A German manufacturer plans its China expansion

Start with the operating plan

The initial questions were whether Germany should own the Chinese company directly or through Hong Kong, how contracts and payments would move, and whether a Hong Kong company would perform a useful commercial role.

AGATE examined where manufacturing and employees would be located, which companies would own assets, where customers and suppliers operated, and how domestic Chinese sales would differ from exports. Banking, management decisions, intercompany transactions and future Asian expansion were part of the same review.

Consider the ownership structure

One proposed route placed a Hong Kong holding and trading company between the German shareholder or group and a Chinese wholly foreign-owned enterprise, commonly called a WFOE. This was a proposal to assess with the relevant advisers before implementation.

1. German shareholder or group
2. Potential Hong Kong holding and trading company
3. China WFOE for manufacturing and local operations

Give each company a real function

The Chinese company would carry out the manufacturing activity, with its own employees, premises and local operating requirements. Its relationship with the other group companies needed to match what happened in practice.

Hong Kong could have a role in international contracts, trading relationships, banking, treasury or management of the Chinese subsidiary where the group could justify those functions. The plan examined which activities and decisions would actually take place there.

Profit allocation needed to reflect functions, risks and substance. Adding a Hong Kong company on paper would not establish a commercial role or settle the tax treatment.

Review tax across all three jurisdictions

The group needed advice on the Chinese manufacturing operation, the proposed Hong Kong activities and the effect on the German shareholder. Treaty relief and any exemption required assessment of the relevant conditions.

• Chinese corporate income tax, withholding and payments out of China.
• Transfer pricing for dealings between group companies.
• Hong Kong profits tax, foreign-sourced income rules and the proposed company's actual activity.
• German controlled foreign company and participation rules.
• Permanent establishment exposure, beneficial ownership, substance and eventual distributions.

Hong Kong's Inland Revenue Department treats the source of business profits as a question of fact. Its foreign-sourced income regime can also apply to specified income received in Hong Kong by multinational group entities. Both were relevant review topics for a potential holding company.

IRD: profits tax IRD: foreign-sourced income

Prepare the banking explanation before incorporation

The banking plan needed to explain why the group wanted a Hong Kong company, its expected turnover, suppliers and customers, and the movement of goods and payments. The file also needed to identify the source of funds, ownership and management.

Considering these points before incorporation allowed the group to assess whether the proposed companies and accounts could support the planned operations.

Coordinate the implementation decisions

AGATE brought the ownership, Hong Kong company role, Chinese operating needs and banking preparation into one roadmap for discussion with local advisers. Decisions in one jurisdiction could change the obligations or practical options in another.

The next stage depended on the German and Chinese advisers' review and the group's decisions about real activity, management and commercial contracts.

When this review is useful

This review is relevant to European manufacturers planning Chinese production, owners comparing direct ownership with a Hong Kong holding company, and groups that need banking, tax and operations assessed together before incorporation.