Shortcut Options: Third Jurisdictions as a Gateway to China

Foreign businesses seeking to enter the Chinese market often wonder whether including a third jurisdiction (e.g., Hong Kong or Singapore) in between their home country and China would bring any advantages to their business model. In fact, advantages associated with this type of structure generally include beneficial tax treatment, lower costs, a stable business environment, smooth payment procedures, as well as “verifiable” business partners. Whether these benefits will be materialized depends on multiple factors. In this section I will be focusing on the advantages and disadvantages of using this approach as another way to access the Chinese market. Third jurisdictions, as a gateway option, can be a great platform for foreign businesses seeking to export goods or provide services to mainland China.

Hong Kong

Hong Kong, conveniently located at the southern part of China’s prosperous Pearl River Delta region, is regarded by many investors as the ideal gateway to mainland China. In 1997, Hong Kong was returned to China and since then it has kept the status of a Special Administrative Region (SAR). Thanks to the “one country, two systems” policy, it has the unique advantage of being a modern Chinese city and a global trading center continuing to maintain its favored legal and economic structure. Its historic, Western orientation makes it an excellent middle ground between the complexities of mainland China and the way business is conducted in the West. English remains an official language and the region is one of the most liberal market-based economies worldwide. In addition to these benefits, Hong Kong offers world-class infrastructure, low taxes, as well as free flow of capital, labor, and information.

While a large number of multinational companies continue to use Hong Kong as their Asia Pacific headquarters, most foreign businesses usually bypass Hong Kong to enter China directly, especially if they are exporting. There is, however, a variety of reasons for foreign businesses to consider having a legal entity in Hong Kong, depending on the nature of the business, the sector, and the size of the company. For the sake of reference I am providing below some of the most common reasons many foreign businesses choose to set up a Hong Kong company:

Establishing a holding company to protect the parent company from any negative legal issues that might arise with its business activities in mainland China.

Benefiting from certain financial and tax systems which include lower corporate tax rates and easier profit repatriation.

Using a Hong Kong shell company to establish an RO in China (which requires an existing office outside of China). This is a smart strategy and is very popular among foreign entrepreneurs and start-ups without an office in their home country.

Getting a quick leg up, as you can set up a legal entity in Hong Kong in a very short amount of time (two weeks versus at least three months in mainland China).

The Closer Economic Partnership Arrangement (CEPA) is a bilateral free trade agreement between China and Hong Kong and came into effect in 2004. According to the agreement, China has agreed to eliminate tariffs for all goods of Hong Kong origin and grants preferential treatment to Hong Kong service providers in a number of service sectors. Therefore, foreign companies registered in Hong Kong can benefit from CEPA regulations. More than 40 service sectors fall under CEPA but certain requirements need to be met in order to enjoy preferential treatment. For instance, the company has to be established for a minimum of three years before it is recognized as a Hong Kong-based company. It would be very misleading to claim that foreign companies need to have a link or presence to Hong Kong to be able to successfully do business in mainland China. It is crucial though that companies consider getting further legal advice if they are in doubt about the optimal strategy regarding their specific situation.

Hong Kong’s Advantages

Hong Kong is one of the most important international financial centers worldwide. As of 2020, more than 9,000 foreign companies operate in Hong Kong, among them 1,300 from the United States. China is the second largest recipient of FDI in the world. According to the National Bureau of Statistics of China, approximately two-thirds of all the FDI into China came via Hong Kong in 2019. It hosts 142 licensed banks and more than 80 ROs of banks from 40 countries. Supervised by the Hong Kong Monetary Authority and the Securities and Futures Commission, Hong Kong’s banking system is very well regulated. Due to the local economy structure, banks based in Hong Kong enjoy a solid international focus, with strengths in project finance and trade. Holding funds in Hong Kong to support or facilitate operations in China enables foreign businesses to enjoy the transparency, freedom, and speed of one of the world’s most business-friendly banking systems.

