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Imminent transformation in Hong Kong’s transfer pricing landscape

By Lu Chen and John Kondos of KPMG in Hong Kong.

On October 26 2016, the Hong Kong government issued a consultation paper on a range of measures including, amongst others, a proposal to introduce specific transfer pricing (TP) rules for Hong Kong (HK). Following Action 13 of the OECD BEPS project, the Hong Kong government is expected to implement a statutory TP regime in Hong Kong, including the adoption of the three-tiered approach to TP documentation – master file, local file and country-by-country reporting (CbCR).

New Hong Kong TP framework


The Hong Kong government's priority is to put in place the necessary legislative framework for TP rules which cover the OECD transfer pricing guidance on value creation/intangibles (Actions 8-10), spontaneous exchange of information (EOI) on tax rulings (Action 5), three-tiered reporting requirements (Action 13) and cross-border dispute resolution mechanism (Action 14) as well as multilateral instruments (MLI) (Action 15).

This will provide a clear legal basis for the Hong Kong Inland Revenue Department (IRD) to address TP issues. As a result, TP in Hong Kong will likely evolve rapidly in response to the Hong Kong government's commitment to align with the OECD BEPS framework and international practices.


As proposed, preparation of both master file and local file is required for enterprises meeting two of the following criteria – annual revenue exceeding HK$100 million ($12.8 million), assets exceeding HK$100 million and workforce exceeding 100 employees. If the enterprise's consolidated group revenue exceeds the equivalent of €750 million (HK$6.8 billion, $836 million), it will have to prepare/have available a CbC report – this is in line with the OECD recommendation.

The TP regime will cover payments for assets and services, financial and business arrangements (e.g. loans) and cost contribution arrangements. Based on the definition of associated enterprise in the consultation paper, HK TP obligations will potentially apply not only to cross-border but also domestic transactions as well. This has resulted in significant industry pushback, many requesting that the new TP documentation requirements not extend to domestic transaction or be phased in much later once companies have adjusted to the new international standards.


Non-compliance with TP rules will render the tax returns incorrect. If there is no TP support, the penalties would follow those in respect of incorrect tax returns provided under sections 80, 82 and 82A of the inland revenue ordinance (IRO). As already stipulated in the IRO, penalties can be up to 300% of the tax undercharged.

TP enforcement/audits

Notwithstanding legislative developments, Hong Kong has already begun active TP enforcement. Companies in a number of industries have been challenged on a variety of related party transactions including IP/royalties. Common challenges are with respect to head office allocation/intra-group services where many financial institutions have also been queried. The most systematic enforcement activity has focused on the asset management sector where profit splits are consistently enforced and controversial challenges in areas such as carried interest persist. All the more demonstrating the IRD's change in mindset and their willingness to take on TP challenges and more rigorously enforce TP.

Dispute resolution (Arbitration/MAP and APA)

The HK BEPS consultation paper states that the MLI seeks to modify Hong Kong's existing comprehensive avoidance of double taxation agreements (CDTA) in order to "implement tax treaty-related BEPS measures in a synchronised and efficient manner." Further, Action 6 – Preventing Treaty Abuse and Action 14 – Improving cross-border dispute resolution mechanism is expected to be addressed in the context of MLI.

With the implementation of statutory TP rules, there will likely be an unavoidable increase in the number of cross-border treaty-related disputes. To address this, the Hong Kong government is proposing "to introduce a statutory mechanism to facilitate the handling of mutual agreement procedures (MAP) and arbitration cases in Hong Kong." If implemented, this could be a useful dispute resolution tool, but it is so far not yet clear what the Hong Kong Government is specifically intending. Naturally there is anticipation to see how this is addressed in the final legislation and guidance.

Other than MAP, KPMG professionals expect taxpayers will increasingly consider advance pricing arrangements (APA) to bring about more certainty in their intercompany pricing. In this regard, the Hong Kong government has expressed its intention to strengthen the APA regime by providing it with a statutory basis and making the programme more workable.

Hong Kong Specific BEPS issues

There are a number of BEPS issues that will affect companies and entities operating in HK. However there are a few notable potential BEPS areas worth elaborating below.

Offshore tax regime

Making offshore claims under Hong Kong's territorial tax system will require corporates to exercise greater care as it could potentially come into increasing conflict with TP regulations. While there is a legitimate basis to make offshore claims in Hong Kong under certain circumstances, Hong Kong corporates will need to carefully consider how this may reconcile with their TP policies and how best to mitigate any potential challenges arising from these arrangements. Those making offshore claims will need to start asking themselves:

  • Are there any economic activities or substance in Hong Kong?

  • Could this lead to red flags when filing a country-by-country report?

  • Is the profit concerned subject to tax in another jurisdiction?

  • Does it create a permanent establishment exposure in a jurisdiction outside of Hong Kong?

