Many foreign companies looking to invest in the Chinese market choose to establish a Hong Kong holding company or special purpose vehicle (SPV) to “hold” their Chinese entity. Registering a Hong Kong holding company is relatively quick and easy compared with establishing a WFOE. However, it does not permit the foreign investor(s) to legally operate in China. Rather, it is often used as a stepping-stone for subsequent investment into China, and can act as a buffer between the parent company and the WFOE, thereby providing the parent company with an additional layer of protection from potential risks and liabilities of the WFOE.

Furthermore, a Hong Kong company makes it easier and more flexible for foreign investors to sell the WFOE or part of their shareholdings in it to another investor if they wish to do so in the future. This is because the necessary procedures in Hong Kong are less complex and time-consuming, and the regulatory environment less strict, than in China. To give an example, if the parent company owns 100 per cent of the Hong Kong company, which in turn owns 100 per cent of the WFOE, selling all the Hong Kong company shares effectively means that all of the WFOE shares are also sold, even if the shares are not technically sold at the WFOE level in China. It should be noted, however, that China has strict laws and regulations governing the indirect sale of WFOEs as they are considered as taxable assets, so it is important to seek professional advice regarding this.

Another reason for setting up a Hong Kong holding company is Hong Kong’s preferential tax regime. Hong Kong not only has lower taxes compared with China, but also a number of tax advantages. For example, withholding tax rates on the repatriation of profits are low, and profits that are not sourced from Hong Kong are not required to pay profits tax. A Hong Kong company also allows the investor(s) to pool and hold the profits earned from the WFOE offshore, where the tax on transactions is usually lower, rather than immediately remit the profits back to the parent company’s home country, which may be subject to stringent anti-tax avoidance regulations. These profits can then be re-invested back into China if necessary, or used for expansion into other countries.

Final reasons for setting up a Hong Kong company include Hong Kong’s close proximity to China, its international business environment, its status as a key economic and financial hub in Asia, and its strong and transparent legal system.