One challenge for foreign investors in China is moving profits generated by their Foreign-Invested Enterprises (FIEs) out of China at reasonable cost. Foreign investors commonly do so through dividends, interest, and royalties paid to them by their FIEs subject to a withholding tax of ten percent. However, bilateral agreements on double taxation create opportunities for withholding tax savings. An attractive way for withholding tax savings is by establishing FIEs through a Hong Kong Special Purpose Vehicle (SPV).
The Enterprise Income Tax Law Raised Withholding Taxes for Dividends Paid to Foreign Investors
Effective on January 1, 2008, China’s Enterprise Income Tax Law ("EIT Law") unifies corporation taxation of FIEs and domestic companies by eliminating differences between their tax rates. It also raises 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.
- There is no tax on the profits of holding companies that do not engage in business or professional activities in Hong Kong.
On January 1, 2008 the Double Taxation Agreement between Hong Kong and China stated that Hong Kong companies need to pay seven percent on interest and royalties, the mainland company pays it. 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 are looking to invest in China, first establish an SPV in Hong Kong and then through that SPV establish a company in China. Following this process allows for a foreign investor to only be taxed at a rate of five percent for dividends they receive from the Chinese company, and seven percent for interest and royalties.
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. But 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 because of the close physical proximity between the mainland and Hong Kong.