Forming a China WFOE: Hong Kong Parent Company is Optional

Forming a China WFOE

I was cc’ed on the following email the other day from one of our China investment  lawyers, responding to a client who wanted to know the “benefits” of forming a Hong Kong company to own its China WFOE, as opposed to its just forming its China WFOE directly in China. I am publishing the email below because it provides a blissfully succinct explanation of the pros and cons of forming a Hong Kong company to own a China WFOE. The key takeaway should be that whether it makes sense to have a Hong Kong entity be the parent of a planned China WFOE truly depends on the individual situation.

There are two basic reasons for establishing a subsidiary in Hong Kong to be the direct parent of a WFOE in China: (1) tax benefits and (2) ease of incorporation.

(1) The tax benefits depend on a number of factors, such as the country where the parent company is incorporated, the tax treaties between that country and Hong Kong (if any), the tax treaties between that country and China (if any), the type of work done by the WFOE, the amount of profit the WFOE is projected to make, the amount of money the WFOE plans to repatriate to the home country, and so forth. Sometimes there are no tax benefits.

(2) Ease of incorporation has to do with Chinese company formation authorities’ substantial (and often nonsensical) documentary requirements. For a variety of reasons, it is almost always easier and faster to submit documentation from a Hong Kong parent company than from anywhere else.

Forming a Hong Kong company also has disadvantages. You will have to pay for incorporating a separate entity, and to maintain that entity you will need to file annual reports, pay taxes, and do all the other things required of Hong Kong corporations. This is all relatively easy and cheap, but it’s an additional layer of complexity. Also, while incorporating a Hong Kong company opening a Hong Kong bank account takes time, a lot of documentary evidence, and an in-person appearance at the bank by at least one representative of the Hong Kong company.

The above discussion presumes the Hong Kong company is a mere shell company with no employees and no operations beyond its ownership of the Chinese WFOE.

Happy to discuss further if you’d like.

4 responses to “Forming a China WFOE: Hong Kong Parent Company is Optional”

  1. I thought it was a WFOE requirement that you can’t just start a China company from nothing? You HAD to have a foreign company that’s expanding into China?

  2. I thought it was a WFOE requirement that you can’t just start a China company from nothing? You HAD to have a foreign company that’s expanding into China?

  3. Dan .. the above is a very good overview – some points missed however relate to 1) The rule of law, and the fact that contractual disputes generally get a better hearing if the company holding the WFOE is from Hong Kong, especially regards trademark and letters of credit disputes.(Hong Kong keeps you at arms-length from China and the weird and wonderful things that can happen there 2) The ability to invoice in RMB through Hong Kong means there is no requirement to relly upon your China partners using USD at an exchange rate they determine (usually with mark-up) 3) The Closer Economic Partnership Agreement (CEPA) opens up far more services and product lines that can be provided in China than if you simply setup in China without a HK holding co.- some business lines are not allowed if don’t use Hong Kong 4) 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 – you can’t do that if it is stand alone

  4. Dan .. the above is a very good overview – some points missed however relate to 1) The rule of law, and the fact that contractual disputes generally get a better hearing if the company holding the WFOE is from Hong Kong, especially regards trademark and letters of credit disputes.(Hong Kong keeps you at arms-length from China and the weird and wonderful things that can happen there 2) The ability to invoice in RMB through Hong Kong means there is no requirement to relly upon your China partners using USD at an exchange rate they determine (usually with mark-up) 3) The Closer Economic Partnership Agreement (CEPA) opens up far more services and product lines that can be provided in China than if you simply setup in China without a HK holding co.- some business lines are not allowed if don’t use Hong Kong 4) 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 – you can’t do that if it is stand alone

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