Hong Kong's transfer pricing (TP) laws were passed on 04.07.2018 with the Inland Revenue (Amendment) (No. 6) Bill 2017 (Amendment Bill), which comes into force on 13.07.2018. This affirms Hong Kong's commitment to implement OECD's Base Erosion and Profit Shifting (BEPS) initiatives. In the following, Deloitte summaries the important points that businesses should pay attention to as they consider the implications of the changes, and plan for future regulatory compliance.
Hong Kong's Legislative Council on 04.07.2018 passed the Inland Revenue (Amendment) (No. 6) Bill 2017 (Amendment Bill), which comes into force on 13.07.2018 after being signed by the Chief Executive and published in the Gazette. The passing of the Amendment Bill completes the long awaited codification of Hong Kong's transfer pricing (TP) laws, and affirms Hong Kong's commitment to implement OECD's Base Erosion and Profit Shifting (BEPS) initiatives.
The Amendment Bill has been amended since the draft that was issued in December 2017, with a number of amendments made through the Bills Committee Stage, in response to comments received from submitters on the original draft. The Amendment Bill will not be the last word on Hong Kong's TP regulations – the Report of the Bills Committee on this Bill has identified several areas for which further guidance would be issued by the Inland Revenue Department (IRD) through Departmental Interpretation and Practice Notes (DIPN)1 . These are expected to be issued within the coming months, and we will issue tax newsletters on these once they are released.
Our comments below are focused on the key changes since that original draft – as well as important points that businesses should pay attention to as they consider the implications of the changes, and plan for future regulatory compliance.
The Bill codifies Hong Kong's transfer pricing regulations for the first time, and requires that TP regulations in Hong Kong are interpreted in a way that ensures consistency with the OECD TP Guidelines – specifically the 2017 Transfer Pricing Guidelines and Model Tax Convention which incorporate the changes following the BEPS initiatives.
The introduction of formal TP documentation regulations has long been expected for Hong Kong. Implementing TP documentation guidelines in line with BEPS Action 13 ensures consistency for many taxpayers with their international obligations.
The thresholds for preparing documentation have changed since the draft Bill, largely in response to concerns from taxpayers and lawmakers about creating excessive compliance obligations. This has been measured against Hong Kong's intention to maintain a credible and reasonable system that does not draw concerns from the international community on Hong Kong's commitment to the BEPS actions.
Taxpayers will be exempt from the TP documentation requirements (i.e. preparing Master File and Local File) if they meet the following conditions:
The contents of the Master and Local Files remain unchanged from the draft Bill, and are consistent with the BEPS Action 13. The deadline for preparing the Local File and Master File has been extended from 6 months to 9 months after the accounting year-end, and is aligned with the tax return filing deadline. Experience from the first year of documentation in other jurisdictions is that for the first couple of years this additional time will be essential, especially for companies that have never before prepared TP documentation.
Other matters of interest include:
Hong Kong resident ultimate parent companies of multinational enterprises with consolidated revenue over HKD 6.8 billion in the previous year, or Hong Kong entities that are nominated as surrogate filing entities, will be required to prepare and submit the CbC Report to the IRD. Penalties will apply for nonsubmission, including a HKD 50,000 – HKD 100,000 penalty, plus a daily fine of HKD 500.
The Amendment Bill has been amended through the Bills Committee Stage to exempt "specified" domestic related party transactions from the TP rules as well as TP documentation requirements. The changes are set out in Section 50AAJ, which outline that a transaction may not be considered to confer any potential Hong Kong tax advantage if it satisfies the following three conditions:
While the exemption is fairly broad, it is possible that certain domestic transactions may still fall within the TP regulations. Accordingly, Hong Kong taxpayers should study whether their related party arrangements do satisfy all the tests outlined above. Further guidance will be issued by the IRD under a DIPN.
The introduction of the OECD's development, enhancement, maintenance, protection, and exploitation ("DEMPE") framework for evaluating the economic ownership of IP brings Hong Kong into line with the latest global standard. Where a Hong Kong taxpayer performs the DEMPE activities / contributes DEMPE assets, but with legal ownership of the IP held by a non-Hong Kong entity, the Amendment Bill introduces specific provision (i.e. Section 15F) to deem the IP-related income to be a taxable receipt of the Hong Kong taxpayer.
IRD will provide more information in a DIPN following the passage of the Amendment Bill, and has deferred the commencement date by 12 months to the year of assessment 2019/20, to allow taxpayers time to prepare.
The Bill requires that the Authorized OECD Approach (AOA) be used to attribute income and profits to Hong Kong permanent establishments (PE) according to the Separate Enterprise Principle. The Bills Committee specifically commented that the impact of the AOA on financial institutions was a large part of why the implementation has been delayed by 12 months, to the year of assessment 2019/20.
The Amendment Bill codifies the APA regime into the Inland Revenue Ordinance, and provides for unilateral, bilateral and multilateral APAs. The IRD will be allowed to charge fees for an APA application based on the hourly rates of the IRD officers involved, subject to a cap of HKD 500,000.
This is the first time Hong Kong has introduced TP regulations and documentation requirements, and signals that Hong Kong is committed to implementing the minimum standards under the BEPS initiatives. It is expected that Hong Kong will pay further attention to transfer pricing in the future. The key actions for taxpayers include:
1DIPNs are issued by the IRD to provide interpretation and guidance in relation to various tax related issues, and are not legally binding.
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