OFFSHORE Series | Why is the "magical" number 25% frequently seen when establishing a Hong Kong company?
Introduction
As a determining factor, the number 25% is crucial in the establishment and operation of offshore entities. For instance, when setting up a Hong Kong company, we frequently encounter the number 25% in the context of equity structure and proportions.
So, where does the significance of 25% come from? What is the basis for this figure? In this article, we will explore and clarify these questions using the example of Hong Kong companies.
Provisions of the Companies Ordinance
Significant Controllers:
One important concept to understand is "Significant Controllers" (SC) as defined in the Companies Ordinance, Chapter 622 of the Hong Kong laws. Significant Controllers refer to individuals or legal entities that have significant control and are required to be registered by the company. According to the Companies Ordinance Schedule 5A, the definition of significant control includes:
Direct or indirect ownership of:
i) 25% or more of the issued shares if it is a share-based company.
ii) 25% or more of the capital or profits (as applicable) if it is a non-share-based company.
Direct or indirect holding of 25% or more of the voting rights.
Direct or indirect power to appoint or remove a majority of directors of the company.
Having the right or actual ability to exercise significant influence or control over the company.
Therefore, 25% plays a vital role in determining significant controllers, and this is reflected in the Significant Controllers Register (SCR) of a Hong Kong company. It is essential for significant controllers to provide identity and address proof when conducting Know Your Clients (KYC) procedures for Hong Kong entities.
Note: Failure to comply with these requirements, including recording such information in the SCR, can lead to criminal liability and fines. Enforcement agencies such as the Companies Registry, Customs, Financial Services Bureau, and Tax Department have the right to access, copy, or inspect the register at any reasonable time for justified reasons.
Beneficial Owners:
The definition of significant controllers also applies to Beneficial Owners (BO). Essentially, they share similarities, but in Hong Kong, they are referred to as significant controllers, while in other jurisdictions such as Singapore, BVI, and Cayman Islands, they are known as beneficial owners. The details are not reiterated here.
Provisions of Anti-Money Laundering Legislation regarding the 25% Requirement
Anti-Money Laundering (AML) Regulations
Under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AML Ordinance) in Hong Kong, regulations regarding Ultimate Owners (UO) also involve the critical number of 25%. The provisions are as follows:
For natural persons:
i) Another individual who ultimately owns or controls the money service business.
ii) In the case of agency, the person being represented.
For partnerships:
i) Directly or indirectly having a right to share or control 25% or more of the partnership's capital or profits.
ii) Directly or indirectly having a right to exercise 25% or more of the voting rights or controlling such exercise.
iii) Exercising ultimate control over the management of the partnership.
For companies:
i) Directly or indirectly owning or controlling (including through trusts or nominee shareholdings) 25% or more of the issued shares of the company.
ii) Directly or indirectly having a right to exercise 25% or more of the voting rights at general meetings of the company or controlling such exercise.
iii) Exercising ultimate control over the management of the company.
The AML Ordinance requires institutions to identify and take reasonable measures to verify the identity of the beneficial owners if the client has them. This aligns with the Significant Controllers Register system.
Note: This is why the Hong Kong government requests documents such as passports, identity cards, driver's licenses, utility bills, etc., as proof of identity and address when establishing a company.
FATF
According to the Financial Action Task Force (FATF) publication titled "Methods for Assessing Compliance with the FATF Recommendations and the Effectiveness of AML/CFT Systems," financial institutions (which can be analogous to financial services regulators) should identify and take reasonable measures to verify the identity of natural persons who ultimately own or control the legal entity's controlling ownership interest.
Note: The controlling ownership interest depends on the company's ownership structure, such as anyone holding more than 25% of the shares. This also regulates services related to the banking industry, such as opening accounts.
Insights from Sinobravo
From the above, it is evident that the number 25% is significant in the Companies Ordinance, AML Ordinance, relevant guidelines, and FATF publications.
In other words, if a shareholder holds more than 25% of a Hong Kong company's equity or has direct or indirect control of 25% or more of the voting rights, they can influence the passing of special resolutions and substantially impact important matters concerning the Hong Kong company. Thus, they are rightfully called "significant controllers."
Similarly, if the company has no share capital, but an individual has the right to enjoy 25% or more of the capital or profits (as applicable) as the ultimate owner exercising controlling ownership interest, they are, in essence, the "beneficial owner" or "ultimate owner."
The system of significant person registers, KYC regulations, and others can be seen as the specific application of corporate governance rules under common law in different scenarios. Once the underlying legal principles are understood, it is not difficult to comprehend why 25% is so common and important concerning Hong Kong companies.
Therefore, we recommend that you carefully consider the beneficial rights and control rights of relevant entities, including Hong Kong companies, when engaging in cross-border investment activities. Plan a reasonable structure in advance to achieve a balance between corporate control, equity distribution, and information disclosure, thereby maximizing investment returns.
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