How to Avoid Tax by setting up a Parent Hong Kong Company
Detailed and Practical Tax Avoidance Case for Foreign Trading Company in Shanghai
By Vincent Cheung
To those who are about to do trading business in China, the major advantage and purpose of setting up a Hong Kong company as the parent company and operating in the subsidiary trading company in mainland is tax avoidance. In Shanghai, there are a few company formation consulting companies that can help you establish a Hong Kong limited company and open Hong Kong bank account without having you fly to Hong Kong. It only takes three weeks and around 100,000 RMB to set up a Hong Kong company. It’s a very popular way for foreign investors to do trading business in Shanghai and avoid tax by setting up a Parent Hong Kong company at the same time. Below is a detailed and practical introduction about tax avoidance by employing formula.
Hong Kong adopts a territorial source principle of taxation. Only profits made in Hong Kong are taxable. Profits generated elsewhere are not subject to taxation. Different countries and areas follow different principles of taxation. For instance, in China, all of the profits, including those made overseas, are taxed by China government. In order to substantially lower the taxation burden, we can take advantage of the difference in taxation systems and policies in different places by using Hong Kong companies to do entrepot Trade. The advantages of doing Import/export trade are as follows:
1) Lower the cost of tax and accelerate the enterprises’ capital accumulation
2) Avoid the loss incurred in the settlement of foreign exchange and lower the risk of exchange.
3) Maintain more control over foreign exchange and make it more convenient to make international payment and receive foreign exchange.
Suppose that your Shanghai company’s clients, mainly hailing from the United States, place a 1 million USD order for apparels. Assume the cost for those clothes is 600,000 USD. Then your Shanghai company might be in two different situations:
1. it’s licensed to import and export, and has a factory, meaning it’s able to both manufacture and sell products totally own its own.
2. It’s not licensed to import and export, so after finishing the purchase in China, it entrusts a trading company with exporting the products.
Under scenario 1, it’s supposed to be an easy bilateral trade. Shanghai company will ship the goods directly to the U.S. after custom declaration, and the American client will make T/T payment upon receiving the goods. In this case, your Shanghai company will generate a profit of 400,000 USD, which is subject to 33% corporate income tax.
It’s considerably high tax even not calculating other taxes levied. Moreover, China still has strong control over foreign exchange, so even though you are licensed to import and export and have a USD bank account, there is still an export limitation to its amount, which means that the part of foreign exchange that exceeds the USD bank account’s limitation will be settled into RMB, and you suffer the loss caused by the settlement of foreign exchange. On the contrary, when remitting for importing goods, the part of dollars that exceed the bank account’s limitation has to be settled. Due to the inward and outward losses, the total loss caused by the settlement of foreign exchange is considerably huge.
Now if you have a Hong Kong company, you can receive your American client’s 1 million USD order in the name of your Hong Kong company. Due to the fact that your Hong Kong company is not a manufacturing entity, it can act as a middleman and purchase Shanghai company’s goods. The purchase contract’s total sum should not exceed the cost of 600,000 USD, or you might be thought to be guilty for dumping. Assume your Hong Kong company sign a 700,000 USD purchase contract with your Shanghai subsidiary company.
Now we can give the logistics and capital things some thought. Your goods will still be dispatched from Shanghai to the U.S directly. Since your Shanghai company is licensed to import and export, you can declare to the custom with that contract. You might want to know whether it’s legal for you to deliver your goods directly to the U.S. since it’s your Hong Kong company that purchases those goods. It’s definitely legal! As long as you make it clear on the contract that the place where your client receive those goods is some port in the U.S. There will be zero problems with custom declaration. It’s just a normal business activity between two companies, so it doesn’t matter at all that you ship your goods directly there. You should declare the products, quantity, value, destination, CO (Certificate of Origin, required by some destination) to the custom.
