On July 1 2021, 130 countries approved a statement providing a framework for reform of the international tax rules. These countries are members of the OECD/G20 Inclusive Framework on BEPS (IF), comprising 139 countries. The statement sets forth the key terms for an agreement of a two-pillar approach to reforms and calls for a comprehensive agreement by the October 2021 G20 Finance Ministers and Central Bank Governors meeting, with changes coming into effect in 2023.
Pillar one of the agreement is a significant departure from the standard international tax rules of the last 100 years, which largely require a physical presence in a country before that country has a right to tax. Pillar two secures an unprecedented agreement on a global minimum level of taxation which has the effect of stipulating a floor for tax competition among jurisdictions.
The five-page statement reflects high-level agreement on key political questions and design features of pillars one and two following a two-day meeting of the IF. The statement diverges in important respects from the pillar one and pillar two blueprints, released by the IF in October 2020. However, in a number of respects the statement builds on the blueprints and resolves some of the key open items from the blueprints. Please refer to KPMG’s Initial Response Level Agreement on Pillar One and Pillar Two for further details.
How will this impact Hong Kong SAR?
Hong Kong SAR operates a simple and low tax system, characterised by a territorial taxation principle under which foreign sourced income of a company is exempt from Hong Kong SAR profits tax, capital gains are not taxed and there is a relatively low headline rate of corporation tax (i.e. currently 16.5%). This may cause a considerable reduction in a company’s effective tax rate (ETR). Hong Kong SAR also currently offers some incentives which may also bring down a company's ETR to below 15%.
With a proposed global minimum tax rate of 15%, it is expected that a significant number of large multinational enterprise (MNE) groups (mainly groups with a total consolidated group revenue above €750 million although parent jurisdictions may choose to apply lower thresholds) with presence in Hong Kong SAR will be adversely affected by the pillar two proposals. Many MNEs operating in Hong Kong SAR may also be taking advantage of incentives and tax breaks in other jurisdictions, and these will also need to be factored in to understand the overall impact of the proposals.
Hong Kong SAR entities could effectively end up being subject to ‘top up tax’ in the MNE parent entity jurisdiction on income that is exempt or subject to a reduced corporate tax rate in Hong Kong SAR where the combined ETR of the entities within Hong Kong SAR is less than the global minimum tax rate of 15%.
The subject-to-tax-rule (STTR) is also expected to impact many Hong Kong SAR entities on their cross-jurisdictional transactions. Where interest, royalties or certain services payments received from foreign related parties are subject to no or low tax in Hong Kong SAR, the source jurisdiction may apply withholding tax to bring the total up to the STTR minimum rate (proposed to be between 7.5% and 9%). There is no jurisdictional blending for this rule, and it is applied on a transaction basis so it would need to be considered regardless whether the entity has an ETR of 15% or above.
Although no public commitments have been made by the Hong Kong SAR government, the Hong Kong SAR government has previously confirmed that it will actively implement the BEPS 2.0 proposals ‘according to international consensus’, whilst emphasising that it will work to maintain the simplicity, certainty, fairness and minimise the compliance burden of its tax regime.
Separately, the EU has expressed concern about foreign-sourced income exclusions. The combined impact of these initiatives may result in significant changes to Hong Kong SAR’s tax system, at least for large multinationals.
Hong Kong SAR MNEs or foreign MNEs with Hong Kong SAR subsidiaries should now therefore be undertaking the preparatory work necessary to be ready to comply with these rules in a little over 18 months. Some key activities for tax leaders in Hong Kong SAR to undertake, may be:
- Model at high level the impact of BEPS 2.0 proposals on existing use of preferential regimes and offshore profits and capital claims and communicate with the C-suite and other stakeholders;
- To the extent a consultation process is opened by the Hong Kong SAR government, engage in the consultation process to keep informed and help to shape the evolution of potential response measures in Hong Kong SAR; and
- Begin the process of planning ahead for the necessary changes in legal entity and supply chain structures along with the significant overhaul of systems and processes required in order to be ready to comply from 2023.
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