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China Company Formation: Meet the New Hong Kong, Same as the Old Hong Kong.

China and Hong Kong legal systems

My roommate my senior year in college was a Who fanatic. And when I say fanatic, I mean fanatic. This guy had lived a few years in London and he had the urban trench coat and the British accent down pat. Most annoyingly, the only beer he would buy was Guiness, which he would not even refrigerate. He did this knowing full well that neither I nor our other roommate would ever touch the stuff. He had about 1000 Who albums, and before you tell me that the Who never made 1000 albums, let me tell you that about 990 of those were bootlegs or “European editions,” or whatever. He had the Who doing just about every song you can think of.

Sorry for the rambling, but I thought of the Who today when a reader sent me a China Daily article, HK attracts record investment in 2008, and asked how much of this might be due to an increase in companies investing in China through Hong Kong. I do not know, but I am sure some of it is.

Ten years ago, if you were going to go into China, you went via Hong Kong. I have no percentages on this, but I am guessing about 90 percent of American and European businesses that formed companies in China did so by first forming a Hong Kong company and then using that company to form their China entity. The other ten percent was made up mostly of British Virgin Island (BVI) companies.

Then, around five years ago, the reasons for forming a Hong Kong company to go into China began disappearing. It had become relatively easy to form a Wholly Foreign Owned Entity (WFOE) in China with a US or EU company as parent and the tax benefits of having a company in Hong Kong were not so great because China’s corporate taxation of WFOEs had become so low. My law firm’s China business lawyers would sometimes have trouble convincing some of our clients NOT to spend the extra time and money to form a Hong Kong company just to go into China even though for more of our clients, Hong Kong was just an administrative and legal expenses.

But now, when clients talk about forming a Hong Kong company first, I listen. And whereas during the last 3-5 years only around 10-20 percent of our clients formed a Hong Kong company to own their China WFOE, in the last six months, it has probably been more like half. China’s corporate tax rate (commonly referred to as its Corporate Income Tax or CIT) is generally 25%, but can be reduced to 15% for qualified enterprises engaged in industries encouraged by the China government (such as high tech companies). Forming a Hong Kong company can, in some instances make sense from a tax perspective.

On top of this, China has now made it marginally easier for Hong Kong companies to register a China WFOE than, say, a U.S.  or EU company seeking to register a WFOE directly. I have absolutely no reason to believe that the likelihood of getting approval for a China WFOE will be any higher by going through Hong Kong, but I do know that a few requirements (such as consularization of certain required documents) have been eased for Hong Kong entities.

Hong Kong is now an issue that needs to be addressed by any foreign company looking to do a China company formation.

What are you seeing out there?

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