Since there are no foreign exchange restrictions or capital controls, like is the case in mainland China, operating a Hong Kong-based multicurrency trading business is efficient and straightforward. With multicurrency accounts, transactions can be completed in most foreign currencies while telegraphic transfers can be executed on the same day. In addition, there is a broad variety of lending and investment options due to the big number of banks, private equity, and venture capital firms that operate in Hong Kong. Most of these fund providers are familiar with the business environment in China and can offer valuable assistance to foreign enterprises in addition to financing. A major concern of many foreign companies and Chinese exporters is the risk associated with the RMB currency. Many banks in Hong Kong currently offer their customers RMB accounts providing flexibility when making payments to and from China. In fact, the availability of RMB banking is a valuable advantage and makes it easier to negotiate with Chinese customers and business partners. Recent political unrest in Hong Kong, following the enactment of the 2020 Security Law, has naturally raised concerns regarding the special status of Hong Kong and the future of foreign companies operating there. Although this law does not affect businesses and financial activities, the high level of concern the business community has expressed is due to the ambiguity of the law. The law is written vaguely enough that any criticism of the Chinese government or actions that penalize China could potentially violate its terms.

Beneficial Tax Regime

A simple and territorial basis of taxation is operated in Hong Kong whereby tax on profits is imposed only where the transaction has a local source, whereas foreign-sourced income remitted to Hong Kong is not subject to taxation. Therefore, transactions can very well be booked through a Hong Kong company and still not be taxable in Hong Kong. The corporate tax rate is 16.5 percent for transactions originating in Hong Kong, while offshore transactions are not liable to any tax. Salary tax is nothing more than a modified flat tax rate of 15 percent of gross income. In Hong Kong there are no taxes such as capital gain tax, real estate tax, VAT, or sales tax. For instance, dividends received from your China-based company to your Hong Kong corporate account are not taxed in Hong Kong and the remittance to the parent company in your home country is also free of withholding taxes.

Dividends paid by a Chinese company to a Hong Kong entity are liable to a 5 percent withholding tax rate, given that certain conditions are met. Dividends from China to most Western countries are generally subject to a 10 percent dividend withholding tax rate. However, to qualify for reduced tax rates, companies must meet certain requirements set out by the Chinese State Administration of Taxation, in which case the resulting tax rates are among the lowest provided under the Chinese tax system. With 0 percent tax on dividend income and 0 percent withholding tax rate on dividends remitted overseas, Hong Kong is the ideal channel foreign companies can use to repatriate income and profits. The 2006 double taxation agreement between China and Hong Kong, in addition to applying to dividends, reduces the withholding tax rates on royalties and other interests. Moreover, with the right repatriation structures, included in the articles of association of your Chinese company, fees received by your Hong Kong company from your Chinese one are tax free, although there is still a withholding tax of 7 percent, which, again, is less than the 10 percent rate you would have to pay if the shareholder of the China company is not based in Hong Kong.

Hong Kong for International Trading Companies

In this section I discuss the special benefits that Hong Kong offers to international trading companies. In fact, a big number of companies seeking to enter the Chinese market are companies exporting services, goods, and technology to China. Managing and coordinating your international trade business from halfway around the globe can be a costly and particularly laborious process. Differences in currencies, time zones, protocol, and language are only the tip of the iceberg. For many Western companies selling to China, one option is to outsource elements of their international trade by changing the sales location from their home country to Hong Kong which can be achieved through selling directly from the company based in your home country to your Hong Kong subsidiary which then sells to China.

This process works in the following way. First, you establish a Hong Kong limited company, which is a wholly owned subsidiary of the company based in your home country. The Hong Kong subsidiary then buys from the mother company or directly through the company’s suppliers to sell to the Chinese buyer, thus invoicing the sale through Hong Kong. The Hong Kong company pays the cost of goods sold either to the mother company or to the supplier and receives payment from the Chinese buyers. All profits are sent back to the Hong Kong company in the form of management fees, as dividends, or simply by cost of goods sold from the mother company. This way, only a small profit amount is recorded in Hong Kong and there are a number of ways to transfer that profit back to your home country in an easy and tax-efficient manner. It is easy to set up this structure using a Hong Kong-based service provider specializing in this sort of arrangements. An added benefit is that, by outsourcing most international trade functions, you can focus your efforts on the key elements of your customer and vendor relationship, such as production, local distribution, and building your network, while leaving the paperwork aspects of these relationships to your service provider.

