payments to Hong Kong are also lower from China, with HK benefiting from only a 5% rate, instead of the 10% levied against other countries.
There is also no tax on dividends in Hong Kong.
If you're able to use your Hong Kong company to handle some or all of the finances for business carried out in China, in an offshore style, then you should benefit from a lower tax burden.
For example, regarding dividends, if your WFOE has made a net profit in China you will need to pay tax on that profit to China, but when sending dividends to HK you will only need to pay an additional 5% withholding tax to China, and no tax on the dividends reaching HK on their side of the border.
Compare this with, say, the USA - you would not only pay Chinese profit tax, 10% withholding tax on sending dividends to the States, but then also a tax on the dividends reaching the States. This is similar for many Western countries. Therefore, it's fair to say that a Hong Kong company is a good way to lower your business's tax burden when getting money out of China.
Important note on tax - A competent Chinese accountant will be able to advise you how to use your HK company to assist with doing business in China while benefiting from HK's lower tax rates and easier banking if that is your goal, but without becoming non-compliant in the PRC. - The CEPA treaty between HK and China - this treaty is a reciprocal deal between the two territories, allowing HK companies certain benefits when trading in or with the PRC (such as tariff free imports), and vice versa. You may find that setting up a China WFOE is a little easier for an HK company than foreign companies from elsewhere, due to this treaty.
- It is far easier to change or add shareholders of your HK company than a WFOE. If your China business increases and you add more shareholders, they can be added to the HK shell company instead which owns the WFOE anyway.
- Issuing shares in Hong Kong is simple. Staff can be given a share ticket, encouraging them to hold shares, whereas in China it is a complex and time-consuming process to issue shares for a WFOE. Even in the case of major shareholding changes in HK, giving a record to the government there is fast and simple.
- When using an HK company to set up a WFOE, your HK company's registration documents (such as business license etc) required for the WFOE incorporation only need to be notarised by a local Hong Kong lawyer, whereas if using an overseas company, such as one from Europe or the USA, the same documents would need to be sent to the Chinese embassy and notarised there, taking more time.
Hong Kong Company Formation Drawbacks
- You will have another company to be responsible for! Long term, this will require more administration and attention on your part. It just depends if the benefits of having it make this worthwhile.
- You need to pay to set up the HK entity, and keep it running in a compliant manner. This means retaining a Hong Kong accountant to look after the books and audits. Admittedly these costs are pretty low (probably only in the thousands of HK dollars per year or so), but it's still something to be aware of.
- Opening a Hong Kong bank account is not easy. This issue continues to rear its ugly head, but unfortunately HK is still very skittish about letting (especially new) companies open business bank accounts (after a crackdown on money-laundering led to HSBC getting a huge fine from the US government). It's not impossible, and it may be possible to buy a shelf company with an existing bank account and hope the bank will allow you to keep it open.
Read our advice on opening a Hong Kong bank account here.
Conclusion: Do You NEED To Open An HK Shell Company To Set Up Your China WFOE?
We suggest that you do, yes.
To be honest, Hong Kong company registry is fast, cheap, and offers foreign investors many benefits, so if you can open your business bank account there, it's not a bad idea to have one if you're planning on doing business in China, Hong Kong, or both.
To recap, you'll have:
- Access to Western-style open banking, but in 'China'
- English working language
- Lower tax than if operating between China and another foreign country, therefore maximising your profits from China
- More options to run the business flexibly - such as ease of changing shareholders
However, I would add that if opening an HK shell company for the purpose of using it to open a WFOE is something that appeals to you, it's important that you get legal and financial advice before doing so, otherwise you may end up with an HK entity which is not much use to you. It really depends on your business plan and circumstances whether you're going to get the maximum benefit out of following this path.
Ready to speak about doing this? We can help, contact us.
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Did YOU open a Hong Kong shell company for the reason described? How did it go, and what benefits did you find that you were able to get?
Have you been considering doing this? What puzzles or concerns you about the process? Contact us, or leave a comment below this blog post and we will be glad to answer and help you.
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