July 6, 2021
Are you considering setting up a holding company in Hong Kong to reduce your tax burden? If so, there are some risks to consider to ensure you avoid any issues with taxation authorities. Comprehending a permanent establishment, the risks, and how to legally open a holding company in Hong Kong will be the first steps to saving money on your business tax bill.
What is a Permanent Establishment?
The People’s Republic of China defines a permanent establishment as a place where the principal business operations are conducted in part or whole. Circular 75 describes a permanent establishment using language such as fixed and permanent. However, working in an office in China does not necessarily mean there is a permanent establishment, creating a gray area that many businesses struggle to understand. The State Tax Administration has clarified that occasional working from home activities do not result in a permanent establishment with the recent pandemic. The pandemic circumstances were deemed “exceptional and temporary” and thus would not result in a permanent establishment. This can be good news for companies trying to avoid higher tax rates.
What is the Risk of a Holding Company in Hong Kong?
Deciphering what constitutes a permanent establishment will help you avoid trouble with taxation agencies. Many businesses look to set up a holding company in Hong Kong and then a subsidiary where all business transactions flow through to bypass taxation at mainland rates. Businesses taxed at Hong Kong rates can save a significant amount of money and conduct business in the same manner through their subsidiary on the mainland. However, the State Tax Administration is catching onto companies purposefully evading taxation and assessing their fines and penalties. As a result, businesses that the People’s Republic of China deems to have a permanent residence could be subject to a 25% tax on China-sourced income, significantly more than Hong Kong rates.
How Can Businesses Legally Take Advantage of More Favorable Tax Rates?
Many companies strive to take advantage of the lower tax rates for businesses and individuals residing in Hong Kong. However, specific criteria need to be met to avoid the People’s Republic of China arguing a permanent establishment on the mainland. The business should avoid an establishment on the continent, including building sites and constructing a property for an extended time. In addition, no agent in China should accept and conclude contracts from the mainland, and there should be no employees working in China for an extended amount of time. Selling and shipping items to the continent do not affect the permanent establishment status. Following these rules can help your business avoid issues with the People’s Republic of China.
Summary
Determining whether your business has a permanent establishment on the mainland will help you understand how to shift your business operations to take advantage of favorable Hong Kong rates. There is a thin line between tax avoidance and tax evasion when businesses set up a holding company in Hong Kong.
Please contact us (inquiries@chinalawsolutions.com) to get a recommendation on an accounting firm which can assist your business in China. All inquiries are treated as confidential.