Singapore

Singapore is China’s third largest investor. The city-state of Singapore was founded in 1819 as a British colony. After joining the Malaysian federation in 1963, it separated two years later and became an independent state which subsequently became one of the world’s most prosperous economies with powerful international trading links and with per capita GDP equal to that of the leading Western European nations. Strategically located at the center of Asia’s major growing markets of China and India and the emerging Asian economies, Singapore offers tremendous opportunities for business growth to Western companies. The country is an international transportation hub with many air and sea trade routes. It is well supported by an excellent financial infrastructure, political stability, English-speaking skilled workforce, a sound infrastructure, and extensive market connectivity. Singapore is ideally positioned to be the gateway to China for global companies and growing Asian businesses. Using a Singapore holding company structure can translate into substantial tax savings for many Western companies. Hong Kong’s global and regional standing in finance facilitates the coordination of capital requirements for the region. If the particulars of the 2020 Security Law for Hong Kong that China recently passed end up being strict enough, and reactions from the United States and United Kingdom are strong enough that Hong Kong’s standing in the financial markets shrinks significantly, Singapore could become an attractive alternative for regional headquarters. Many aspects of its financial market, from company listings to foreign currency exchange, already rival or surpass Hong Kong. Its political security, efficient infrastructure, quality schools, and other features only add to its attractiveness as a base for regional headquarters. U.S. technology firms in fact already have twice as many regional headquarters in Singapore as in Hong Kong.

For the many years in a row Singapore has been ranked by the World Bank as one of the easiest places to do business in the world. As a leading financial center, Singapore is seeking to become a trading and investment hub for the Chinese Yuan. Many financial analysts regard Singapore as a bridge between Europe, East Asia, and the Middle East. Apart from its key geographical location, Singapore offers the cultural advantages of a multiethnic society where over 70 percent of the population is Chinese. Trade between China and ASEAN (Association of South East Asian Nations) has seen a dramatic growth in the last decade with more and more business being done in Chinese RMB instead of dollars. Recently, the Bank of China and the Industrial and Commercial Bank of China were both given full bank licenses in Singapore and were granted permission to open 25 local branches in the city-state. Singapore has become the first country outside China to host RMB clearing accounts. Foreign investors wishing to establish a business in Singapore can choose from a wide range of business structures. Below I am providing a description of the main Singapore business structures available to foreign investors. Private limited companies are the most popular option for doing business in Singapore.

Over the years, Singapore-based companies with their services, products, and capabilities have built up a strong reputation for reliability and quality in China. The expertise that many Singapore companies possess dovetails with the increasing needs of the evolving Chinese economy for modern business solutions. These factors, coupled with Singapore’s familiarity with the Chinese culture and language, provide a comparative advantage to Singapore companies wanting to enter China. As exports to the recession-stricken West decline and government spending becomes more responsible, China’s focus on boosting domestic consumption and expanding urbanization creates many opportunities. Many Singapore companies whose expertise and strength lie in the service industry will benefit from the gradual liberalization of sectors such as education, health care, and environmental services.

Setting up a company in Singapore is pretty straightforward and fast. It is a very popular option and an alternative to Hong Kong for foreign investors seeking to create an entity before entering the Chinese market. Entrepreneurs starting a business in Singapore can be confident of a fair legal system which protects IPRs. Most foreign entrepreneurs prefer a Singapore LLC to conduct international business although other entity types are also available, such as sole proprietorship, limited liability partnership (LLP), branch company, and RO. The process of establishing a company is done through the Accounting and Regulatory Authority of Singapore (ACRA). The current cost for registering a company with ACRA is S$300.

