China has become adept at spotting and hunting down foreign companies doing business in China without a required Chinese entity. What exactly constitutes doing business in China at a level requiring a Chinese corporate entity ? That is far too complicated to answer in a blog post, but suffice it to say that the Chinese government has a very expansive definition of “doing busness in China” because such a definition increases its tax coffers.
As China accelerates its crackdown on foreign companies doing business in China without a Chinese entity, our China lawyers are seeing a sharp incease in foreign companies setting up companies and paying taxes in Hong Kong, believing that doing so will bring them into compliance with Chinese law. But it doesn’t.
Whenever a client asks whether setting up a company in Hong Kong will solve the problem of their operating in Mainland China without a company, I respond by saying: “Think of Hong Kong as New York or London. Having a Hong Kong company will no more help you get legal in China than setting up a new company in New York or London. When it comes to business law, you should consider Hong Kong as a completely different country than the PRC.”
We most often see the Hong Kong company problem with foreign companies that have Chinese “employees” in China but no company there. This is 100% illegal in China. Yet this is common and it is also common for the Chinese government to catch foreign companies that do this and come down on those companies like a ton of bricks. For a more complete explanation of this, check out my Forbes article, China’s Tax Authorities Want You. The chief reason companies with employees in China want to avoid having a China entity is because China employer taxes and required benefit payments are roughly 40 percent of salaries and if you have can keep your China employees off China’s “tax grid”, you can avoid paying those taxes and benefits.
Often, the “Hong Kong excuse” is generated by a Chinese employee who wants its foreign “employer” to operate illegally in China so the employee’s pay can be higher because there are no employer taxes and no employee income taxes. he or she is not paying income taxes. The Chinese employee convinces its foreign employer that forming a Hong Kong company will be both cheaper and equally effective as forming a PRC company, and usually they insist that it is perfectly legal.
Generally, the Chinese government does not care about its own citizens being paid illegally, but it cares a ton about foreign companies operating illegally. This is borne out by how often foreign companies come to us after being ratted out by their own employee who has either become disgruntled with their foreign employer or who is getting immunity and/or a payoff from the Chinese government.
But it isn’t. Sorry. If you have employees in China or if you are otherwise doing business in China at a level that requires an entity (there’s that vague line again) and you do not have a registered PRC entity, you are at huge risk of legal and a tax problems. For more on the China-Hong Kong distinction on corporate entities, check out How to Form a China WFOE: What’s Hong Kong Got to Do with It?
And since we are discussing how Hong Kong entities do not satisfy PRC entity requirements, I should also remind you that having a trademark in Hong Kong, Taiwan or Macau does not give you any trademark rights in the PRC and vice-versa. Again, you must think of these jurisdictions as being legally separate as that is the case when it comes to trademark rights as well. For more on this, check out China Legal. Not Hong Kong Legal. Not Taiwan Legal. Not Macau Legal.
One last area where we often have to deal with the differences between Hong Kong and China is on contracts relating to manufacturing, such as NNN Agreements and Product Development Agreements. Many Chinese manufacturing companies want their agreements with their foreign customers to be with the manufacturer’s Hong Kong entity, not its China entity. This creates complicated ownership, payment, liability, and jurisdictional and venue issues that must be resolved correctly to prevent a legally nonsensical or invalid agreement or even worse, an agreement that makes perfect legal sense, but provides no protections to the foreign buyer. Again the key issue here is that Hong Kong and the PRC are legally separate when it comes to commercial transactions. See Who Should Sign Your China OEM Agreement?
How many of you were aware of the above and for how many of you is the above a revelation?