Utilising Hong Kong For International Trade
Contributed by TBA & Associates
10 December, 2019
Despite being only 1104 square kilometers in size, Hong Kong is one of the world's major financial centers, is consistently ranked as one of the busiest ports on the globe, and, in the Index of Economic Freedom Survey issued by the Heritage Foundation, it was cited as the world's freest economy – for the fourteenth successive year!
Hong Kong has long been considered the "Gateway to China" and it has worn this badge proudly. Not surprisingly, it is one of the largest investors into China, and the most commonly used location for foreign companies to base their international trading operations – whether it be sourcing products from China to sell into overseas markets, creating joint ventures with local Hong Kong or Chinese companies, or setting up Wholly Foreign Owned Enterprises in China to sell products and services locally – in one of the world's largest and fastest growing economies.
Now a special administrative region of China, Hong Kong has a very deep-rooted competitive business doctrine demanding low taxation. The current rate of corporate income tax is just 16.5% and this is only applied on a territorial basis thus earnings outside Hong Kong are not taxed and there is no imposition of capital gains taxation.
Hong Kong is now firmly a service-based economy, which accounts for over 90% of it's GDP. Its economy is open, has a strong and sophisticated banking system, mature and stable legal system, is market driven and designed as a base for foreign business to launch their international operations.
Base for International Trade
The Hong Kong Limited Company has become a popular vehicle within the field of international trade, with currently over 950,500 Hong Kong companies registered in the city.
The basic concept central to most trading structures set up by foreign companies using a Hong Kong trading entity is that of outsourcing their back-office functions, while retaining full control of their international trading business. This can best be explained by example, as shown below.
Many importers from North American, European, and Pacific Rim countries have been buying products from China, India, and many other Asian countries over several years, to sell to their home markets – typically to large retail chains, or through their own stores.
As their businesses grow and develop, most of these importers look for an effective way to manage this process while giving them an international presence, often enable their larger customers to buy FOB from an Asian port and expand their sales into new markets around the globe. These importers typically set up a structure like the one illustrated below.
The importer now has a truly international business with a local presence in Hong Kong, they retain control of their expanding business and its costs (with the trade services outsourced to TBA), and the profits are retained in their Hong Kong company – usually tax free under Hong Kong's territorial tax system.
With this structure set up and maintained by TBA, importers get a Hong Kong virtual office (prestigious office address in Central with mail forwarding, telephone, fax and email), full trade services (including PO's, LC processing, banking, shipping documentation, liaison with freight forwarders), preparation of management accounts and audited profits tax returns, preparation of contracts, employment related matters and trade financing. TBA can also assist by setting up Representative Offices in China so that the importer can have their own staff on the ground to work with their suppliers typically on quality control and shipments.
In recent years, foreign trading companies have been increasingly establishing their own manufacturing facilities in China and other Asian countries, to ensure that they have full control of their supply chain and enable them to sell into local Asian markets (particularly China).
In China, many manufacturing plants set up by foreign companies have been established through Joint Venture arrangements, or direct investment (through the establishment of a Wholly Foreign Owned Enterprise or WFOE) usually in conjunction with a local advisor. While the opportunity for such trading companies can be substantial, the associated benefits are also significant.
The process outlined for the importer in the first example above, becomes the building block for the manufacturer. In addition, TBA's consolidated approach through its Hong Kong and China offices, enables the manufacturer to set up the right structure the right way - effectively identifying and controlling many of the risks from the outset.
The manufacturer may have a structure similar to this:
As was the case with the importer, TBA can set up and maintain this structure for the manufacturer. The manufacturer gets a Hong Kong company, a WFOE in China, Hong Kong virtual office (prestigious office address in Central with mail forwarding, telephone, fax and email), full trade services (including PO's, LC processing, banking, shipping documentation, liaison with freight forwarders), preparation of management accounts and audited profits tax returns, preparation of contracts, employment related matters and trade financing.
TBA can also assist other back office functions relating to quality control and shipments.
Hong Kong Taxation
Hong Kong is one of the few countries in the world that tax on a territorial basis. Many countries levy tax on a different basis, and they tax the world-wide profits of a business, including profits derived from an offshore source. Hong Kong profits tax is ONLY charged on profits derived from a trade, profession or business carried on in Hong Kong. Consequently, this means that a company which carries on a business in Hong Kong, but derives profits from another place, is not required to pay tax in Hong Kong on those profits. Hong Kong sourced income is currently subject to a rate of taxation of 16.5%. There is no tax in Hong Kong on capital gains, dividends and interest earned.
The principle of Hong Kong profits tax is that it is a tax on profits that has its source in Hong Kong rather than a tax based on residence. Income sourced elsewhere, even remitted to Hong Kong, is not subject to Hong Kong profits tax at all. Consequently, if a Hong Kong company's trading or business activities are based outside Hong Kong no taxation will be levied.
A factor that determines the locality of profits from trading in goods and commodities is generally the place where the contracts for purchase and sale are affected. 'Effected' does not only mean that the contracts are legally executed. It also covers the negotiation, conclusion and execution of the terms of the contracts.
If a business earns commission by securing buyers for products or by securing suppliers of products required by customers, the activity which gives rise to the commission income is the arrangement of the business to be transacted between the principals. The source of the income is the place where the activities of the commission agent are performed. If such activities are performed through an office in Hong Kong, the income has a source in Hong Kong.
Certain sums, like royalties, paid or payable to non-resident persons for use of or right to use certain intellectual property are subject to withholding tax. The payer who claims deduction for the use of the intellectual property against its assessable income is required to withhold a prescribed percentage from the payment while that recipient is not subject to Hong Kong profits tax. The prescribed percentage is 4.95% on
the gross payment if the payer and the recipient are not related, but 16.5% if the payer and recipient are related. The recipients of the royalties may enjoy different treaty rates under double taxation agreements.
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