The Benefits of Incorporating Your Business

Background Information

Currently, many businesses in Hong Kong are being operated in the form of unincorporated companies such as sole-proprietorships and partnerships.

There are many benefits for using unincorporated businesses such as:

However, the are also many disadvantages attributable to unincorporated businesses: 

The decision of whether to remain as an unincorporated business will depend on the weighting that the owner(s) wish to place on of the benefits and disadvantages listed above. Over time, the weightings will inevitably change and there will always be a stage when the disadvantages outweigh the advantages of having running unincorporated companies rather than limited liability companies.

In the past, only the first two disadvantages as listed above would play any significant part in the decision of whether to convert to a limited liability company.


The Tax Evasion Crackdown

The fourth disadvantage listed above will play an increasing role in the decision of whether to incorporate. The Inland Revenue Department is currently laying the foundations for "self-assessment" of liability to taxation. An example of the changes that the IRD has made is to allow for small companies to dispense with the requirement to file supporting documents with their tax return. This may appear to some people to be a welcomed change as they would be allowed to have more scope to manipulate their reported profits or delay the audit of the accounts. The IRD is making these changes so that they may streamline their operations and not to lessen the burden of companies as all companies would still be required to prepare accounts, have them audited if necessary, and they would be making random requests to companies to have these supporting documents filed for review. Any company that fails to file these supporting documents within a very short time limit would be liable to heavy fines.

The increase in efficiency of the IRD as a result of the streamlining of their operations would allow for the IRD to allocate more resources to their investigation and field audit teams. The number of IRD staff deployed in field audit and investigation has grown from 28 in the 1991/92 fiscal year to 91 in 1999/2000. The number will be expected to increase significantly after the full implementation of self-assessment in five to eight years time.

Although many companies do not engage in tax evasion, once a company has become a target for investigation, they may expect severe interruption to their normal routines and the IRD would require detail examination of the companies records for seven years. Any company that is found to have understated profits would be imposed with fines that are significantly higher than current practice - the freedom of self-assessment will carry a heavy price for tax evaders.

How Can Incorporation Help

The benefits of incorporation is that every limited liability company will be required by law to have annual audits. Certified public accountants will be available to ensure that the company's records are being maintained in an orderly manner and may even advise on areas where legal tax avoidance is possible. The benefits of employing an auditor is that the auditor would become very familiar with the affairs of the company and hence, should a company be unlucky to be chosen for field audit or investigation, the company would be able to call upon an auditor to assist as a tax representative. Although any tax representative will be able to assist or advise in a field audit or investigation, it will be more efficient and effective to engage the auditors who have performed audits on the company over a period of years. These auditors would already be familiar with the affairs of the company and hence would not need to charge for the familiarization time that fresh tax representatives would require.

Furthermore, with the knowledge that the accounts would be audited, the owners would have less tendency to engage in tax evasion. Although the owners would be paying higher taxes in the short-term, they would not be required to pay the punitive fines that the IRD would impose for tax evasion. In an IRD investigation, the onus to proof that incomes are lower or costs are higher would rest with the tax-payer and if the IRD is satisfied with the evidence the tax-payer may even be assessed to a level of profits higher than actual profits.


How to Incorporate Your Business

If you already have businesses in the form of sole-proprietorship or partnership companies then you would need to incorporate a limited liability company.

As the new limited liability company is a separate legal entity from the current owners of the businesses, the transfer of the business will need to be properly documented if all legal procedures are to be followed. However, for most cases, the transferor of the business and the transferee will have the same owners and hence a formal legal sale and purchase agreement may be dispensed with for the sake of convenience and cost efficiencies. However, the acquisition of the business by the new limited liability company must, at least, be properly authorized by the board of directors.

The actual transfer of a business will usually involve the limited liability company acquiring all the assets and liabilities of the business. The assets may include both tangible assets such as machinery, office equipment and cash as well as non-tangible monetary assets such as debtors. Liabilities will include trade and loan creditors. The Transfer of Businesses (Protection of Creditors) Ordinance will need to be complied with to ensure that a business is legally transferred.

The most simple way to transfer a business would be to transfer only the fixed assets of a business to the new limited liability company. All new business transactions will then be carried out by the limited liability company and hence the debts and liabilities of the old and new businesses can be kept separate and distinct. In this mode of transfer, the old unlimited company will need to be kept in existence so that its debts may be collected and creditors paid. After all debts and liabilities of the old unlimited company have been settled, the company may be terminated by informing the Inland Revenue Department that the business has ceased business.

The more correct method to transfer a business would be to sell all the assets and liabilities to the new limited liability company in one set of transactions. The old company will then be able to be dissolved immediately after the transfer. The best method to transfer a business will depend of the particular circumstances of each business and the wishes of the owners. For more information and advice on how to incorporate your business, you may contact us to arrange for consultation.