When you decide to set up a business in Hong Kong, your choice of business structure or entity is crucial: It determines your liability as a business owner or director, your potential tax liability, and your general prospects of success as a business in Hong Kong.
Here, we compare the three key options for setting up a business in Hong Kong; the limited company, the partnership, and the sole proprietorship. That way, you can evaluate which option is best for your particular business.
Liability for owners, shareholders, or directors
A sole proprietorship in Hong Kong does not have a distinct legal identity. Under the law, the business itself is the same as the owner and operator of the business. One key consequence of this is that the owner/operator has unlimited liability. This means both that their personal assets are in jeopardy in case of business debt default, and that the owner/operator can be sued personally for the activities of the business.
In a partnership (whether general or limited), those who oversee and manage the day-to-day affairs of the business, have full legal liability for the debts of the business, as well as the activities of other partners. In a limited partnership, the liability of limited partners is limited by the capital they invest.
In the case of a Hong Kong limited company, the liability of members/ shareholders is limited by the capital contributed. This means that in the case of business insolvency, creditors have no claim over their personal assets.
Note, however, if a director personally guarantees a debt of the business, then their personal assets will become vulnerable.
Ease of attracting investors
In a sole proprietorship, the only capital, usually, is the sole proprietor’s own investment. Any loan from a bank, or family or friends, will be a personal loan to the owner/operator and will not convey an ownership interest in the business. There is no ability for a partner to be included within the business, and it is usually more difficult for the business to get loans from banks and other financial institutions. This limitation on investment can severely hinder business growth.
In a partnership, it is often easier to attract investment. In the case of a general partnership, there is often a steady stream of employees interested in becoming general partners, and therefore buying into the partnership (think law and accountancy firms). In the case of a limited partnership, potential investors can be attracted by the limited liability that applies to a limited partner.
In a limited company, raising capital is perhaps easiest of all: Capital can be raised by issuing shares, and banks are often willing to extend loans — banks know that companies are likely to have more assets than a sole proprietor, and are not at risk of non-payment due to owner bankruptcy.
Transferring ownership interests
Sole proprietorships and partnerships cannot be sold. Only the assets of the business may be sold. Note, however, that in a partnership, general partners can usually relinquish their stake in the business according to the terms of the partnership agreement. This commonly happens when the partner retires — they receive a payment equal to their initial capital contribution and thereby give up any ongoing rights or liabilities with respect to the business.
By contrast, shares in a Hong Kong limited company may be freely sold. In the case of a public limited company, those shares can be sold openly on a Stock Exchange.
Note, however, that all share transfers must be reported in the company’s annual compliance return.
Sole proprietorships are not always well regarded by other businesses in Hong Kong. When another business contracts with a sole proprietor, they are aware that they are placing themselves at added risk: If the business owner personally goes bankrupt, the business is bankrupt. They are also aware that a sole proprietorship usually has a small amount of capital investment.
Partnerships, whether general or limited, have an excellent reputation. However, that reputation is limited to specific sectors: For example, law, accountancy and other professional services firms are generally expected to have the partnership form.
Hong Kong has a two-tiered system for taxing business profits. Note, taxation is carried out on a territorial basis, with income derived from activity in Hong Kong being taxed (rather than worldwide profits).
Sole-proprietorship and partnerships pay:
- 7.5 percent on the first HKD $2 million
- 15 percent thereafter.
- 8.25 percent on the first HKD 2 million
- 16.5 percent thereafter.
Ending the Business
A sole proprietorship in Hong Kong is relatively easy to close. The sole proprietor ensures that all business debts are paid, informs the Inland Revenue Department, and makes sure that an accurate final tax return is submitted.
By contrast, both limited partnerships and companies must follow a similar ‘winding-up’ process prescribed under the law. As long as the business is solvent, and there is 100 percent agreement from partners (in the case of a limited partnership), or shareholders (in the case of a company), this is relatively straightforward. In the absence of agreement, or in the case of insolvency, the winding-up process can become protracted.
Which option should you choose?
For international businesses, a sole proprietorship is generally not recommended: The business may suffer reputationally, and the owner’s personal assets will be in jeopardy.
For most businesses, a Hong Kong limited company will make sense, as liability for debts and under the law is strictly limited.
A limited partnership is more suitable in industries where the partnership is the generally expected form, and the business needs to attract investors.