Newsletter Nr. 141 (EN)

I. Introduction

 

Hong Kong is one of the few countries in the world which generates a budget surplus every year. The surplus for the 2013/2014 fis­cal year is an estimated EUR 6.5 billion. In recent years, the Hong Kong government has tended to invest a significant part of this surplus into very large infrastructure pro­jects, such as the ex­pansion of the mass transit railway (“MTR”), the express train line to Shenzhen and Guang­zhou and the Hong Kong-Zhuhai-Macau Bridge (due to be completed in 2016). As many local contractors are too small to meet the de­mands of such large projects, an in­creasing num­ber of tenders have been submit­ted, and won, by for­eign companies.

 

This newsletter has been drafted to give an over­view of how a foreign company can con­duct business in Hong Kong, particularly in re­gards to short term projects. This overview will include a review of the relevant labour, com­pany and tax law.

 

Foreign companies can conduct business in Hong Kong as follows:

 

• Set up a Hong Kong company as a sub­sidiary or a sister company of the foreign company.
• Register a permanent establishment of the foreign company in Hong Kong.
• Set up a Joint Venture (“JV”) with a local partner-enterprise. There are two types of JV in Hong Kong:
• Incorporated (or Equity) JV, whereby the JV is registered in the Hong Kong
• Compa­nies Registry and a new corpo­rate body is created.
• Contractual JV, whereby the co-operation be­tween the parties is based on a con­tract without any registration. No new cor­porate body is created and the rights and liabilities of each JV part­ner remain separate.

 

II. Set up of a Hong Kong company

 

1. Set up of a Hong Kong company

The most popular corporate format in Hong Kong is a limited liability company. The setup costs are low and the procedure can be com­pleted quickly. One director and one share­holder are required and both posi­tions can be filled by the same person (natural person or cor­porate body). According to the new Companies Ordinance every limited liability company must have at least one natural person as director. A company secretary is also re­quired. If the company has multiple directors then one of these can also act as the company secretary. However, the company secretary can­not be the same person as the company’s sole director.

 

The company can be registered via a postbox ad­dress, an actual physical office is not neces­sary. There is no minimum capital amount (theo­retical 1 HKD possible, approx. 10 US cent) and there is no duty to pay up the share capital. Consequently, interest will not apply to non paid-up share capital. However, the shareholders are personally liable as debtors of the company for any unpaid amount.

 

The Articles of Associ­ation should be signed by all shareholders and submitted with the registration. Most Hong Kong companies use standard articles. A certification/notariza­tion of the Articles of Associ­ation or of the signa­tures is not required. The full registra­tion process – from delivery of the documents to entry in the registry – takes four to seven work­days. The opening of a local bank account takes approx. seven workdays, if all documents are submit­ted properly.

German readers should note that according to § 138 Abs. 2 Nr. 1 AO the setup of a new com­pany overseas must be reported to the fi­nance authority.

 

2. Liquidation of a Hong Kong company

If a Hong Kong company has completed its pro­ject, it may be wound up and liq­uidated. This procedure is extensive and takes substan­tially longer than the original set up. For exam­ple, the liquidation of a small company usually takes 6 months. Liqui­dation is initiated by a share­holders’ resolution. The Board of Direc­tors is then recalled and a liquidator is ap­pointed. The liquidator has all the powers and rights necessary to conduct the whole business of the com­pany, including clearing and collecting debts.

 

The next step is for the liquidator to submit a closing balance sheet to the Companies Regis­try and the Inland Revenue Department and to pay all outstanding tax debts. All the compa­ny’s other debts are then paid and any re­maining capi­tal is distributed to the sharehold­ers. The liq­uidator reports the ending of the liquidation to the Companies Registry and the company will be deleted from the Com­panies Registry within 3 months.

 

3. Tax law treatment

A Hong Kong company’s tax liability is based on Section 12 (1) Chapter 112 In­land Revenue Ordinance.

 

„(1) …profits tax shall be charged for each year of as­sessment at the standard rate on every person carrying on a trade, profession or business in Hong Kong in re­spect of his assessable profits arising in or derived from Hong Kong for that year from such trade, profession or business …”

 

For profits realised by commercial activities a “Profits Tax” is levied. According to the terri­to­rial principle, profits are only taxable when they are generated in Hong Kong (On Shore Profit). Profits are deemed to be gener­ated in Hong Kong when the following 3 re­quirements are fulfilled:

 

• The tax payer undertakes business in Hong Kong.
• The profits arise from this business.
• The profits are generated in Hong Kong.

