Setting up an office in Hong Kong in an international environment - How to avoid the common pitfalls?
- Stefan Schmierer
- 8 hours ago
- 7 min read
Author: Stefan Schmierer, Managing Partner.
Part 1: The Foreign Shareholder
For decades, everybody who considered setting up an office in Hong Kong, being it to enter the local Hong Kong market or for entering the Mainland Chinese market, has heard and is aware of the ever-repeating mantra of the Hong Kong government and its related marketing arms:
“Doing business in Hong Kong is simple and easy, and a Hong Kong company can be set up in only a few days, or even within 24 hours!”
This statement has been well received by the local (and unfortunately also be some international) service-providing businesses and has been echoed by them for at least as long as the government statement has been around.
Whilst this statement is certainly correct in regards to several aspects, and a Hong Kong private company limited by shares can indeed be set up within a few days or even within 24 hours, the following article shall examine whether it is always a good idea to be on the fast-moving track, or whether there are circumstances that warrant a longer consideration period as to whether and how to set up an entity in Hong Kong:
The Basics - How to set up your office in Hong Kong?
The most common form of a legal entity in Hong Kong is a “private company limited by shares”. The exact definition of this legal entity goes beyond the scope of this article, but it is worth mentioning that other forms of legal entities in Hong Kong typically take more than a few days, or even just a couple of hours to set up.
However, if one considers setting up this basic form of entity, the requirements are simple and straight forward:
The new entity (hereinafter referred to as “NewCo") requires only one shareholder. This shareholder can be a natural or a legal person and does not need to reside in Hong Kong;
The company needs a registered capital, which can be in any major currency as low as 1 HKD;
NewCo requires at least one director who is a natural person, and this director does not need to reside in Hong Kong as well. This is a substantial advantage of Hong Kong over Singapore, since in Singapore at least one of the directors needs to permanently reside in Singapore, opening the door for Singaporean businesses to charge substantial fees for their nominee director services;
NewCo needs a company secretary, which is usually provided by the service provider that sets up the entity; and
NewCo needs a registered address, which can be a letterbox office, often also provided by the service provider/ company secretary.
Contrary to many jurisdictions worldwide, no documents submitted to the authorities for the set-up require notarisation or any other form of confirmation.
Where the problems arise
The problems that businesses with their Hong Kong subsidiaries usually face do not so much arise from the setting-up procedure or the local Hong Kong side of NewCo, but rather from the involvement of international elements.
Whereas many businesses in Hong Kong are structured as local businesses, meaning all involved persons (shareholders, directors, company secretary) are local Hong Kong natural or legal persons, the matter becomes much more complicated once an international element enters the stage. It goes directly to the root of the purpose of setting up NewCo, i.e., creating more business and profit by setting up NewCo. Setting up NewCo not only costs money, but money also needs to be paid for the administration of NewCo and, most importantly, for tax.
Combined with the Hong Kong government’s above listed marketing slogan goes the claim that Hong Kong has a simple and low tax regime (which is not really true…), but it becomes more complex, when the shareholder(s) of NewCo are foreigners, being it legal or natural persons, and when NewCo has subsidiaries in other countries (mostly Mainland China).
In such circumstances, looking at the Hong Kong tax side is certainly not enough and equals to looking at a problem with only one eye. The core question arises how are profits that NewCo generates not only taxed in Hong Kong (if at all), but how are these profits taxed in other jurisdictions, and does it commercially make sense to open NewCo if a substantial part of its gross profits is eaten up by taxes (in Hong Kong or elsewhere).
Having a closer look
For having a closer look at this problem and for getting a better understanding, the following scenario shall be considered: A foreigner (either legal or natural person) sets up NewCo as sole shareholder, i.e., is the 100% owner of NewCo. After successful incorporation of NewCo, NewCo opens a 100% subsidiary in Mainland China.
In this scenario, NewCo is a mere holding company without its own operations, and the profits of the group are generated by the Chinese operating entity by selling its products either within the group or to external customers.
This is a simple and straight forward business structure, which has been incorporated in the last decades over and over again, and has served its purposes well.
After incorporating the entire structure, the business started, and, after paying profits tax in China, the Chinese subsidiary created a net profit of 100 USD. The owners now decide that this net profit should be repatriated to NewCo as its sole shareholder in the form of dividends.
Dividend payment from Mainland China to Hong Kong
However, China imposes a withholding tax of 10% on dividends that shall be paid abroad, so that under local Chinese laws, NewCo would only receive 90 USD, since 10 USD are kept by the Chinese tax authorities. However, this 10% can be reduced to 5% according to the Double Taxation Agreement (DTA) between Hong Kong and Mainland China.
