Question: While I was exploring setting up my own factory in China, I noticed most investors first set up a HK holding company which then owns the China based entity. Why don’t the foreign investors directly own the PRC based factory, sourcing office, sales office, warehouse or trading company?
Based on interviews with other international businesspeople who own companies in China, I can offer 4 major justifications for setting up a HK company to own a PRC company.
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.
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. 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.
Advanced sourcing skills: WFOE’s and other options for a China presence
(If you are interested in setting up operations in China and need formal support and advice, you can find the list of business formation agents, lawyers, tax advisors and accounting services used by the author at this link.)
Wishing you successful China sourcing!
About the author: Mike Bellamy
Advisory Board Member & Featured Blogger at the not-for-profit China Sourcing Information Center (www.ChinaSourcingInfo.org). Author of “The Essential Reference Guide to China Sourcing” and founder of PassageMaker Sourcing Solutions.