 

Assuming that the foreign company joins a Hong Kong project, then all profits resulting from this project are taxable in Hong Kong. However, if the profits are distributed to the European par­ent company, then they may be tax free in the foreign country too (e.g. Ger­many: non-de­duc­tibility of operating costs ac­cord­ing to § 8b Abs. 5 KStG). The standard “Profits Tax” rate is 16.5%.

 

A Hong Kong company is legally obligated to keep books and to submit an annual bal­ance sheet which is confirmed by a certi­fied audi­tor. Hong Kong has a number of service com­pa­nies (including the “Big Four”) that will keep these books on the company’s behalf in ex­change for a reasonable fee.

 

4. Summary

A Hong Kong company is a corporation entity which is simi­lar to a German GmbH. It is a tax subject. A double taxation problem will not arise so long as the Hong Kong company does not have a registered office in Germany.

 

III. Set up of Joint Ventures

 

As noted above, business activities can be con­ducted in Hong Kong in co-operation with other compa­nies via a JV.

 

1. Incorporated JV

An Incorporated JV (or Equity JV) is where at least two partners agree to set up a new corpo­ra­tion entity, the Joint Venture. Issues such as owner­ship structure, profit and loss shar­ing, rights to vote and occupation of the po­sitions etc can be negotiated freely between the part­ners/shareholders and then confirmed in writ­ing via a Sharehold­er or Joint Venture Agree­ment.

 

Once the JV has been registered in the Compa­nies Registry and at the Inland Revenue De­part­ment, it is a legally accepted Hong Kong company and it is treated the same as any other company. The com­pany and the shareholders are subject to Hong Kong law.

 

All the JV partners will have limited liability like any other shareholder so long as their capi­tal has been fully paid up. Profits generated by the JV can be distributed to JV partners as divi­dends. The partners are free to determine the profit participation in the Articles of As­so­ci­ation. Usually, but not always, the profit participation will reflect partners’ share ratio. The same applies to voting rights; thus the JV partner who invests the most can control who is appointed as a director etc and how key de­ci­sions are made.

 

2. Contractual JV

A Contractual JV is where the JV partners en­ter a contract to cooperate with one another for a stated purpose. No new company is es­tab­lished. For example, Partner 1 promises to produce cement, Partner 2 promises to use the ce­ment for the agreed purpose of building a new bridge. As no new corporation entity has been created, the parties under a contractual JV are directly responsible and liable for the debts and other liabilities of the JV. In Germany such JVs are called “Ar­beitsgemeinschaft” or ARGE. Normally ARGEs are used for mega projects like tunnels or road works.

 

In Hong Kong Contractual JVs must be regis­tered with the Compa­nies Registry. A contact ad­dress and person within Hong Kong must also be determined. As many local agency compa­nies provide their address and a contact per­son for a small payment, this requirement is not a real problem. Each partner to a Contrac­tual JV is individually liable for their own tax if the pro­ject generates profits that are taxable ac­cord­ing to Hong Kong tax regulations. Conse­quently, JV partners (for exam­ple a German GmbH) have to sub­mit a tax declaration and pay Profit Tax (if applicable) in Hong Kong. In Germany the tax which has been paid in Hong Kong can be credited against the partner’s Ger­man tax liability under § 26 Abs. 1, 2 KStG and § 34c EStG. However, investors should con­sider if it would be advantageous to cre­ate a JV with a company from Austria, Luxem­bourg or Switzerland rather than from Germany since such coun­tries have full double taxation agreements with Hong Kong (Germany may have one in 2015).

 

IV. Permanent Establishment

 

It is also possible for a foreign enterprise to conduct business in Hong Kong via a branch rather than a new le­gal entity, since the branch is regarded as part of the mother company.

 

1. Registration

At the start of operations (i.e. immediately after or before starting work) the company has to reg­ister the branch with the Companies Regis­try. The foreign address of the parent company and the Hong Kong address of the branch must be an­nounced and a representa­tive of the compa­ny in Hong Kong must be named. Further, all di­rectors and sharehold­ers must be announced and an excerpt from the (German) commercial register must be obtained as proof of its valid existence. Moreover the company’s (German) Articles of Associ­ation (trans­lated) must be submitted to the Company Registry. As all the aforementioned (German) documents must be translated, the whole registration process can take several weeks, i.e. much longer than the set up process.

 

Finally, it should be noted that since branches are not corporation entities, they cannot be held di­rectly liable for their actions and debts (like a Ltd. or GmbH). Instead the parent com­pany will be held liable.

 

2. Tax law treatment

The branch should be registered with the In­land Reve­nue Department and must submit an au­dited balance sheet annually within 4 months af­ter the tax assessment period has expired, even if the Inland Revenue De­partment does not explicitly request such a submission.

