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Trade & Investment

China and Hong Kong: one country, two systems.


Hong Kong

After being a British Colony for more than 150 years, Hong Kong was handed over to China by the United Kingdom in 1997, becoming one of the two Special Administrative Regions of the People’s Republic of China since then. The principle of “One Country, two systems“ comes from Deng Xiaoping, Paramount Leader of China from 1978 to 1992, as the way he conceived a formula for addressing the challenges arising from the reunification of China. This July 1st, China and Hong Kong will commemorate the 15th Anniversary of   the hand over.

With a population of more than 7 million, Hong Kong has maintained its autonomy after the hand over in 1997, managing to remain as the most freest economy in the world for fourteen consecutive years according to The Heritage Foundation, as well as to become the most competitive economy in 2012 as indicated in the World Competitiveness Yearbook published by the IMD from Switzerland.

During my experience as China & Hong Kong Business Advisor, I have received very often the same question: what are the differences between Hong Kong and China? and off course, all the necessary questions arising from those differences such as which is the most suitable place to establish an office? or what are the advantages of being in one of the places instead of the other? etc. Let’s start for the basic differences and then try to provide practical implications of such differences in terms of business.

Legal System

Hong Kong follows the Common Law system while China follows Civil Law system, in addition, Judiciary system in Hong Kong is with no discussions organically independent from any other power, rules of the game are clearer in Hong Kong, while in China due to its gradual transformation from a Centrally Planned Economy towards a Social Market Economy, rules are adjusted or created permanently, thus creating a more complex legal environment for foreign Businessmen and Investors. This is probably one of the reasons for having Hong Kong as the source of more than 50% of the total Foreign Direct Investments in China in 2011, according to The Economist Intelligence Unit, which means that most of the Investors set up a Holding Company in Hong Kong as a first step when investing in China.

Official Languages

Hong Kong has Chinese and English as official languages, all regulations, contracts and important documents are in both languages. China has Chinese (Mandarin) as official language and recognises more than 50 dialects as well. In the practice the challenge in China is that regulations and all type of documents are in Chinese and the Chinese version will prevail over the English one in case of controversies. It is common due to lack of time that many businessman sign documents with no idea about what is written there.

Currency and Capital Flows

In Mainland China is the Chinese Yuan (CNY), also known as Renminbi (RMB), while in Hong Kong although there is Hong Kong Dollar (HKD), bank accounts handle more than 14 currencies such as USD, EUR, CHF and also the Chinese Yuan, which represents both a huge advantage in terms of access to a wide variety of currencies as well as enjoying the absence of Capital Flow restrictions (in Mainland China there are restrictions in place are I don’t expect it changes soon), meaning that there is no limit for receiving or remitting money in or out of Hong Kong.

Setting up  and Closing Down a Company

In Mainland China a foreign Investor might find a good number of options for establishing a Company such as a Wholly Foreign Owned Enterprise (WFOE) which is a type of Limited Liability Company that can be 100% owned by a foreigner, this option has become the most popular for Companies seeking on-the-ground operation in China avoiding the need of having a Chinese partner (known as Joint Ventures JV) due to the risk involved in such deals. Setting up a WFOE might take minimum two to three months, but there is chance of spending more time depending on the experience of the Advisory Firm chosen, the sector of the investment (there are some sectors still not allowed for WFOE’s and some other restricted), the location etc. In addition, a Foreign Company or Investor can register a Representative Office (RO) for having a first approach and test the water, as it allows operating an office, importing a maximum of four expatriates and hiring locals through the authorized Agencies in China.

Closing down a Company in China  implies a procedure which complexity will be given by the way the Company has been handling its compliance, mainly in the Tax and Labor matters, the timing will be usually not less than  six months and can be extended for more than one year in many cases. In Hong Kong it usually takes six to nine month and provided the latest Audit Report is ready and Taxes cleared, no issues should arise.

Paying Taxes

One of the most sensitive topics for anyone in business: paying Taxes, is another area of huge difference between Mainland China and Hong Kong. In China, Corporate Income Tax (CIT) is of 25% with few exceptions for SME’s and High Tech Companies , whereas Hong Kong levies an Income Tax rate for Corporations of 16,5%, the big difference is that China follows Global Source approach while Hong Kong applies a Territorial Base, meaning that in Hong Kong it is possible to be exempted of paying tax on the Income derived out of Hong Kong, this is just one of the examples, another one is that Hong Kong doesn’t have Value Added Tax (VAT) while China applies 17% VAT in general. For individuals, Employers in China must withhold and pay Individual Income Tax (IIT) monthly when paying salaries, which rates range from 3% to 45% (most of the Foreigners might fall in a range of 20% to 45%), in Hong Kong Individuals are responsible for filing its Tax Return annually and the tax rates range from 4% to 17%. There are off course much more areas to be compared in taxation, however in this Article we just have a preliminary view and more details can be discussed later.

It is fair to mention that the previous comparison doesn’t have as a purpose to show  the convenience of one jurisdiction instead of the other one, the idea is to provide practical elements for understanding that Mainland China and Hong Kong are not the same and why. The good thing out of these differences is that they create valuable advantages when deciding how to enter, structure, re-structure and operate in this part of the world, whereas for Import-Export, Sourcing-Procurement, Services, Investments and all variety of business projects trying to capitalise the huge opportunity posed by the Chinese and Asian blooming markets.

China and Hong Kong, one Country, two systems, a vast ocean of more than 1.3 Billion of opportunities, understanding how they work together is critical for the whole China Business Community and the world.

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