International Tax Review (ITR): What advice would you give to companies about how to reduce the risk of becoming involved in a tax dispute with IRD?
Tracy Ho (TH): To avoid tax disputes with the IRD, taxpayers should make proper disclosures in their tax filings and maintain sufficient documents to substantiate the tax positions taken.
For multinational companies that have a large volume of transactions with related parties, they should ensure that these dealings are transacted on an arm's-length basis. Although transfer pricing documentation is not mandatory under the current tax law, taxpayers are advised to keep contemporaneous records on how prices between related parties are determined, which should be produced upon request by the IRD.
Taxpayers can apply to the Commissioner of Inland Revenue (CIR) for an advance ruling on how a provision of the Inland Revenue Ordinance (IRO) will apply to a contemplated arrangement.
The CIR's ruling is final and binding on the CIR. However, each ruling is confined to its specific terms and cannot be relied upon as a precedent for similar arrangements or for a future ruling application, regardless of how similar the facts of that application may be to the issued ruling.
For transfer pricing matters, multinationals can consider using the advance pricing arrangement (APA) services, recently launched by the IRD, to obtain certainty for related party transactions. However, the IRD is only prepared to consider bilateral or multilateral APAs, and unilateral APAs would only be considered under certain exceptional conditions.
ITR: What options do Hong Kong taxpayers have to resolve disputes with the IRD other than litigation?
TH: While litigation is normally the last resort, the first thing a taxpayer should do if aggrieved by a tax assessment is to file an objection within one month of the date the assessment is issued so as to keep their objection rights and litigation options open.
Before a tax assessment is determined against a taxpayer by the CIR, thus triggering the litigation process, there would be correspondence and negotiation between the tax assessor and the taxpayer.
During the correspondence negotiation process, it is important for the taxpayer to establish the relevant facts and put forward its legal argument supporting the tax position it took on a particular issue and understand the tax assessor's counter argument and view on the issue.
Since many tax issues may fall into the grey area, it is often possible to negotiate a compromised settlement with the tax assessor, even if the taxpayer cannot completely win over the tax assessor on the issue. This is particularly true where numerous tax issues are under dispute, so that the tax assessor and the taxpayer have more scope to give and take on the issues concerned.
The positives of a compromised settlement are that it would be flexible and could also deal with the penalty issues involved in the dispute. The negatives are that such a settlement may have to be negotiated year after year, taking into account the relevant factors that may be specific to the year concerned.
ITR: Are you seeing any trends in the types of dispute cases which the IRD is taking up, and those where it is succeeding in the courts?
TH: It appears the IRD is increasingly disputing offshore claims for the source of profits; tax treatment which is inconsistent with the accounting treatment of the item concerned; and arrangements perceived as tax avoidance and therefore challengeable under the general anti-avoidance provision of the IRO.
On source of profits, the IRD has a few successes in the courts and the tax tribunal in re-characterising the nature of the income based on the peculiar facts of a case.
For example, in the Kim Eng case, the IRD successfully challenged in the courts that the income earned by the taxpayer was not in reality commission income earned for the execution of securities trades on the Singapore Stock Exchange (which would be non-taxable offshore income in Hong Kong), but a profit-sharing arrangement undertaken by the taxpayer in Hong Kong to circumvent the rules of the Singapore Stock Exchange and, therefore, taxable onshore income in Hong Kong.
From late 2007 to 2009, there were four Court of Final Appeal cases in which the CIR successfully invoked the general anti-avoidance provision to challenge that the sole or dominant purpose of the taxpayers for entering into the transactions in question were for obtaining a tax benefit. These decisions have been viewed as rendering the general anti-avoidance provision of the IRO a more powerful and flexible weapon for the CIR to attack aggressive tax arrangements carried out by taxpayers.
However, in the Nice Cheer case, the CIR has so far been unsuccessful in seeking to tax the unrealised year-end revaluation gains in respect of trading securities recognised through the profit and loss account of the taxpayer. The CIR has now lodged his appeal of the case to the Court of Final Appeal, the hearing date being scheduled in October 2013.
ITR: What do you think multinationals in Hong Kong can expect from the IRD in future?
TH: In addition to the expected continuation of the trends identified above, we expect the IRD's audit focus in the next couple of years will be on transfer pricing. In the past three years, Hong Kong has concluded more than 20 comprehensive double taxation agreements with other jurisdictions, all of which contain specific provisions dealing with transfer pricing. In fact, the IRD has recently devoted one senior assessor and three assessors to specifically handle transfer pricing issues and its launch of the APA services in Hong Kong.
For the time being, alternative dispute resolution and real-time reporting for large taxpayers do not appear to be on the agenda of the IRD.
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