MEMORANDUM
TO:FROM: / Corporate Team, Blank Rome Solicitors, Hong Kong
DATE:
RE: / Proposal of Conducting Business in China via Hong Kong
C/M NO.:
I. Background
The Company’s current operations are as follows:
· It is a designer and wholesaler of fashion jewellery in the United States and has been doing business in China for over 15 years.
· It has all of its products manufactured and completed in China. The majority of the factories are Korean owned and settlement of invoices for the most part are wired to Korea and Hong Kong.
· Currently, the Company employs four employees, including one manager, in Qingdao, China. Their duties include monitoring factories, checking developments, inspecting samples and production. The Company has provided the employees with its email addresses for business and they report back to the New York office every day. It makes monthly payments to the manager (personally) via wire transfer who then pays the other employees in China.
· One of the employees just resigned and another one is going on maternity leave. The expectant employee has asked about insurance coverage.
· The China office space is leased in the name of the manager. The Company reimburses the manager for the rent, office equipment, travel and miscellaneous expenses on a monthly basis.
· The Company sends samples to the factories and to the China office. However, the Company is now having trouble clearing customs for the samples sent to the China office because it is not a registered Company in China.
· Over the years, its business has increased substantially and is expected to continue to grow. Thus, the Company is planning to expand its operation in China and to employ a total of 7-10 people next year.
II. Legal Issues
Based on our understanding of the Company and information provided to us above, these are the issues to be considered:
1. Legal Entity.
· Generally, a foreign company cannot engage in business operation in China without setting up an legal entity. A foreign company may either set up a Representative Office (“Rep Office”) or a Wholly Owned Foreign Enterprise (“WFOE”) in order to conduct business in China.
2. Employment.
· In China, labour relationship must be created through labour contract, which needs to be registered with the local labour bureau.
· Normally, all hiring of Chinese nationals for a Rep Office must be done indirectly through contracting with a Chinese employment agency. On the other hand, a WFOE can hire employees directly.
3. Wire Payments to the Manager.
· Currently, the Company wires all the payments to the manager for distribution and it has the risk of bear all loses and liabilities. The Company may consider setting up a bank account in Hong Kong in order to have control of the money and transfers into and out of the account.
· However, the Company must have a legal entity set up before it is able to set up an account.
4. Maternity insurance.
· Under China’s Social Security Policy, the maternity insurance system mainly covers urban enterprises and their employees.
· Generally, the premiums are paid by the employers participating in the maternity insurance scheme, and should not be more than one percent of the total wage bill. Individual employees do not pay the premiums.
· Employers have not participated in the scheme will still be responsible for providing maternity insurance benefits.
· Employees who have given birth may enjoy a childbirth allowance for 90 days.
· Women employees who have given birth or had abortions shall maintain their original wages and positions, and get reimbursements for their medical expenses according to related regulations.
5. Tenancy agreement.
· The Company’s current China office is leased in the name of the manager. This bears the risk for the Company that in the case of, for example, there is a falling out with the manager, the Company may be no longer entitled to the lease. The lease should be in the name of the Company once it has established a legal entity in China.
To better advise and assist the Company with its business operations in China it would be helpful if the Company can provide us with the following:
- The Company’s Operation in China
· Has the current China office ever registered with any local agencies/governmental bureaus?
· How are the current agreements entered into with the factories?
· How are sales conducted through the China office?
· How are the sales invoices issued?
- Employments
· Has the Company entered to any agreements with the Chinese employees?
· Besides their salaries, what are other compensation, if any, that these employees receive?
III. Corporate Structures in China for Foreign Investment
China’s foreign investment regime recognises several types of companies that can be set up by foreign investors. After initial thoughts and based on the information provided, two types of investment vehicles that could be applicable to the Company as shown below.
(3) or (4)
United States
*
Hong Kong
(2) or (1) Mainland China
(1) Representative Office
A Rep Office itself is not a company and therefore not a separate legal entity. Moreover, a Rep Office is prohibited to engage in any direct business activities. It can only represent its head company in sales liaison activities, promotion of goods and services, market surveys and research, and technological exchange within the scope of business of the head office. Furthermore, as mentioned above, a rep office cannot directly hire its Chinese nationals but must be hired through a government-designated labor service company. Thus, it may not be the best option for the Company to operate business in China.
(2) Wholly Foreign Owned Enterprise (“WFOE”)
WFOE is a limited liability company with 100% foreign ownership. An investor’s liability is limited to its share of the registered capital (equity) of the WFOE. Unlike other types of entities, such as joint venture, the investor will have 100% management control, which can avoid culture conflicts of management.
