The Benefits For Russian Companies When Setting Up In Hong Kong To Access Mainland China Opportunities
Russia-Chinese investment on the increase. Hong Kong offers low tax access.
Many companies looking at the Chinese market choose to establish a holding company or special purpose vehicle (SPV) to hold their Chinese investments, and this applies to an increasing number of investors from Russia and the Eurasian Economic Union. Using a Hong Kong company typically provides flexibility and an added layer of protection to their corporate structure.
Foreign investors have commonly chosen Hong Kong to set up a holding company or SPV, and this is becoming the vehicle of choice for Russian investors. Russian investment into Hong Kong increased by 53% in 2017 as a result of the recent Russia-Hong Kong Double Tax Treaty, which provides tax relief for Russian businesses trading with Hong Kong, and that trend continues.
There are many other reasons for this – Hong Kong is in close proximity to mainland China, it remains a key financial hub in close proximity to mainland China, it remains a key financial hub in Asia, and has a transparent legal and highly developed financial system with a well developed business rule of law, based upon the British system.
To add to these, Hong Kong continues to be one of the easiest places to do business, ranking fourth of 190 economies in 2019, much higher than mainland China, which is ranked at number 48. However, recently there have been heightening concerns about Hong Kong’s business environment becoming more regulated.
Marcos Salgado, Assistant Manager of Dezan Shira & Associates Business Advisory Services in Hong Kong, explains the situation from on the ground, “while there have been some recent concerns surrounding the tightening of Hong Kong’s anti-money laundering regulations and know your customer (KYC) requirements, these changes offer foreign investors greater legal certainty by enhancing the rule of law and safeguarding the integrity and stability of the financial system.”Salgado adds, “in addition, Hong Kong has implemented a two-tier profits tax system to encourage investment from SMEs.” Therefore, the reality is, that though the business environment is getting more challenging for foreign investors, Hong Kong still holds many key advantages for businesses, stemming from its free economy, low tax rates, and its simple and transparent regulatory environment.
Here we highlight four key benefits for Russian businesses to setting up a holding company in Hong Kong.
Why set up a holding company in Hong Kong?
1) Corporate structure benefits
A holding company in Hong Kong adds to the robustness of a group’s legal entity holding structure in many ways, as it is a reliable base from which to invest in China. Having a Hong Kong entity in the group structure provides investors with some flexibility in terms of selling their China investments, which is of use to funds or short term investors looking to cash out.
Paul Dwyer, Head of International Tax and Transfer Pricing at Dezan Shira & Associates provides an example to illustrate this, “Take for example a common holding structure which consists of a Moscow HQ wholly owning a Hong Kong incorporated company, which in turn wholly owns a PRC wholly foreign owned entity (WFOE).”
“The PRC WFOE can be sold directly by way of the Hong Kong entity selling its shares in the WFOE. Alternatively, the Moscow HQ can indirectly sell the WFOE by way of disposing its shares in the Hong Kong entity,” Dwyer explains.
2) Preferential tax regime
Hong Kong has a preferential tax regime and adopts a territorial basis of taxation.
Profits tax is payable by every person (defined to include corporation, partnership, and sole proprietorship) carrying on a trade, profession, or business in Hong Kong on profits arising in or derived from Hong Kong from that trade, profession, or business. In other words, profits which do not have a Hong Kong source are not subject to profits tax.
Hong Kong’s profits tax rate is very low. Incorporated entities are subject to profits tax on two-tiered system.
The first HKD 2,000,000 (Rs.16.5 million) of profits are subject to profits tax at 8.25 percent with the remainder subject to profits tax at 16.5 percent. This is quite low when compared with China’s corporate income tax rate (CIT) of 25 percent. Capital gains and receipts that are capital in nature are also not subject to tax.
Hong Kong has a very expansive tax treaty network and does not impose withholding taxes on payments of dividends and interest.
China has concluded a double tax agreement (DTA) with Hong Kong. The treaty provides, subject to meeting certain conditions, for a preferential rate of withholding tax on dividends of five percent.
If the necessary conditions are satisfied, this can be of great benefit as profits can be repatriated back to the Russian HQ or to Hong Kong efficiently, minimizing withholding tax leakage.
3) Cash pooling
If an investor wants to re-allocate profits from the foreign-invested enterprise (FIE), a holding company offers a solution to do so, which bypasses the need to remitting it to the parent company.
Funds can be pooled in the offshore holding company, where tax on the transaction is often lower, and re-invested elsewhere.
Hong Kong is one the largest offshore RMB clearing centers. This means the two territories are the best equipped to handle RMB-denominated banking, including receiving dividends and other fees from China-based entities. It also enables the holding company to assume cash pooling functions.
Ensuring your holding company is compliant
In light of the Organisation for Economic Cooperation and Development’s (OECD) base erosion and profit shifting (BEPS) program, tax authorities across the world are cracking down on the practice of companies entering into transactions lacking in sufficient business substance and which are performed primarily to obtain a tax benefit/advantage.
