When you decide to incorporate an entity In Hong Kong, you need to consider which is the best business structure or entity for your international enterprise: Each structure has its pros and cons, and it's important that you choose the one that's right for you.
Some of the questions you will need to ask include:
- What is the purpose of your enterprise in Hong Kong? Some business structures are only appropriate for certain business purposes.
- How much personal liability does the business structure impose? And, how much personal liability are you comfortable with as a business owner and operator?
- Will the business structure or entity be attractive to investors?
- How much does the particular business structure cost to set up and maintain?
- How long will it take to set up the new business structure or entity?
- What are the tax and compliance consequences of the chosen structure or entity?
- What obligations does the business structure impose on those who set up the business?
The most common types of business structure or entity in Hong Kong are the following:
- Sole proprietorship. As the default business structure, a sole proprietorship is, perhaps, the easiest business structure to set up. However, as this means no legal distinction between the individual person and their business, it also means unlimited liability for the business owner: Any business debts put their own personal assets at risk.
- Partnership. In a Partnership, two or more individuals share ownership and control of the business. In a general partnership, all partners have joint and several liability for debts and the actions of the other partners. Limited partnerships are also available, however, which offer limited liability to limited partners.
- Company. International enterprises can incorporate a new company in Hong Kong, such as where they want to set up a local subsidiary. Strictly speaking, this is the only situation in which an entity is incorporated in Hong Kong. Or, they can set up a branch office or representative office of the international company in Hong Kong.
In this guide, we give them an overview of the different business structures and entity types in Hong Kong, looking at their pros and cons, so you can decide which form is right for you.
Business Structure or Entity Type: Sole Proprietorship
Sole proprietorship is a simple business structure. Technically, it is not a type of business ‘entity’, as no entity is incorporated. The business is owned and operated by a single individual (though they may employ or contract others in the name of their business). As there is no separate legal entity, the owner and the business are treated as the one entity under the law.
While usually a sole proprietor would be resident in Hong Kong, an authorized agent can be used for the purposes of registering with the Inland Revenue Department as a sole proprietor in Hong Kong. Below we consider the advantages and disadvantages of this business structure:
- Ease of setup. Sole proprietorships are a default business structure, and are easy to set up.
- Straightforward compliance. Generally speaking, only tax returns need to be submitted. There is nothing equivalent to the annual return that Hong Kong-incorporated companies must submit via a company secretary.
- Cost. With no business incorporation fees, no need to appoint a company secretary, and no need for audited accounts, sole proprietorship is a low-cost business structure.
- Ease of business termination. Ending a sole proprietorship is easy. It requires simply notifying the Inland Revenue Department. By contrast, a company must go through the more complicated winding up (liquidation), and de-registration procedures.
- Poor public reputation. Many reputable businesses only want to contract with other duly-incorporated companies. Many businesses are concerned about the risk of non-payment from a sole proprietor due to low startup capital, and the risk posed by personal bankruptcy (if the sole proprietor of a business goes bankrupt on a personal level, the business itself becomes bankrupt).
- Unlimited personal liability for debts. As there is no separate entity, the business owner and operator have full liability for the debts of the business. This means that in the case of insolvency (being unable to pay their debts), their own personal assets may be at risk.
- Increased legal liability. Where a sole proprietor enters into contracts, that individual becomes personally liable for breach, and any consequent damages. By contrast, in a limited company, it is the company itself that enters into the contract, and has liability under that contract (though in some cases, directors of limited companies can still have liability for the activities of the company).
- Difficulty in selling the business. As there is no separate entity to be sold, the business can only be transferred by the sale of individual business assets.
Business Structure or Entity Type: General Partnership
A partnership is a business that is set up and co-owned by two or more individuals
who share the profits of the business. There are two types of partnership in Hong Kong: general partnerships and limited partnerships.
In a general partnership, every partner is jointly and severally liable for the debts of the business. Furthermore, all partners are legally responsible for the business activities of another partner.
- Ease of setup. Like a sole proprietorship, there is no requirement to incorporate an entity in order to establish a general partnership. Furthermore, there are fewer ongoing compliance requirements for partnership than there are for a limited company. Note, however, it is wise for a general partnership to be organized through a formal written legal document. Drafting an appropriate document can be relatively time-consuming and expensive.
- Reputation. In some businesses, such as accountancy or law firms, partnership is the expected business form. Other businesses may be reluctant to engage with you where your business does not have the conventional form.
- Attractive to employees. Many employees are attracted by the idea of becoming a full partner of the business in due course.
- Unlimited liability for debts. All the partners in the firm are personally liable for the debts of the business, including each other's debts. This means that the personal assets of the partners are potentially on the line in case of non-payment of debt.
- Increased legal liability. Partners can be liable for the actions of other partners acting in the course of the business.
- Complexity of decision-making. As the partners jointly control the business, it is often necessary to get all the business partners to agree to key decisions.
