Foreigners’ Business Structure for China Sourcing

This article is a general introduction about sourcing business in China from foreigners’ point of view. Professional advice and tailor-made services about Hong Kong company formation, China RO formation, China corporate entities formation, and tax planning are available in Asia Business Centre.

For businesses in competitive industries with thin profit margins such as sourcing in China, finding the economic route to operate in China is the key to business continuity.

Only Hong Kong limited companies can make China representative offices (ROs) the most affordable solution of China sourcing since the use of either solely China representative offices or joint ventures is no longer economically feasible. Here is our view:

China Representative Offices (RO-only)

Back in 2011, PRC government overhauled its regulation regarding the activities of China’s representative offices, and diminished financial advantages to overseas SME as their presence in China for sourcing and trading. Highlight of changes in rules are as follows:

• ROs are prohibited from conducting profitable activities (i.e. to issue the invoice, and to conduct product or service sales, domestic procurement, and investment).
• ROs are allowed to involve in market research, promotion and marketing activities, and liaison between China’s suppliers and customers with the foreign enterprises.
• ROs are required to provide audited accounting annually.
• The penalty is imposed for the violation.

Together with China’s tax rules amendment in 2010, in which ROs’ tax liability are no longer exempt from Corporate Income Tax (CIT), Value Added Tax (VAT), Business Tax (BT) and tax filing, China has successfully clamped down on the use of RO for quasi-trading purposes.

China corporate body (China-only)

At first, forming joint ventures (JVs) with Chinese partners, or setup of foreigner only corporate body (i.e. FOCE, WFOE) is the right choice. However, when they have to bill clients in China, there is a 25 percent corporate income tax rate, plus a 5.5 percent turnover tax each month based upon the business cash flow. For the foreign investors in JVs, they have to pay an additional 10 percent dividends tax in order to repatriate any profits.

Hong Kong Limited Companies with China RO

To minimize tax liability of foreign investors, Hong Kong limited companies (HK companies) is an essential tool as a middleman, possible setup solution as follows:

1. Incorporate of a Hong Kong limited company
2. Divide its shares among foreigners investors (and Chinese partners, if any)
3. Apply for a China RO using the Hong Kong company

Reasons behind this HK company/China RO:

• China RO holds a place of presence in China for marketing research and point of communication with suppliers.
• The entire sourcing business is out of China’s tax reach since China suppliers bill to the Hong Kong company.
• Although China ROs are subjected to a deemed profit tax rate of 15 percent, this is against the actual overheads and thus the tax liability is controllable.
• Hong Kong’s corporate profit tax rate is 16.5 percent against 25 percent in Mainland China.
• Hong Kong does not impose a dividend tax in Hong Kong, and capital is free to flow in and out to anywhere as against 5 to 10 percent dividend tax in China.
• Change of directorship and shareholding structure of Hong Kong companies can be done by filing the changes to companies registry of Hong Kong; Such changes in China corporate entities involve government approval.
• Hong Kong is a well developed financial hub with proven history and Hong Kong companies is reputable in China as against other offshore financial centers.