Under BEPS, one key concern is foreign tax authorities seeking to tax for themselves Hong Kong offshore income. To address this challenge it is recommended to thoroughly review and address the TP arrangement. By first verifying the arm's length income due to Hong Kong and confirming the appropriate arm's length income that remains in other overseas jurisdictions will help establish that the income recognised in Hong Kong for TP purposes is correct. On that basis any Hong Kong offshore claim applied to the income allocated to Hong Kong is then a matter of Hong Kong domestic tax law and practice.

Clearly there will be many challenges ahead and companies are strongly encouraged to seek TP and corporate tax advice appropriate to their particular facts and circumstances. To help mitigate risk and address appropriately, companies will need to take careful steps to establish their corporate tax/TP positions and put in place a well-established framework.

Intangibles – form and substance

The OECD Transfer Pricing guidance, as revised by Actions 8-10 (i.e., aligning TP outcomes with value creation – adopted by Hong Kong) has wide ranging implications. In the past, the transfer pricing of intellectual property typically focused on the legal ownership first then on the economic ownership (the principal developer). However, the new definition of intangibles under the OECD BEPS project encompasses a much broader scope of functions, namely development, enhancement, maintenance, protection and exploitation (DEMPE). With this broader definition, there is expected to be increased controversy as to how intangible-related income is shared within a multinational group.

Hong Kong is a regional hub for many multinational groups supporting Asian regional activities. For the most part this is limited to coordination and routine support but in some cases this may extend to non-routine functions or DEMPE activities. Taxpayers in Hong Kong will need to make an increased effort to bolster their documentation by clarifying the nature of activities performed in Hong Kong and by related parties outside Hong Kong in order to minimise misinterpretation and avoid unnecessary and protracted tax disputes.

Additionally, the Hong Kong government is engaging in initiatives to foster creativity in intellectual pursuits (e.g., innovation and technology). In response to this and also resulting from supply and value chain operation led restructures, IP migration and IP issues are becoming more pertinent to Hong Kong. Naturally this will necessitate additional TP vigilance by Hong Kong taxpayers.

Corporate treasury centre

Intra-group financing arrangements now form a key part in the TP master file under the OECD BEPS initiatives. Together with the increase in information transparency, these arrangements now need to be properly supported and documented. Companies must assess the robustness of these arrangements and determine an appropriate group financing structure.

Relevant to Hong Kong are the newly introduced Corporate Treasury Centre (CTC) incentives by which Hong Kong is promoting itself as a potential regional treasury hub. To support any treasury hub and any financial transactions in general that relate to Hong Kong, it will become necessary to build additional TP support not just of the interest rate charged, but also on arm's length conditions and appropriate levels of deduction based on capital structure (e.g., debt-to-equity ratios, and possible thin capitalisation).

Preparing for the future

Once Action 13 is fully implemented, the Hong Kong tax authorities will clearly have access to more taxpayer information via the aster file and CbC report and will be able to examine those documents in conjunction with the local file. With greater transparency and awareness of the group as a whole, KPMG professionals expect this would lead to added scrutiny and an increase in challenges from the tax authorities.

As such, taxpayers will need to bolster their Hong Kong local TP files to better reconcile the facts and/or put the local facts in the proper context. If they have not done so already, Hong Kong taxpayers with related party dealings will need to formalise and document their TP arrangements with related parties in light of the forthcoming legislation in line with BEPS principles, and are recommended to do so early enough to be sufficiently ready in time.

Lu Chen



KPMG in Hong Kong

8th Floor, Prince's Building

10 Chater Road

Central, Hong Kong

Tel: +852 2143 8777

Lu is a partner of KPMG's Global Transfer Pricing Services team in Hong Kong. In her transfer pricing career, she has worked in the United States as well as various markets within China, including Shanghai, Shenzhen/Guangzhou and Hong Kong, and has accumulated valuable experience from US, China, and Hong Kong transfer pricing perspectives.

Lu has led various types of transfer pricing engagements including transfer pricing documentation, planning, risk assessment in an M&A or IPO context, advance pricing arrangements (APA), and transfer pricing audit defence, for clients in the consumer market, retail, financial services, and technology industries. These clients include foreign multinationals investing in China as well as some of the leading China or Hong Kong-based companies making investments overseas.

Lu has contributed to numerous articles on China's transfer pricing in professional publications such as the International Tax Review, BNA Transfer Pricing Forum, and the A Plus Magazine. She is also a frequent speaker at both internal and external events on transfer pricing matters.

John Kondos



KPMG in Hong Kong

8th Floor, Prince's Building

10 Chater Road

Central, Hong Kong

Tel: +852 2685 7457

John is the lead partner of KPMG's Global Transfer Pricing Services group for Hong Kong.

John has completed a large number of Advance Pricing Arrangements (APA) as well as transfer pricing audit defence and controversy management across Asia. He has extensive experience in transfer pricing documentation, planning, M&A due diligence, controversy, audit resolution, including competent authority matters. John serves clients in a wide range of industries with a focus on financial services.

Having lived and worked in Asia for over 15 years, John has extensive experience in TP issues across the region with respect to Japan, Korea, Hong Kong, Singapore, Taiwan, China, India, Indonesia, Philippines, Vietnam, Thailand and Australia.

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