The Peoples’ Republic of China (PRC, China, or Mainland China) is the second largest economy in the world after the United States and is the world’s fastest-growing major economy, with growth rates averaging 10 percent over the past 30 years. Since the implementation of its open-door policy in the late 1970s, China has become the world’s premier destination for foreign investment. China was the largest recipient of global foreign direct investment in the first six months of 2012. Over 480 of the Fortune Global 500 firms are doing business in China. China joined the World Trade Organization (WTO) in 2001 to enhance its competitiveness in the global market, and by 2010, China’s exports amounted US$1.19 trillion. Its main export partners are the United States (17.7 percent), Hong Kong (13.3 percent), and Japan (8.1 percent). China’s trade surplus in March 2013 amounted to US$11.19 billion.
Hong Kong is the world’s 10th largest trading economy and 11th largest exporter of commercial services. It has always had a laissez-faire policy aimed at promoting barrier-free trade. Foreign direct investment (FDI) is very active in Hong Kong. According to UNCTAD World Investment Report 2012, Hong Kong is the second largest source of FDI in Asia after Japan, with an outflow of US$81.6 billion in 2011. Hong Kong is also the key entrepôt of China. According to Hong Kong government statistics, in 2011, China was the destination of 54 percent of Hong Kong’s re-exports. A majority of the direct investments in China are implemented through Hong Kong.
Hong Kong’s Role in the Economic Development of China
In March 2011, the 11th National People’s Congress (NPC) passed the 12th Five-Year Plan for the National Economic and Social Development of PRC (12th Five-Year Plan). For the first time, PRC’s National Five-Year Plan contains a chapter on the role of Hong Kong in the development of China. It aims at:
- Further consolidating and elevating Hong Kong’s competitive advantages, including its status as an international center for financial services, trade, and shipping;
- Developing Hong Kong into an international asset management center and offshore renminbi (RMB) business center, so as to strengthen its global influence in the financial sector; and
- Nurturing emerging industries and facilitating extending their fields of cooperation and scope of service in China.
In response to the 12th Five-Year Plan, the Hong Kong government encourages its enterprises to tap into the China market with emphasis on promoting Hong Kong’s role as an offshore RMB business center. As for industrial development, the Hong Kong government set up the Financial Services Development Council to promote Hong Kong’s financial services industry and complement the internationalization of RMB and Mainland China’s financial market.
Hong Kong has become a conduit to funnel capital, high-caliber talent, and technology into China from all over the world, while also introducing China’s enterprises, products, and services to the global market. In essence, Hong Kong provides a springboard to China’s strategy of “going out” and “bringing in.”
Advantages of Doing Business in China via Hong Kong
Hong Kong is the largest foreign direct investment source in China. As of June 2011, there were 3,752 regional headquarters and regional offices in Hong Kong representing their parent companies located outside Hong Kong, with an increase of 3.1 percent from the previous year. Of these companies, 81 percent were responsible for business in China, confirming Hong Kong’s role as a gateway to China.
Robust Legal System
Hong Kong was a British colony from 1842 to 1997. After the handover in 1997, the “Basic Law” has been the supreme law of Hong Kong. Its underlying principle of “one country, two systems” enacted by the NPC indicates that the prior colonial-era capitalist system and way of life are to remain unchanged for 50 years. The most prominent feature of the Basic Law is the upholding of the common law system and rule of equity. Also, all ordinances not contradicted by the Basic Law are to remain in force. Hong Kong has a robust legal system and an independent judiciary that provide a fair and just operating environment for businesses. Under the Basic Law, Hong Kong has its own final appellate body, the Court of Final Appeal, which is crucial in maintaining the independence of the judiciary. Over the years, it has invited distinguished overseas judges to sit on its court and assist in the development of local jurisprudence. For example, Sir Anthony Mason, a former chief justice of the High Court of Australia, frequently sits in the Court of Final Appeal. The same applies to many law lords from the United Kingdom. This arrangement, which is unprecedented, not only signifies Hong Kong’s determination to retain judicial independence, but, equally important, it adds an international dimension to Hong Kong’s legal system.
