Hong Kong SAR: What do the latest pillar two rules mean for businesses?
Lewis Lu and John Timpany of KPMG China discuss the potential impact of the GloBE model rules on businesses from a Hong Kong SAR tax perspective.
On December 20 2021, the OECD/G20 Inclusive Framework (IF) on BEPS released the anticipated global anti-base erosion (GloBE) model rules which consist of the income inclusion rule (IIR) and the undertaxed payment rule (UTPR). The GloBE model rules differ in a number of areas from the original October 2020 blueprint on pillar two. It is anticipated that the explanatory commentary on the GloBE rules and the subject-to-tax rule will be released early 2022.
The latest GloBE model rules and how this may affect businesses in Hong Kong SAR are discussed, along with the general issues for Hong Kong SAR businesses to consider.
Domestic top-up tax
Jurisdictions can introduce a domestic top-up tax regime that operates in a way consistent with the outcomes of the GloBE rules. Instead of being treated as a covered tax, the domestic top-up tax payable under such regime will be credited against the GloBE top-up tax to come up with the jurisdictional top-up tax amount. This means that even if a multinational enterprise (MNE) group’s jurisdictional effective tax rate (ETR) in Hong Kong SAR reaches 15% due to any domestic tax regime (DMT) regime in Hong Kong SAR, the group’s compliance burden of computing the jurisdictional top-up tax amount is not relieved unless a safe harbour linked to the presence of such DMT regime will be introduced.
The Hong Kong SAR government has indicated it will look at measures to capture tax on activities in Hong Kong SAR. How this tax would be treated for the GloBE rules purposes will need to be carefully considered.
The expanded scope of the UTPR
The UTPR can now be applied to deny deduction (or make an equivalent adjustment in form of a deemed taxable income or an additional tax) of all tax-deductible payments (including payments made to unrelated third parties) instead of related-party payments only.
In addition, the maximum amount of UTPR top-up tax allocated to a constituent entity (CE) will no longer be limited by the amount of related party payments made. This means MNE groups will have little room to mitigate the UTPR tax exposure by rearranging the flow of their intra-group payments. This also signifies a policy shift from using the UTPR to address the BEPS issue arising from intra-group payments (from high-taxed CE to low-taxed CE) to using the UTPR as a means to ensure the low-taxed income of a MNE group is subject to tax at the minimum rate of 15%.
Treatment of tax losses
Tax losses carried forward are common in many groups operating in Hong Kong SAR, as Hong Kong SAR does not have any group tax consolidation rules. The GloBE rules treat the deferred tax asset arising from prior year tax losses (recast at the lower of the 15% minimum rate and the domestic income tax rate in general) as a covered tax, excluding the impact of any valuation adjustment or accounting recognition adjustment. There is an option to use a GloBE loss election which provides an alternative deemed deferred tax asset. The potential benefit of making such election should be explored.
Significance of accounting policies and treatments
The adjusted deferred tax accounting approach is now used to deal with accounting (book) to tax timing difference. In addition, the accounting treatments of certain items (e.g. whether to adopt the fair value accounting approach in respect of an asset or recognise an income in the profit and loss or other comprehensive income) may impact the computation of the jurisdiction ETR in a given year.
As such, in-scope MNE groups should review the accounting policies and treatments currently adopted and consider whether any changes will be desirable.
The release of the GloBE model rules brings the international community one step closer towards the implementation of an unprecedented global minimum tax of 15% under the BEPS 2.0 project.
The model GloBE rules are complex and can have significant impact on in-scope MNE groups. Given the implementation timeline of the rules in 2023, tax leaders need to understand the potential impact of the rules on their groups. Tax leaders should also consider the pillar two impact together with the impact of the upcoming changes to the Hong Kong SAR tax system as a response to the EU’s grey list for tax purposes.
For further details on the impact of GloBE model rules on industry-specific issues from a Hong Kong SAR tax perspective, please see KPMG’s BEPS publication here.
Partner, KPMG China
Partner, KPMG China