Hong Kong SPVs Reduce Withholding Taxes in China
One challenge for foreign investors in China is moving profits generated by their Foreign-Invested Enterprises (FIEs) out of China with low costs. They commonly do so through dividends, interest and royalties paid to them by their FIEs while being subject to a withholding tax of ten percent. However, bilateral agreements on double taxation create opportunities for withholding tax savings. An attractive way is through establishing FIEs through a Hong Kong Special Purpose Vehicle (SPV).
The Enterprise Income Tax Law Raised Withholding Taxes for Dividends Paid to Foreign Investors
China’s Enterprise Income Tax Law (“EIT Law”) became fully effective on January 1, 2008. The EIT Law unifies corporation taxation of FIEs and domestic companies by eliminating most differences between their tax rates. It also raised withholding taxes for dividends paid to foreign investors from zero to ten percent. A rate of ten percent is applied to withholding taxes for interest and royalties paid.
Hong Kong SPVs Can Take Advantage of Bilateral Double Taxation Treaty
Hong Kong is a tax haven with the following traditional advantages:
- There is no withholding tax on dividends and interest paid to offshore investors of Hong Kong companies.
- It does not tax the profits of holding companies that do not engage in business or professional activities in Hong Kong.
The Double Taxation Agreement Between Hong Kong and China fully entered into force on January 1, 2008. According to this Agreement, Hong Kong companies only need to pay seven percent on interest and royalties the mainland company pays it; and if it owns at least 25 percent of the mainland company, its withholding tax rate for dividends paid is only five percent.
Thus, if foreign investors looking to invest in China first establish an SPV in Hong Kong, and then through that SPV establish a company in China, they will only be taxed at a rate of five percent for dividends they receive from the Chinese company, and seven percent for interest and royalty.
Hong Kong Is Generally Superior Than Other Tax Havens
Hong Kong is not the only country or territory with withholding-tax-friendly bilateral treaties with China. However, Hong Kong is usually the better choice for two reasons. First, China’s bilateral treaties with Hong Kong are least likely to be re-negotiated because of the mainland’s strong political and economical ties with Hong Kong. Second, it is usually more convenient for FIEs in China to deal with Hong Kong authorities than other countries such as Barbados because of the close physical proximity between the mainland and Hong Kong.
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