Availability of quality legal services is an important factor for corporations that use Hong Kong as a regional center. Hong Kong is a one-stop professional advisory services center with over 7,400 practicing solicitors, 1,100 barristers, and more than 33,000 certified public accountants. Over 1,400 foreign lawyers qualified in 29 different overseas jurisdictions are practicing in Hong Kong and are capable of counseling on matters pertaining to the laws of the United Kingdom, United States, China, and others. In recent years, leading U.S. law firms have established bases in Hong Kong, making it a true international legal hub. According to statistics published in the October 2012 issue of American Lawyer, out of the top 100 global law firms ranked by revenue, 65 have offices in Hong Kong, and 50 of them are practicing as local Hong Kong firms of solicitors.
The in-depth knowledge of Hong Kong legal practitioners in the Mainland China market and Hong Kong’s regulatory framework facilitate transactions involving parties from China by acting as a bridge between clients from the international and China capital markets. Also, sophisticated legal services are provided for fund-raising, finance, securities, international trade, and cross-border transactions.
Effective Dispute Resolution
In addition to a fair and efficient judicial system, alternative dispute resolution mechanisms to deal with business disputes are available. Hong Kong provides highly cost-effective arbitration services. In June 2011, Hong Kong reformed its Arbitration Ordinance Cap. 609; it now has a unitary regime of arbitration based on UNCITRAL Model Law for all types of arbitration, abolishing the distinction between domestic and international arbitration.
Under Mainland Judgments (Reciprocal Enforcement) Ordinance Cap. 597, certain commercial judgments by either the China or Hong Kong courts may be enforced reciprocally. Arbitration awards made in Hong Kong are enforceable in more than 140 jurisdictions through the New York Convention and the Arrangement Concerning Mutual Enforcement of Arbitral Awards between China and Hong Kong.
In Noble Resources Limited v. Zhoushan Zhonghai Food and Oil Industrial Limited (2009), whereby the party applied for approval from the Supreme People’s Court of its denial of enforcement of a Hong Kong International Arbitration Centre award on the basis of public policy, the Zhejiang Higher People’s Court highlighted that “there has not been any precedent of denying enforcement of HKIAC awards in the Mainland.” The Supreme People’s Court enforced the award finding in favor of the foreign party.
With sophisticated legal expertise, internationally recognized regulatory standards, an independent judiciary, and an effective alternative dispute resolution system, Hong Kong is truly a one-stop hub in Asia that provides efficient and wide-ranging services that meet the needs of different kinds of businesses at different stages of development.
Mainland–Hong Kong Closer Economic Partnership Arrangement
Hong Kong enjoys a unique advantage under the Mainland–Hong Kong Closer Economic Partnership Arrangement (CEPA), which was first concluded in June 2003, with the latest supplement effective on January 1, 2013. CEPA plays an important role in strengthening cooperation between Hong Kong and China in areas of finance, trade, and investment facilitation and in promoting joint prosperity and development of the two entities. Prominent preferential liberalizations for goods and services of Hong Kong to enter the China market were announced. It is expected that free service trade between the two entities will be further promoted in the coming supplements. The liberalizations under CEPA provide better terms than the WTO commitments of China, adding to the desirability of Hong Kong as a base for doing business in China.
All products “made in Hong Kong” complying with CEPA origin rules and upon application by local manufacturers, except for a few prohibited articles, can be exported to China tariff-free under CEPA. “Made in Hong Kong” means goods must be “substantially transformed” in Hong Kong with at least 30 percent of value added therein (including R&D and design costs). Since the implementation of CEPA, the number of goods eligible for tariff-free treatment increased from 273 to 1,739.
International firms that incorporate in Hong Kong enjoy all the benefits available under CEPA, as well as the obvious geographic advantage of being located in Hong Kong, which facilitates connecting with suppliers and consumers in China.
Also, Hong Kong service suppliers enjoy preferential treatment and relaxed market access conditions when setting up business in China. Financial, geographical, and ownership constraints are reduced or removed, such as allowing wholly owned operations and reducing registered capital requirements, which facilitate entrance to the China market for small to medium enterprises. Free trade in services between Guangdong and Hong Kong is expected to be achieved in 2014.
Any company can benefit from CEPA if it is incorporated in Hong Kong with three to five years’ operation (depending on the sector). Fifty percent of its staff must be employed locally and liable to pay Hong Kong tax. Overseas service providers can partner with, invest in, or buy into a CEPA-qualified company to acquire easier access to China.