 

3. Problem of the double taxation

Expenses of the branch can be partly deducted as expenses of the parent company. However, the distinction is far from clear, and might cause more work than it brings benefits.

 

A branch in Hong Kong is tax liable. This cre­ates problems, since profits must be ascertained sepa­rately for each branch. As an exact distinc­tion is not possible, it has to be estimated which costs and income are apportioned by the branch and which are appropriated by the par­ent com­pany. This bears the inherent risk of double taxa­tion as the Hong Kong Inland Rev­enue De­partment and the foreign tax authori­ties are not bound by each other’s judgments. Tax au­thorities on each side can decide freely on how much tax should be paid even if con­tradictions and double taxation are the result.

 

Therefore in order to avoid double taxation it is usually better to set up a company rather than a branch in Hong Kong. The company is then an independent tax subject and conse­quently is not liable for tax abroad. Consider­ing Hong Kong’s relatively low tax rate, a tax sav­ing of up to 30% is possible.

 

V. Labour law

 

Every foreigner working in Hong Kong needs an Employ­ment Visa from the first working day, no matter how long the working period and how much the remunera­tion is. The Employ­ment Visa application is usually submitted by the em­ployer (the “spon­sor”) who must be ei­ther a Hong Kong com­pany or a natural per­son registered in Hong Kong. Thus both a Hong Kong subsidi­ary company and a branch can act as a sponsor. Cer­tain employee docu­ments (curriculum vitae, certificates and proof of spe­cial skills) must be submitted along with an ex­cerpt from the Com­panies Registry, bal­ance sheet, business plan etc. All documents which are not in the Chi­nese or English lan­guage need be translated. If at the time of ap­plication the employer has not yet established a com­pany or a branch then a Hong Kong busi­ness part­ner can submit the visa application and act as the sponsor. How­ever, for time and cost rea­sons many local part­ners are unwilling to pro­vide such assistance. Therefore, investors are ad­vised to clarify in ad­vance who must ap­ply for such visas and who must bear the costs.

 

Once all the documents are submitted, the visa will be issued within 4 to 6 weeks. Most visas are valid for one year, although longer and shorter periods are possible

 

VI. Miscellaneous

 

1. Import and export

Hong Kong is a free harbour and on the whole does not levy any customs tariffs on imports and exports. Only 4 types of commodities are dutiable: Liq­uor, Tobacco, Hydrocarbon Oil and Methyl Alcohol.

 

An import/export declaration will be required for the transported goods and wares. The dec­lara­tion procedure is straight forward and just involves stating the type of goods (listed in cat­e­gories). The declaration costs amount to sim­ply 0.5% of the goods’ value.

 

2. Retention of title

In theory, Hong Kong allows for retention of title clauses to be included in commercial con­tracts. However in practice such clauses are not popular because of the common law tradition that the seller’s right to payment does not out­rank the purchaser’s right to the property.

 

Under retention of title clauses if a purchaser is unable to pay the amount owed (i.e. they are in­solvent) the seller will be en­titled to repossess the goods to the exclu­sion of other creditors. However, under the law, where the sale is for spe­cific goods which are already in a “deliver­able state” the property in the goods passes to the buyer when the contract is made, unless a different intention appears (Section 20 Rule 1 Sale of Goods Ordinance, Chapter 26). For the sale of specific goods where the seller must do something to the goods to put them into a de­liv­erable state, the property passes to the buyer when such task is completed (Sec­tion 20 Rule 2 – Rule 3, Sale of Goods Ordi­nance). Thus, ac­cording to the above mentioned rules, the prop­erty passes regardless of whether total pay­ment has been made or not.

 

However, under Section 21 Sale of Goods Or­di­nance where the contract has a retention of title clause it can be considered that the prop­erty passes only upon a specific condition be­ing fulfilled (i.e. payment). The condition must be formu­lated precisely. Further, the condi­tion must be agreed and intended by both parties. Re­tention of title clauses for produced or man­u­factured goods or “all liabilities” clauses are also possible. Such clauses must be formu­lated exactly and spe­cifically, as any inaccu­racy will be decided in favour of the pur­chaser. In most cases this means that the clause will be invalid, thus the seller will lose the prop­erty in the goods even if there is no pay­ment received from the buyer.

 

VII. Conclusion

 

A company which wishes to conduct short term business activities in Hong Kong can ei­ther set up a new legal entity (Co. Ltd. or JV) or establishment branch office. In most cas­es the foundation of a Hong Kong com­pany will be preferable as only this format can be used to avoid double taxation.

 

However, which business model is the best op­tion will ultimately depend on the cir­cum­stances of each case. There is no general rec­om­mendation. A complete analy­sis regard­ing company and tax law is always required which includes a consideration of the interests of the parent company.