For example, China, has strict anti-avoidance rules concerning the indirect transfers of PRC taxable assets.
Dwyer explains, “it is important to be mindful of these to not run afoul of these laws. In many cases, even when the indirect transfer is done for valid commercial reasons. “Now China does have strict rules dealing with the latter case where an indirect sale of ‘PRC taxable assets’ are made. It is important to be aware of these and we have discussed these further below.”
“These laws, coupled with the tax authorities’ increased focus and scrutiny on related party transactions, means that companies need to think carefully before performing these transactions; it is important to show justifiable commercial reasons and that the transactions are legitimate,” Dwyer adds.
4) Hong Kong has a double tax treaty with Russia
Signed at the beginning of 2016, the CDTA aims to provide greater certainty on taxing rights between Hong Kong and Russia, incentivizes foreign investment with reduced income tax and withholding tax rates, and helps investors to better assess their potential tax liabilities on business transactions.
Before the CDTA came into effect, companies operating in Hong Kong but listed in Russia were subject to income tax in both jurisdictions. In some cases, the taxation of repatriated profits of a Hong Kong company based in Russia would be determined by the tax bureau individually, depending on the source of the income.
For either case, tax credits can now be used to relieve double taxation under the provisions of the treaty. The residence jurisdiction, either Hong Kong or Russia, is required to grant a tax credit for tax payable accrued in its counterpart. According to Article 2, Paragraph 3, the following tax categories are qualified for double tax avoidance:
(1) in Hong Kong:
- profits tax;
- salaries tax;
- property tax; whether or not charged under personal assessment;
(2) in Russia:
- the tax on profits of organizations;
- the tax on income of individuals.
Under the agreement, the dividend withholding in Russia for qualified Hong Kong companies is now taxed at a lower five percent or ten percent than non-treaty companies, according to the shareholding of the dividend beneficiary. The agreement also provides a zero percent Russian withholding tax on interest and a cap of three percent in Russian withholding tax on royalties. Together, these provisions account for a cutback of 17 percent from the non-treaty tax rate. A detailed comparison of Russia’s withholding tax rates on Hong Kong residents before and after the agreement is shown below:
Hong Kong – China – Russia Benefits
Even though Beijing has eased regulations for businesses in recent years, Hong Kong still acts as a critical link between Russian and Mainland markets for both inbound and outbound investment. Governed by the “One Country, Two Systems” framework, Hong Kong enjoys a close political and economic connection with the Mainland while benefiting from well-developed legal and financial systems that favor foreign investment. Based on the current tax regime between Hong Kong and Beijing, companies operating in the Special Administrative Region benefit from various tax deductions laid out in the Mainland and Hong Kong CDTA. Meanwhile, the Mainland has streamlined the process for Hong Kong companies wishing to register in Mainland and provided investment incentives, such as zero tariffs for goods originating from Hong Kong. The newly enforced agreement between Russia and Hong Kong further enhances tax benefits that encourage Russian companies to establish operations in Hong Kong as a stepping stone to tap the Mainland market.
The agreement is also seen as a means for Hong Kong to extend its presence in Eurasia. Hong Kong has been actively promoting itself as the “Super Connector” along the Belt & Road Initiative, determined to expand its current international tax treaty network with jurisdictions along the modern Silk Road. According to its Chief Executive, Hong Kong aims to seize the opportunities brought by the Initiative by negotiating with countries along the Belt and Road on investment protection agreements, CDTAs, and agreements on double taxation relief arrangements for shipping income.
For Russian investors and businesses, a key advantage of the Agreement is that Hong Kong’s withholding tax rate on royalties is reduced to a maximum of 3% from 4.95% for companies and 4.5% for individuals (and from 16.5% for companies and 15% for individuals if the royalties are received by or accrued to an associate). This has advantages for Russian companies who structure their investments in China through Hong Kong companies. There are no withholding taxes in Hong Kong on dividends or interest.
Despite the clear benefits to establishing a holding company in Hong Kong, businesses should consider carefully whether this is the most appropriate corporate structure for them, weighing up the pros and cons, as well as doing a thorough cost-benefit analysis.
Further, once set up and enacted, it is prudent to consult your local advisers to ensure the holding structure and entities comply with the local laws and requirements.
This article has been adapted from the Russia Briefing article “Russia’s Double Tax Agreement with Hong Kong” published on 21st May 2019 and the China Briefing article “Establishing A Hong Kong Holding Company For Your Business In China” published on 18th July 2019.
This article was written by Dezan Shira & Associates. The firm assists Foreign and Russian investors establish operations throughout China and Asia, in addition to Hong Kong, and has offices throughout the region. Please contact Maria Kotova at firstname.lastname@example.org or visit us at www.dezshira.com