Languages and Accessibility
Hong Kong has the root of Chinese cultures with British features from its colonial history. Chinese and English are both official languages in Hong Kong and are commonly used in business.
Hong Kong’s geographical location has made it the central hub of the Asia-Pacific region. It is within easy flying distance of China, Southeast Asia, India, and Australia. Hong Kong is the world’s third-busiest container port system. Hong Kong International Airport is the world’s busiest cargo gateway and two additional runways are planned to increase its capacity by 2020.
Construction for the Hong Kong-Zhuhai-Macao Bridge is expected to be completed in 2016, enhancing the economic development of the region. The Hong Kong section of the Guangzhou-Shenzhen-Hong Kong Express Rail Link is expected to be completed in 2015, strengthening economic ties between the areas, accelerating the economic integration of the Western Pan River Delta and its neighboring provinces, and increasing Hong Kong’s competitiveness.
Banking and Finance in Hong Kong
As an important banking and financial center in the Asia-Pacific region, 70 of the world’s top 100 banks are based in Hong Kong. According to the Bank for International Settlements, Hong Kong is the third-largest foreign exchange market in Asia and the sixth-largest in the world. In 2011, Hong Kong was first in the world for initial public offerings (IPO) for a third year in succession and was a prominent offshore capital-raising center for China enterprises. As at December 2011, there were 640 China companies listed in Hong Kong, making up 55.5 percent (i.e., US$1.2 trillion) of the market total. Listed companies in Hong Kong are regulated by the Securities and Futures Commission and the Hong Kong Stock Exchange, which have strong reputations and high standards for listing.
Eight licensed China-incorporated banks and five representative offices operate in Hong Kong. Some of them have set up their branches in Hong Kong, such as the Bank of China, China Construction Bank, Industrial and Commercial Bank of China, and Agricultural Bank of China.
Benefits of Using a Hong Kong Holding Company
The Foreign Investment Industrial Guidance Catalogue (2011 Revision), amended by the Ministry of Commerce, came into effect on January 30, 2012. The Catalogue is a tool used by the China government to control foreign investors and divides foreign investment industries into three categories: (1) Encouraged; (2) Restricted; and (3) Prohibited.
For investment in the Encouraged category, foreign investors are generally allowed to establish wholly foreign-owned enterprises (WFOE). The Encouraged category includes mining and textile manufacturing. For investment in the Restricted category, foreign investors generally need to make their investment through a joint venture with a China partner. The foreign investor’s equity interest in the joint venture can be subject to limitation. As for industrial projects in the Prohibited category, foreign investment is not allowed, for instance, in postal services and media.
On the other hand, Hong Kong provides foreign investors freedom of investment, as the restriction and limitation control by the Hong Kong government is minimal. For example, a foreign investor can set up a company in Hong Kong to hold 100 percent of a WFOE, or to incorporate in a joint venture in China.
The benefit of this practice is that, by an appropriate shareholders’ agreement, stock option plan, or asset and business management agreement, the maintenance and management of a WFOE or joint venture can be operated at the Hong Kong holding company level, which is governed by the laws of Hong Kong, and any transfer of shareholding at the Hong Kong holding company level will not require approval by the China government.
Second, as a benefit of Hong Kong’s mature banking and finance system, the Hong Kong holding company level can conveniently obtain loans and credits.
Third, on August 21, 2006, the China and Hong Kong governments signed the Arrangement for the Avoidance of Double Taxation on Income and Prevention of Fiscal Evasion, which provides added incentives for international investors to enter the China market through Hong Kong. For instance, where a Hong Kong resident company disposes of less than 25 percent of shareholding in a China company and the assets of the China company are not comprised of mainly immovable property situated in China, gain derived from such disposal will be tax exempted. Without this preferential treatment, the gain would be subject to a 10 percent withholding tax. As for indirect income such as interest, dividends, and royalties, Hong Kong investors are provided with preferential treatment.
In brief, we have set out the advantages of using Hong Kong as a base for doing business in China, including, but not limited to, a robust legal system, a simple tax regime, a leading capital market and financial center, a regional hub, quality manpower, proximity to China, an efficient government, free trade and a free market economy, global connections, and a logistic center with efficient transportation.
In this mini-theme covering Hong Kong legal services, my fellow colleagues of the Law Society of Hong Kong will cover additional legal topics that will be of interest to you and your clients that wish to do business in China.