The choice of a business structure can determine the success or failure of your business. It is one of the most important decisions for any entrepreneur, as the choice affects many aspects of the business – how you will be taxed, your exposure to law suits, how your business will be perceived by stakeholders, your ability to raise capital, the ease of your business expansion or dissolution, the degree of legal compliance you will need to adhere to, etc.

The previous article titled Types of Business Entities in Hong Kong provided a detailed overview of each of the three main types of entities: Limited Liability Company (LLC), Sole Proprietorship and Limited Partnership. In this article, we will present a comparative analysis of the different business entity types in Hong Kong. The terms limited liability company and private limited company are used interchangeably in this guide.

Key Factors Compared

Separate Legal Identity

Sole proprietorships are businesses owned and operated by a sole person. Since the business is not an incorporated entity, there is no separate legal identity. The owner and the business are considered one. Similarly, Hong Kong limited partnerships do not enjoy a separate legal entity status and the partnership is considered a mere extension of its partners.

On the other hand, Hong Kong limited liability companies have a legal identity of their own, distinct from their members. This enables the company to acquire assets, go into debt, enter into contracts, sue or be sued in its own name.

Business Liability

Since sole proprietorships do not enjoy a separate legal identity status, the sole proprietor is responsible for all business debts and liabilities. In other words, the owner has unlimited liability and there is no protection of personal assets (including personal property).

Limited partnerships are comprised of general and limited partners. While limited partners are not personally liable for any business debts incurred by the firm or the wrongful acts of another partner, general partners have unlimited personal liability.

In the case of limited liability companies, the liability of members to contribute to the debts of the company is limited to the amount of their investment in the company and does not extend to personal assets.

Perpetuity and Succession

Sole proprietorships have a limited life and no perpetual succession. The business ceases to exist on the death of the sole proprietor.

Limited partnerships enjoy perpetuity as limited partners can leave or be replaced without dissolving the partnership.

Limited liability companies have a continued existence notwithstanding the death, resignation or insolvency of shareholders or directors.

Ease of Expansion

For sole proprietorships, the only source of capital is the sole proprietor’s personal finances and business generated profits. There is neither an option of bringing in another partner nor the ability to take on risk-free loans from banks and other large financial institutions. Often, due to limited working capital, business growth and expansion can be hampered.

Limited partnerships often find that it is easier to raise capital as compared sole proprietorships. Sources of finance include loans from partners, taking on new partners and bank loans extended on the basis of combined assets of all the partners.

Limited liability companies can more easily raise capital by bringing in new shareholders or issuing more shares to existing shareholders. Furthermore, a strong public perception makes it easier for limited companies to secure bank loans when compared to other types of business entities.

Taxation

Profits derived from carrying on a trade, profession or business in Hong Kong is subject to profits tax (i.e. corporate tax). However, the rates of tax vary for different business entity types. Hong Kong follows a territorial basis of taxation. Hence, only profits which arise in or derived from Hong Kong are subject to tax in Hong Kong. There is no capital gains tax, withholding tax on dividends or interest and no sales tax or VAT in Hong Kong.

Sole proprietorships and partnerships are taxed at the rate of 15% on their assessable profits. However, there is an exception: if one of the partners of the limited partnership is a company, its income from the limited partnership will be taxed at the rate of 16.5%.

Limited liability companies are subject to a flat tax rate of 16.5%.

Transfer of Ownership

A sole proprietorship and limited partnership cannot be sold as a whole. The business can be transferred only by the sale of individual business assets.

Limited liability companies enjoy easier transfer of ownership. Ownership of the company can change hands by selling all or part of the company’s total shares, or through the issue of new shares to additional investors. Legal documentation is not complicated and business operations are not impacted.

Setup costs and maintenance

Sole proprietorships are the easiest and least expensive form of business to set up and maintain, with minimal documentation and formalities. All you need to do is register the business with the Inland Revenue Department and obtain a Business Registration Certificate for a fee of HKD 450 (1 year certificate) or HKD 4550 (3 year certificate). There are no other ongoing compliance requirements, except for renewal of the Business Registration Certificate.

Setting up a limited partnership is more complex than a sole proprietorship but less complex than a private limited company. The registration fee for a limited partnership is HKD 340. There are certain other additional fees payable. Like sole proprietorships, limited partnerships must register with the Inland Revenue Department and obtain a Business Registration Certificate for a fee of HKD 450 (1 year certificate) or HKD 4550 (3 year certificate). The only compliance requirements is notifying the Companies Registry of any change in the registered particulars and renewing the Business Registration Certificate.

Incorporating a limited liability company is generally considered more complex, expensive and complicated when compared to sole proprietorships and partnerships. A registration fee of HGD 1,720 and additional capital fees are payable to the Companies Registry. Companies must also register with the Inland Revenue Department and obtain a Business Registration Certificate for a fee of HKD 450 (1 year certificate) or HKD 4550 (3 year certificate). There are a number of statutory compliance requirements that private limited companies must adhere to.

Public Perception

Sole proprietorships have very low public perception. Since only one person is accountable for all business deals, this entity is the least preferred for serious business. It is difficult to raise capital and attract high-caliber employees or senior level executives who usually look for owning a share of the business.

Like sole proprietorships, limited partnerships also do not have a very high standing in the eyes of the public when compared to private limited companies.

Limited liability companies as a business structure communicate permanence, credibility and stature. Large organizations and people in general are more comfortable dealing with such companies and this makes it easier for the business to conduct transactions and grow. It is also easier to attract senior management and top notch employees to join the company.

Dissolution

Sole proprietorship termination in Hong Kong can be done by the owner at any time. There are no legal formalities involved. The owner is only required to intimate the Inland Revenue Department upon cessation of business.

On the other hand, the process for terminating a limited partnership in Hong Kong is the same process as that for winding up a private limited company. The role played by directors is substituted for by general partners. The process of closing a company is complex, time consuming and expensive and applies to both limited partnerships and private limited companies.

Which option to choose?

Taking into account the pros and cons of all the three entities, the obvious choice for entrepreneurs is to incorporate a limited liability company. The advantages of a limited liability company far outweigh its disadvantages. For further details on how to setup a limited liability company in Hong Kong, refer to Hong Kong Company Setup guide.