Not until all of those documents are ready will any shipping companies accept your goods. You Shanghai company will receive a receipt, which is later expressed to the American client. The problem is that, on the bill of documents, the Hong Kong company is the consignee, so you need to endorse the bill of lading and change the consignee to your American client. Your American client will have zero problems with receiving the goods. As to the cash flow, first, your American client will make T/T payment to your Hong Kong company’s account after receiving the goods according to the order with Hong Kong company, and then Hong Kong company will remit the 700,000 USD back to your Shanghai company to do the foreign exchange verification in conformity to the purchase contract signed with your Shanghai company.
After this procedure is properly handled, your Shanghai company’s tax base will reduced to 100,000 USD from 400,000 USD, and the rest 300,000USD profit left in your Hong Kong company is not subject to the Hong Kong tax due to it territorial source principle of taxation. So you tax cost is significantly reduced.
Then how do you use the capital in your Hong Kong account? There are two scenarios:
1. In the event that your account is opened in Hong Kong, you can withdraw the cash freely, cause there is no foreign exchange control in Hong Kong.
2. If your account is an offshore account opened in mainland China, it equals to the bank account opened out of China, the capital in that account can be remitted to companies and individuals in all countries without submitting any governmental approval, custom declaration, verification, invoice or contract. It equals to your personal pocket, foreign exchange can flow freely, and any payments, including the personal commission when collecting the foreign exchange, won’t be intercepted, because foreign accounts are not subject to mainland
China’s foreign exchange control. It’s very convenient for you to make payment or receive money when doing international trade.
Vincent Cheung, www.PathtoChina.com
“Path To China” is an International Business Consulting Firm that provides foreign investors with business registration service in China.
November 9th, 2007 at 1:26 pm
Is there any reason you could not do the exact same thing here, except instead of using the HK company as the middleman, you instead use the American company that owns the WFOE in China that is allowed to import and export?
November 13th, 2007 at 3:45 am
you still get taxed if you use a company from US as a middleman.
November 13th, 2007 at 8:15 am
via a Hongkong, in case the tax avoidance fails, you are only subject to the 17% tax, however, suppose you can use a us company as a vehicle of avoiding tax, in case it doesn’t work out, a much higher tax will be levied against you.
December 6th, 2007 at 11:30 am
I saw the figure for setting up a company in Hong Kong, including a bank account is RMB100,000 but did you mistype that or is that the company capitalization? All of the companies I have set up in HK have cost less than about 7,000 if I have done it myself and about 11,000 if I have employed a corporate secretary.
Are you talking about the cost of the Chinese company too or the licensing?
I am interested in this route for avoiding taxation but want to make sure that I have understood properly. Thanks
December 7th, 2007 at 10:15 am
Hello Cat Rust,
Dear dear lord! It’s a horrible typo, It is 10,000 RMB, instead of 100,000 RMB. I have no clue what I was thinking when writing that. Thanks a lot for telling me that typo, I will write to the editor right away to correct it.
December 10th, 2007 at 4:10 pm
Man I love reading your blog, interesting posts !
January 1st, 2008 at 11:45 am
Hi Vincent,
I am a graduate from VA, USA, and am now a Chinese language student in Beijing for 1 year already. I plan to set up a retail business, importing low-cost apparel from China to the US. Due to the competitiveness of this market, where do you think I should set up the company formation? Your advice would be greatly appreciated. Thank you. P.s. As per the corrected typo, the amount of 10,000RMB is affordable.
January 2nd, 2008 at 10:38 am
hello fellas,
for those who need to get a hold of me, please contact me at vincentisv@gmail.com
June 9th, 2008 at 10:34 am
Hi,
Do you know how to setup a company in Macau, because the tax rate much lower than HK. Thanks
June 10th, 2008 at 5:31 pm
Hello,
Someone told me abnout the low taxation in Macao too. Can I trade from the East with a company in Macao when I am staying in the UK and holding a HK ID Card? How does it work?
