The Hong Kong government issued its consultation report on
measures to counter base erosion and profit shifting (BEPS) on
July 31 2017. The report summarises the feedback received
during the public consultation exercise to gauge views on the
implementation of the OECD's anti-BEPS initiatives that ended
on December 31 2016. More specifically, it explains how the
government intends to implement a new transfer pricing regime
in Hong Kong, which includes mandating the preparation of
transfer pricing documentation based on the three-tier
standardised reporting approach (including a master file, a
local file and a country-by-country (CbC) report).
According to the report, there is overwhelming support from
those who responded to the consultation exercise to codify
transfer pricing rules into the law.
The government plans to introduce a bill for this purpose
into LegCo by the end of 2017. The bill will refer to the
OECD's transfer pricing guidelines and clarify which version of
these guidelines should be followed. The Inland Revenue
Department (IRD) will subsequently issue a departmental
interpretation and practice note (DIPN) to facilitate the
understanding of the "fundamental transfer pricing rule" in the
future. This rule essentially empowers the IRD to adjust the
profits or losses of an enterprise that engages in
non-arm's-length dealings with associated enterprises.
The report sets out a number of key updated proposals, most
notably the relaxation of exemption thresholds for the
preparation of master and local files, which thereby reduces
the compliance burden for taxpayers. Specifically, taxpayers
will not be required to prepare master and local files if they
meet either one of the following two sets of exemption:
1) Size of business (any two of three
criteria per financial year):
- Total annual revenue less than or equal to
HK$200 million ($25.6 million) (originally HK$100
- Total assets less than or equal to HK$200
million (originally HK$100 million); or
- Employees less than or equal to 100.
2) Related party transactions (for that
particular category of transactions per financial year):
- Transfers of properties (excludes
financial assets/intangibles) less than HK$220 million;
- Transactions in financial assets less than
- Transfers of intangibles less than HK$110
- Any other transactions (e.g. service
income/royalty income) less than HK$44 million.
So far, as the threshold for preparation of local files is
concerned, the rules now refer to the size of related party
transaction amounts, with the amounts generally mirroring those
that apply in mainland China. If a taxpayer is exempted from
preparing all types of local files set out in the above, it is
also not required to prepare a master file. This is also in
line with mainland China's exemption provisions.
Although the government has relaxed these initial
provisions, it has maintained its stance on other issues,
namely stating that domestic transactions will still be
included in the transfer pricing regime. There is also no
change to the reporting threshold for filing CbC reports, which
remains at €750 million ($899 million), or about HK$6.8
billion. Parent surrogate filing implementation issues will be
addressed in an upcoming DIPN.
Penalties for incorrect tax returns relating to
non-arm's-length pricing remain the same as those that apply
generally for under-reporting in other tax contexts. These can
amount up to 300% of the tax undercharged if "reasonable
excuse" is lacking, or there is "wilful intent to evade tax".
Unfortunately, the preparation of OECD-compliant transfer
pricing documentation will not automatically lead to a
reduction of penalties. Rather, conditions for penalty
reduction will be based on the actual facts and circumstances,
with transfer pricing documentation being only one of the
factors to be considered. There is no specific mention of
interest being charged in addition to penalties.
The implementation of statutory transfer pricing rules will
likely lead to more disputes, thus there is an anticipated rise
in demand for advance pricing agreements (APAs) and for more
certainty. The bill will give the IRD more flexibility to cater
for unilateral, bilateral and multilateral APAs, whereas
currently only bilateral APAs and multilateral APAs are
considered. Further details of the proposed dispute resolution
mechanism will be set up in the DIPN.
Other key points include:
- Specific provisions will be introduced to
ensure that a person who develops, enhances, maintains,
protects and exploits intellectual property in Hong Kong
(so-called DEMPE functions) will be compensated with a return
calculated on an arm's-length basis;
- Hong Kong will not impose thin
- The bill will not contain any safe harbour
- The time bar for claiming tax credits will
be extended to six years; and
- Taxpayers will be required to take all
reasonable steps to minimise the amount of foreign tax
payable before claiming a tax credit.
The government has reiterated that it will take a pragmatic
approach to minimise the compliance burdens on businesses
arising from the new transfer pricing regime.
In anticipation of these coming mandatory transfer pricing
documentation requirements, taxpayers in Hong Kong will need to
begin proactively assessing, if they have not already done so,
their potential compliance obligations. Also, taxpayers will
need to consider carefully the impact of their related-party
domestic transactions within Hong Kong as well.
Lewis Lu (email@example.com) and
Curtis Ng (firstname.lastname@example.org)
Tel: +86 (21) 2212 3421