After the company registration is completed, the company must register for GST (Goods and Sales Tax) in case sales exceed RMB 1million (U.S.$801,540) per year. Singapore levies a 7 percent of GST in lieu of import duties and VAT. On the other hand, company sales to international customers are GST exempt. Investors who establish a company in Singapore have access to a wide range of double taxation treaties. Singapore has signed such agreements with 62 countries, including China, Japan, Germany, France, the United Kingdom, and Canada.

Private Limited Company

In Singapore, the private limited company is commonly known as “PTE Ltd” company. A private limited company offers investors the flexibility to protect their personal assets from the company’s liabilities. There are special tax benefits this particular company structure can benefit from. A PTE Ltd has its own legal identity which is separate from its members: shareholders (who own the company) and directors (who manage the company). Corporation tax is paid by the company on their profits. A PTE Ltd must have less than 50 members. Members have limited liability and are not personally responsible about the losses and debts of the company. This type of structure is subject to tax as a Singapore-based resident entity. The PTE Ltd must appoint a minimum of one director who ordinarily resides in Singapore. This company structure is very similar to the German GmbH.

Branch Office

Foreign companies seeking to set up a place of business or conduct business in Singapore may opt for a branch office. In fact, a Singapore branch is considered an extension of the foreign company and not a distinct legal entity. As a result, it is the mother company of a branch office that is liable for the losses and debts of the branch. The taxation basis for a branch office is the same as that for a resident entity. On the other hand, the branch office is not eligible for incentives and tax exemptions offered to local companies. In addition, the branch must appoint two agents residing permanently in Singapore.

Representative Office

Foreign companies wishing to get a foothold in Singapore may consider to set up an RO as a way to assess the business environment there before deciding to step fully into China or before committing to a more permanent structure. The rules are pretty much the same as in the case of a China-based RO. An RO is not allowed to engage in any commercial or profit-making activities. As such, it is not subject to taxation and, given that it has no legal identity, all liabilities extend to the mother company. A Singapore RO may operate for a maximum period of three years, provided that its status is evaluated and renewed on an annual basis. The RO’s activities are supervised by a chief representative, appointed by the mother company.

Sole Proprietorship

A sole proprietorship is a business carried on by an individual. It is usually a one-person operation without the use of a distinct business form. A sole proprietor is personally liable for all obligations and debts of the business. Profit generated by the business is the income of the sole proprietor who is taxed on an individual basis. A sole proprietorship must appoint at least one Singapore-based manager if he or she resides outside of Singapore.

Partnership

A partnership is defined as the relationship between physical persons carrying on business together with a view to a profit. In Singapore a partnership can legally have up to 20 partners. Such a structure does not have a separate legal status. Therefore, the partners are liable for all obligations and debts of the business. Profits are distributed to the partners who, in turn, are taxed on an individual basis. In case all partners reside outside of Singapore, a Singapore-based manager should be appointed.

Limited Partnership

Another popular business structure is the Limited Partnership or “LP,” a business organization consisting of one or more general partners and one or more limited partners. In an LP a general or limited partner can either be an individual or a corporation. The legal status of an LP is not separate from that of its partners. An LP cannot sue or be sued or even own property in its own name. A general partner is legally responsible for all obligations and debts of the LP, while a limited partner is only liable up to the amount of their agreed contribution. However, while a general partner can take part in the management of the business, a limited partner cannot. As an LP is not liable to tax at an entity level, each partner is taxed on their share of the income they earn from the LP.

Limited Liability Partnership

An LLP is an interesting business structure in the sense that it combines the operational flexibility of a partnership with the limited liability characteristics of a company. It is a corporate body, capable of suing and be sued, with a legal status separate from that of its partners. It can also own property in its name. Every LLP must have a minimum of two partners. As in the case of the LP, an LLP partner can be either an individual or a company. However, partners are not liable for any obligation of the LLC. Partners are only liable for any individual omission or wrongful act without being liable for any omission or wrongful act of any other LLP partner. Each partner is taxed on their own share of the income they receive from the business activities of the LLP.

Hong Kong and Singapore: Tax Similarities and Differences

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