October 16th, 2008 at 11:23 am
Hi Vincent,
using a company in Hong Kong for sending goods from mainland China to other parts of the world, is it necessary to have an office in mainland China? Can you send directly from the manufacturer and invoice and sending documents can be under the Honkong Company, so that the manufacturer stays anonym.
Do you have to make any export or taxdeclarations in Hong Kong?
October 18th, 2008 at 10:46 am
It is much complicated to set up a Macau company, it takes longer and the registration/maintenance fees are much higher. I strongly advice against using a Macau company as offshore instrument.
Also, you should understand that the 17% corporate tax in Hong Kong are only levied against profits realized from operations in Hong Kong. If the HK company is just used for invoicing in international transactions, as for the case Vincent has developped here, you are not subject to this corporate tax.
BVI and Seychelles are other options worth considering, and cheaper to operate as well.
October 19th, 2008 at 3:48 am
Hi Vincent,
2 questions :
1. 10 kRMB to set up a company in HK, this is for 1st year, then, for following years, based on your experience, any idea about “Yearly Maintenance fees” ?
2. Is it possible to do same business than you describe but just with a bank account in HK (not company set up in this territory) ?
By the way, can anyone open a bank account in HK or do you need any justification (company located in HK, HK ID,..) ?
Thanks.
October 24th, 2008 at 1:25 pm
Hi all,
My partner and I just established a training & coaching company in Macau. The whole process had its quirks but it was pain free and very much cheaper. We paid a total of MOP 650 for the entire process, including various duties.
I recommend using IPIM’s One Stop Service (http://www.ipim.gov.mo/en/index2.asp). Taxes is definitely cheaper, and I find Macaunese to be business-friendly.
October 29th, 2008 at 4:43 am
The ipim website says a one time setup fee of MOP5,000 is required for registration of an offshore company in Macau, and operating fees of MOP5,000 to 15,000 every six months. Can you elaborate on how you paid a total of MOP650 only for the entire process?
November 4th, 2008 at 5:16 pm
Hi all, be careful with the evolution of the HK/China agreements relative to taxation!!
Profits derived by activities carried out in mainland China are not subject to taxation in Hong Kong. It is true. BUT Mainland China may claim some taxes on them, provided the company performs these activities for more than 6 months in a year…
My CPA told me about it, their contact info is on www.htscpa.com.hk
April 9th, 2009 at 9:16 am
if you want to set up a Macao company, please visit our website: www.macaolegal.com
April 14th, 2009 at 4:47 am
There’s been a lot of focus in the thread on domestic Enterprise Income Tax in the PRC relating to activities conducted in China but whereby the actual booking of revenues may be made through a Hong Kong holding company. This is fine if the residual after tax profits are to be left in China!! However, in most cases that I have worked on, FIE’s don’t want to leave the profits in China but want to repatriate these. Thus, one of the critical points is…if the funds are being repatriated as a dividend to the parent company, which jurisdictions make sense? Using a HK holding company (regardless of where the ultimate parent may be situated), makes a lot of sense as the withholding tax out of China to a HK Holdco is levied at 5% (if the HK company owns more than 25% of the equity in the Chinese operation) as opposed to much rates for many other jurisdictions. Witholding tax rates to traditional offshore jurisdictions such as the BVI and Barbados have increased considerably so this is defintiely something that should be taken into consideration.
Hong Kong itself levies no domestic tax on dividends, nor is there withholding tax for funds flowing out of Hong Kong to another destinations. While in some cases, the repatriated dividend may be taxed when it is sent back to the ultimate parent company - where a Double Tax Avoidance (DTA) Treaty is in place (and I use the Canada/China treaty as an example), a local tax advisor in the parent country can often have the dividends classified as “Flow Through Exempt Surplus” and therefor still covered under the DTA.
Hope this helps - it’s an issue we come across and deal with a lot for SMEs balancing a tax efficient and cost effective structure for engaging with the Chinese market.