- Difficulty in selling the business. As with the sole proprietorship, there is no distinct business to be sold over and above the assets of the business. Any partner wishing to disentangle themselves from the business needs to find a way to sell their interest to another partner.
Business Structure or Entity Type: Limited Partnership
In a limited partnership, there are both general and limited partners. General partners have unlimited liability, while limited partners have liability limited by the amount of share capital contributed. Limited partners do not participate in the management of the partnership.
- Reputation. A limited partnership combines the excellent business reputation of a general partnership with the protection of (partial) limited liability.
- Attractive to investors. Unlike a general partnership, investors can put money into the business without subjecting themselves to unlimited liability for the activities of the business.
- Unlimited liability for general partners. As general partners have unlimited liability, their personal assets are still at risk in the case of non-payment of debt.
- Restrictions on limited partners. As limited partners are unable to be involved in the day-to-day management or operation of the business, they essentially become investors only.
- Expense and difficulty of set-up. Limited partnerships have more compliance requirements than general partnerships, therefore they can be more expensive and time-consuming to establish.
Business Structure or Entity Type: Representative Office (RO) of an Overseas Enterprise
International companies can set up a representative office (RO) in Hong Kong. The representative office must register with the authorities, but can only engage in limited activities in Hong Kong (i.e., no profit-making activities).
- Pace of set-up. Setting up a representative office can be done extremely quickly and at low cost.
- Leveraging the reputation of the international company. As the representative office is simply a component of the international company, it can benefit from the reputation of the international company itself.
- Ease of deregistration. It is very straightforward to close down a representative office in Hong Kong.
- Limited activities. A representative office can only engage in a very restricted set of activities. They are usually used for initial market research or negotiation purposes, before setting up a limited company in Hong Kong, or to explore whether it is worth setting up such a company.
- Delays company incorporation. As setting up a representative office is often the first step in setting up a company, it can be an exercise in delaying the inevitable. By incorporating a company straightaway, the company is immediately able to engage in profit-making activities.
Business Structure or Entity Type: Branch
An international company can operate directly in Hong Kong through a branch of the international company, rather than incorporating a separate entity. A branch registers with the Inland Revenue Department in Hong Kong, and usually pays tax at the same corporate income tax rates as a Hong Kong incorporated company (16.5% ).
- Business reputation of the international company. As the branch operates under the full legal name of the international enterprise, they can benefit from the reputation of the international business.
- Limited liability. As a branch is a part of the international limited company, the liability is strictly limited. This means that the, generally speaking, assets of the shareholders are not at risk.
- Ease of termination. Unlike a subsidiary company, there is no need for a branch of an international company to be wound up or liquidated upon the ending of operations in Hong Kong. This means the process of deregistering that branch can be much quicker and more straightforward than closing down a subsidiary company.
- Liability for the international enterprise. As the branch is an integral part of the international company, and acts in the name of the international company, that international company is fully liable for the debts, and the consequences of any contracts entered into by that branch in Hong Kong. By contrast, where a subsidiary of an international company is set up in Hong Kong, the international parent company is not liable for the debts of that subsidiary, nor is it liable for any contracts entered into by that subsidiary.
- Eligibility for government incentives. Some government incentives and allowances are only available for companies incorporated in Hong Kong. A branch of a foreign company is usually not eligible for these.
Business Structure or Entity Type: An Incorporated Hong Kong Company
The most common way for international enterprises to do business in Hong Kong is via incorporating a local Hong Kong company. Where the international company has majority ownership of the new company it is known as a ‘subsidiary’; where the international company has 100% ownership of the Hong Kong subsidiary it is known as a ‘wholly-owned subsidiary.
- Limited liability. The shareholders and directors of a company incorporated in Hong Kong are not liable for the debts of that Hong Kong company. Nor are they personally liable for any contracts entered into by that Hong Kong company. Note, directors can become liable if they personally guarantee any debts of the Hong Kong company.
- Ease of setup. Hong Kong is one of the easiest countries in the world to set up and incorporate a company. Neither shareholders nor directors need to be resident in Hong Kong, and corporate directors are permitted. Hong Kong companies can have 100% foreign shareholding.
- Reputation. Hong Kong companies have an excellent international reputation making it easy to do business internationally from there.
- Liberal share capital requirements. There is no minimum shareholding required for a Hong Kong company making them cost-efficient to set up.
- Confidentiality and privacy are respected. Unlike many other jurisdictions, Hong Kong permits directors to be bodies corporate. This means that a foreign company can appoint a ‘nominee company director’ in Hong Kong to act on their instructions, while their real identity can be obscured from the public. Note, however, that the Hong Kong authorities will still require detailed information on control and beneficial ownership structures of any foreign shareholders or directors.
For many international enterprises operating in Hong Kong, incorporating an entity as a subsidiary company will be the way to go. However, there are other entities and business structures that may be appropriate in some circumstances, such as general partnerships, limited partnerships, representative offices, and branches. Whichever entity type is chosen, it is essential that the business complies with all legal requirements for that entity type.