The following is the exclusive transcript of highlights from an interview I did on the subject of “transfer pricing/ HK offshoring” with the “global from Asia” podcast.
Visit https://www.globalfromasia.com/transfer-pricing/ for the full podcast.
Q: So today’s topic transfer pricing, this is something I learned about when first in China – can you explain a quick definition?
Mike Bellamy (MB): First off- I’m not an accountant or lawyer, so today, I’m just sharing what I have learned setting up my own supply chains and managing them on behalf of our clients. Having said that, simply put, transfer pricing works like this:
Example: you buy a widget in China at 1 USD and you sell it in your home market for 10. Your profit was 9, you are taxed on that profit.
Let’s say you set up a HK company (or you hire one), and that HK entity buys for 1 USD and sells to your HQ back home for 9, and then HQ sells to the end user for 10. In this case 8 bucks of markup stays with the HK entity and only 1 USD profit is on the books with the HQ.
The magic happens when you realize that if you set up a HK company or outsource it, in the right way, profits are not taxed. HK called this an “offshore transaction” and its profit is not taxed by HK if you set your HK company up right and following some simple rules set by the HK government. Of course, when you repatriate the funds back home, you get hit with tax, but until that time…this pile of money builds up in HK and can be recycled to buy the next order “tax free” if you will.
That’s an over simplification, but you get the picture.
Q: Many business owners listening today are doing trade around the globe, buying from china, via a HK company a lot of times, selling to their company in USA – what are some normal cases for transfer pricing?
MB: While the HK tax code is very business friendly, things get complex in your home country depending on how that HK company is viewed. Now we are talking about “Arm’s length” issues.
Also, the PRC tax man is also wise to the game, especially if you own the PRC company and sell to your HK arm. It’s a big red flag is you are selling it at a loss in China to avoid PRC profits taxes.
Q: So they should setup multiple companies? Or just buy direct from the factory from your USA company? How to value the product, at each stage in the distribution chain? There’s manufacturing, importing, wholesaling, retailing – are there standard margins people can or should use?
MB: There are actually a couple of important sub questions on there. I’m assuming you asking the question with regards to transfer pricing and keeping an arm’s length.
For example…if you own a WFOE in China, you need to be asking the question: what’s the lowest price I can sell from my WFOE to my HK company without breaking any laws in the PRC. That required some benchmarking. Kepe in mind you are going to pay taxes, I’m not suggesting breaking any laws, I am suggesting your simply optimize your global tax plan to reduce and defer taxes in full compliance with the laws in all the juristictions where you operate.
In the worst case, depending on how seriously you home country takes this “arm’s length issue”, there may be no advantage for having a HK holding company. If your government views that HK as under your “control”, then you may get taxed anyway.
Another big mistake is to count on things being “profit tax free” in HK, only to realize too late that you broke the rules about how to enjoy the “offshore” classification. For example, if you sign deals in HK, have contracts with HK based customers, or keep a formal office with real staff based in HK…then you will need to pay HK profits tax because it’s not “off shore” business. Granted, the tax rates are a lot better than back home in US or Europe, so paying tax in HK isn’t that bad!
Q: All governments want the max in tax income, does each country have different rules and policies?
MB: Yes, here are the questions to ask your domestic income and business tax advisor:
- From my government’s perspective, how do they define “control” and “arm’s length” issues regarding overseas companies that I may be associated with?
- If I set up a HK company, can I used it, in a fully legal way, to reduce my taxes back home?
- Do I even need to have a company back home? What if I moved my business to HK, how would that impact my personal income tax?
Q: Mike, you are American, have a HK holding company and source from China. You talk about “doing it right”, any tips for my listeners with regards when is the right time to setting thing up right in HK?”
MB: Don’t try to be sneaky, realize you are going to need to pay tax somewhere. So just be smart about it and find the option that is fully legal, yet reduced your global tax exposure.
If you are spending less than a few million USD in China, then setting up a HK company may be over kill. If you are spending more than a few million USD in China and you haven’t explored your options in HK, then you are doing yourself a big disservice and missing a major opportunity.
Q: What stages of a business, say an Amazon seller, should start to think about this? Is there an easy way to get started, then get more complex?
MB: At risk of sounding like a salesman, a first step can often be to work with a company, like mine (www.PSSChina.com), that has operations in China, HK and clients globally. We have a system in place already that can be leveraged for small/medium client, and when the project gets large, the client can think about setting up their own operations.
Q: Some may have their heads spinning now, what is #1 thing a listener can take away today to get started improving their business with transfer pricing/ HK off shoreing?
MB: Look at the corporate tax rate in HK vs your country. Multiply it against your annual business volume. If the difference is tens of 10…not worth the effort. If 100’s of thousands of USD, then you need to look into things a lot closer.