While this was a simple procedure in the last decades, and China more or less always granted the reduction from 10% to 5%, Chinese tax authorities in the last years began to apply the reduction only if the shareholder (i.e., NewCo) is an entity in Hong Kong that has substance, and substance is often described as NewCo having its own physical office in Hong Kong, its own employees, and most management decisions being made in Hong Kong. To establish such substance, NewCo needs to apply to the Hong Kong Inland Revenue Department (IRD) for a “Certificate of Residency”. Whereas the application form for such certificate is quite short, it usually takes NewCo appr. 6 to 9 months to obtain such certificate, if at all. If the IRD is not convinced that NewCo has sufficient substance (which most letterbox offices do not have), the certificate is denied and NewCo will not be able to enjoy the tax reduction under the DTA, in essence doubling the withholding tax in Mainland China.
b. Dividend payment from NewCo to shareholder
For the following, and following most of the practical cases, it shall be assumed that NewCo was not able to obtain a Certificate of Residency and the PRC tax authorities withheld 10% on the dividends, so that NewCo only received 90 USD.
The owner now decides that these 90 USD shall be further paid to the shareholder in the form of dividends. As Hong Kong does not impose any form of tax on dividends (either on the receiving or the paying side), no tax implications in Hong Kong arise. To illustrate the example further, the shareholder of NewCo shall be a legal person located either in:
Switzerland,
Germany, or
Luxemburg,
representing typical jurisdictions in Europe in which shareholders of Hong Kong companies are located.
i. Switzerland
If NewCo pays the 90 USD as dividend to its Swiss shareholder, then the DTA between Switzerland and Hong Kong can reduce the tax on these dividends charged by the Swiss authorities (usually 35%) to 10% or, under certain circumstances, even 0%. However, it needs to be determined by a Swiss tax advisor whether the DTA is applicable in cases where the paying entity (i.e. NewCo) is a mere letterbox office, and whether the Swiss authorities also require a Certificate of Residency from NewCo.
ii. Germany
Unlike most other jurisdictions in the European Union, Germany does not, and most likely will not for the near future, maintain a DTA with Hong Kong (it seems that political considerations top economic interests), meaning the tax rate for the dividends paid from NewCo to its German shareholder depends solely on domestic German tax law, which can be significantly higher than the taxation of dividends under a DTA treaty between Hong Kong and other EU jurisdictions.
iii. Luxemburg
Luxembourg is another popular EU jurisdiction via which investments into Hong Kong are usually channelled due to its low and simple domestic tax regime. Dividend payments from NewCo to a potential Luxembourg shareholder are taxed under the Luxembourg- Hong Kong DTA at either 0% or 10%, depending on the shareholding percentage of the shareholder. Assuming the Luxembourg shareholder holds at least 10% of the shares of NewCo, then the 0% tax rate will apply.
In Summary
The above examples show how differently dividends earned by a Chinese subsidiary or by NewCo can be treated in different jurisdictions and under different scenarios. It is noteworthy that the above scenarios have been substantially simplified in order to keep this information comprehensive and digestible, and most of the domestic tax laws have been left out.
It is also notable to mention that the absence of a DTA between Germany and Hong Kong seems to be a substantial disadvantage for German-based companies when considering an investment in Hong Kong, and it is many times more favourable to structure an investment into Hong Kong via a third-party jurisdiction.
A word of caution
Once again, the scenarios above have been substantially simplified, and the actual reality is much more complex and complicated than described and local domestic tax laws of Switzerland/ Germany/ Luxembourg have been left out more or less completely For entities that consider a potential investment into Hong Kong, it is absolutely advisable not to listen and blindly follow the marketing slogans of the Hong Kong government, a marketing organisation or a local business advisor that does not have the necessary international horizon.
When planning the setup of a Hong Kong entity, we usually work very closely together not only with the client himself, but also with their tax advisors in their home jurisdiction, and, in case the client considers structuring the investment via other jurisdictions as well, with tax and legal advisors in those jurisdictions too, in order to come up with a comprehensive market study and comparison of the advantages and disadvantages of the different jurisdictions. This might take weeks or months to carefully plan, or it might be the case that the plan falls through since it does not appear to be commercially viable after careful consideration.
Need help setting up your Hong Kong office? Contact us today.
Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.
For specific advice about your situation, please contact:
Managing Partner
+852 2388 3899
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