Hong Kong, a transitional step into China?

Is Using Hong Kong to enter the Mainland Chinese Market a Good idea? Considering your different options of entering the Mainland Chinese market? Not sure if you should be using a third jurisdiction like Hong Kong? Well let us break it down a little for you.

Hong Kong is often a popular choice for a third jurisdiction when trying to enter the Mainland Chinese market. The reasoning for this varies, but the main few can be summarized as follows:

Hong Kong itself

Hong Kong is one of the freest regions in the world, where it promotes itself as a market driven with minimal government interference. With both close links and understanding of Mainland and international markets, it is often seen as the meeting point for eastern and western businesses. With a transparent system, secure market and political stability, it is often seen as a safe starting point for non-Asian companies.

In terms of tax, it has a simple tax system, with a relatively low corporate and individual income tax. In addition, it has no turnover tax or dividend tax, making it attractive for many foreign investors. Especially for importers, the lack thereof custom duties and import tax makes it even more advantageous for foreign companies. For those looking to enter the Mainland market, Hong Kong is often used as a hub to then import necessary goods just-in-time to minimize tax duties, only importing to Mainland when necessary.

A transitional step into China

Being a major entry port and economic centre of Asia, it is without surprise that it’s accessibility attracts many companies to situate there geographically. However, with its obvious geographical and cultural proximity to Mainland China, it is also regarded as an entry point to Mainland China. Having a western twist in the Hong Kong culture, it is seen as a stepping-stone for western companies to slowly adapt into the Chinese market. First stepping into the shallow waters of Hong Kong before diving into the depths of Mainland China. Its culture, customs and language are all similar to Mainland China, therefore seen as providing a transitional step for western companies.

DTA

Since the signing of the new DTA in 2006, lower withholding tax rates for passive income can be enjoyed between Mainland China and Hong Kong SAR. Amongst the countries and regions who have signed DTAs with Mainland China, lower rates have been gifted to Hong Kong.

What this means is that Hong Kong holding companies can enjoy 7% withholding tax rate for interest and 5% for dividends. This is a respective 3% and 5% lower than the normal 10% withholding tax rate given to most other DTA countries. Though it must be noted that there are requirements, such as the Hong Kong company’s shareholding must be at least 25% of the Mainland company and the Hong Kong Holding Company should have substance business factors, conducting actual business in Hong Kong. If not met, the original 10% withholding tax rate applies. In terms of Royalties, Hong Kong holding companies also enjoy a 7% withholding tax rate. Once again, it is the lowest amongst all DTA countries.

Figure 1: A Table showing the withholding tax rates of passive income

In addition, in terms of capital gains, as long as the Hong Kong company meets the two requirements of: (a) selling less than 25% of the shareholding of the Mainland company and (b) that the Mainland company is not mainly comprised of immovable assets located in Mainland China, then Hong Kong companies can enjoy a full tax exemption to any capital gains from the depositing of Mainland shares. 

CEPA

In addition to the Double Taxation Agreement signed between China and numerous other countries (Hong Kong SAR included), which promotes investing amongst the parties through reduced tax rates on dividends, interests and others, Hong Kong has established a unique business relationship with Mainland China through CEPA. CEPA is an agreement first signed in 2003 to enhance the business and trading environment between Mainland China and Hong Kong. It promotes finance, trade and investment between the two sides with the constant publishing of supplements, where the latest one was effective on 1^st January 2013. 

CEPA creates opportunities for Hong Kong goods to be traded and sold to the Mainland market liberated from original trade barriers. Hong Kong goods that comply with the CEPA rules and requirements, such as having at least 30% of its value added in Hong Kong, have the opportunity to be imported into Mainland Tariff-free. There are, of course, exceptions for prohibited goods and many requirements that need to be met in order to be considered a “Hong Kong good”, but the whole idea provides a platform in which a more advantageous channel of trade can enter the Mainland Chinese market. 

Currently, in terms of services, the Hong Kong Service Suppliers enjoy relaxed market access, such as allowing wholly owned operations, and preferential treatment in the Mainland market. These benefits are especially advantageous for SMEs entering the Mainland market. Though not in the agreed supplements yet, but there is an expectation that Free trade in services may be introduced between Guangdong and Hong Kong in 2014. 

But it’s not all immediate…

However, though it may seem beneficial to use a third jurisdiction, more recent events have caused Chinese authorities to become more stringent in the use of third jurisdictions just for tax reduction. Therefore it is important that if you do have a Hong Kong holding, it must have justifiable commercial reasons for establishing in Hong Kong as well as substantial amount of economic flow. If not, you may not be qualified to enjoy the DTA and CEPA benefits.

In addition, to be able to enjoy the CEPA benefits in particular, you need to meet the CEPA requirements of being a “Hong Kong company”. This involves having a physical office in Hong Kong with the necessary operational and trade flow. Therefore PO box offices would not suffice. The company must have been operating in Hong Kong for at least three to five years depending on the sector with at least 50% of all employment originating from Hong Kong.

So, It really depends on the type of business and the individual plan of each business on how you should be entering the Mainland market. Creating a Hong Kong Holding may not be beneficial to you if you originally didn’t plan on having operations there. If you are unsure if this is the way for you, please do not hesitate to contact us and we would be happy to assist you with our expertise regarding this topic. In most cases, direct establishment of a wholly owned foreign enterprise (WFOE) or a Representative office (RO) may be more suitable depending on the extent of entry and type of good or service. 

	Richard Hoffmann is a partner at ECOVIS Beijing China. Richard obtained an honors degree in law and worked in Germany, the United States and China for various prestigious law firms prior to joining ECOVIS. He has published more than fifty articles in international magazines, frequently speaks at high profile events in China and abroad and is often invited as a legal expert by international TV stations. Contact: richard.hoffmann@ecovis-beijing.com
Ecovis Beijing is the trusted tax and legal advisor of several embassies and official institutions in China. It specializes in mid-sized international companies and is focused on tax & legal advisory, accounting and auditing. If you’re interested in finding out more about tax and legal, don’t hesitate to sign up to our Newsletter, give us a call +49 (0) 6221-9985639 or contact us directly via Beijing@ecovis.com