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.