WFOE has many advantages in comparison with a Rep Office:
· It is a legal entity in China
· It is able to hire local staff directly
· It is able to enter into contracts in its own name
A WFOE can generally engage only in activities that are within its business scope. The establishment of a WFOE is subject to governmental approval. It is also subject of the regulations set out in the Foreign Investment Industrial Guidance Catalogue (Amended in 2007, “Catalogue”) as well as various industry-specific regulations.
Generally the jewellery industry is permitted under the Catalogue. Based on the information provided, the Company should be able to manufacture jewellery in China, as long as no ivory carving, processing of tiger bones, production of “bodiless lacquerware” (as defined in the Catalogue) and production of enamelware are involved.
*Intermediate Hong Kong Holding Company
There are many benefits of setting up a Hong Kong holding company. In particular, if the Company wants to divest its interest in China, it can be more straightforward to keep a transaction offshore (i.e. outside of China) due to the barriers created by the regulations and approvals in China. Dealing with the Hong Kong holding company would also significantly increase the flexibility for the Company in restructuring.
Below are some of the benefits of Hong Kong holding companies.
1. English legal system. Hong Kong’s corporate law is still based on the English common law, affording stable legal system.
2. Easy to set up. Setting up a Hong Kong company is well regulated and very quick and simple. With all required documents, it normally takes 7-10 days to set up a Hong Kong company. The minimum issued share capital is only HK$1. It requires only one shareholder and one director and can be 100% foreign owned.
3. Easy corporate restructuring. China’s regulations and company laws are being refined and changed all the time and are not simple to handle. Direct investing in China involves a long term commitment to play by the local rules in China. A Hong Kong company enjoys the ease and freedom of selling and reallocating shares to other parties. It does not need to confront with Chinese laws and requires approval from the Chinese government, which at times, have proven not so supportive and responsive. For example, transfer of interest in Shanghai may take more than 2 months while it only takes 1 week in Hong Kong.
4. Financial Centre. Hong Kong is a well established financial centre with most of the major players in the financial and legal practitioners being represented. Furthermore, as a financial centre, Hong Kong has a stable and efficient banking system coupled with a robust regulatory system, an effective and clean government as well as efficient accounting services.
5. No storage costs and less financial risk. The option of selling goods “Free On Board” from China has become a huge success factor for foreign companies to set up Hong Kong company. By opening a letter of credit to the Hong Kong company which is then passed on to the China supplier, the danger of non-payment by the customer can be easily eliminated.
6. Lower risk of suppliers being disclosed. To channel the business through a Hong Kong Company lowers the risk of Chinese suppliers being disclosed to customers overseas. When the final goods are shipped, all documents, labels, addresses and other hints are rewritten in Hong Kong so that customers as well as suppliers only know the Hong Kong Company, but not each other.
7. Low tax jurisdiction. The current profit tax rate stands at 16.5% in Hong Kong compared to approximately 25% in China. Hong Kong has no capital gains tax, tax on share capital, tax on dividends, tax on interest from financial institutions, value added tax (VAT) and estate duty. Additionally Hong Kong has signed a Double Tax Agreement (“DTA”) with China (1998, second protocol 2006) to prevent double taxation on income of a company that is incorporated in Hong Kong.
8. No currency control. There is no restriction on capital transfer in/out of Hong Kong.
9. Flexibility in managing exchange risks through Renminbi deposits. Hong Kong is covered by the Renminbi trade settlement pilot scheme which allows companies to deposit RMB at participating Banks in Hong Kong. This provides companies with the possibility to deposit their RMB income in a save and stable financial environment without being exposed to the risk of currency fluctuations. Hence, a Hong Kong company can transact businesses in Renminbi with little or no restrictions.
IV. Proposal for the Company to Incorporate in Hong Kong
Given the flexibility of legal system in Hong Kong, the Company may consider to establish a Hong Kong company as follows:
(3) The Company becomes the parent company, holding 100% shares of the Hong Kong company. The Hong Kong company becomes a wholly owned subsidiary and can be hived off through a merger and acquisition transaction. Since the Hong Kong holding company is not governed by the laws in Mainland China, it is a straightforward matter for the Company to divest its interest by selling its shares in the Hong Kong company without any requirements of Chinese government approval.
(4) X and/or Y and/or the Company may all be the shareholders of the Hong Kong company. No Chinese government approval is required when a shareholder wants to sell his/her/its shares in the Hong Kong company. Please note that there may be reporting requirements.
After the set up a company in Hong Kong, the Hong Kong company can then establish a WFOE in China to carry-out the Company’s manufacturing business there.
Our Hong Kong office can gladly assist in setting up a Hong Kong company, and our Shanghai office can offer further assistance of setting up a WFOE in China. If you have any further questions, please feel free to contact us.
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