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Hong Kong Publishes Ordinance Implementing BEPS Measures Including New Transfer Pricing Rules, Master and Local File Requirements, and CbC Reporting

On 13 July 2018, the Hong Kong Government announced the publication of the Inland Revenue (Amendment) (No. 6) Ordinance 2018 in the Official Gazette, which primarily implements the minimum standards of the BEPS project. The main aspects of the Ordinance are summarized as follows:

Transfer Pricing

The OECD's transfer pricing rules are codified into the Inland Revenue Ordinance (IRO) so that both domestic and cross-border transactions between associated enterprises will be taxed on the basis that they are effected at arm's length. This includes reference to the 2017 OECD Transfer Pricing Guidelines and the OECD commentary on the associated enterprises article of the OECD Model Convention.

In general, the rules relating to the computation of income or loss for provision between associated enterprises on an arm's length basis will apply in relation to a year of assessment beginning on or after 1 April 2018, while rules relating to the attribution of income or loss to permanent establishments of non-Hong Kong resident persons as if the permanent establishment were a distinct and separate enterprise will apply in relation to a year of assessment beginning on or after 1 April 2019. Further, rules will apply from 1 April 2019 to ensure that a person carrying out the functions of development, enhancement, maintenance, protection or exploitation (DEMPE) for an IP in Hong Kong will be taxed on the basis of that person's contribution in carrying out such functions.

APA Regime and Advance Rulings

New provisions are introduced to formularize an advance pricing agreement (APA) regime for unilateral, bilateral, and multilateral APAs. For each application, the applicant is required to pay fees that include a service charge calculated on the basis of each hour spent by IRD officers (capped at HKD 500,000) and payment or reimbursement of other fees or expenses related to the application. The applicant may be demanded to pay a deposit before the application is entertained. The deposit paid will be applied to settle the fees payable upon the determination of the application.  

In addition, the fees payable for advance ruling applications are adjusted. The new application fees are HKD 45,000 for a ruling on territorial source principle and HKD 15,000 for a ruling on other matters.

Permanent Establishment and Control

A new Schedule is introduced on the meaning of permanent establishment, including that where there is an applicable tax treaty, the treaty definition of permanent establishment will apply, and where there is not an applicable tax treaty, a definition in line with OECD standards, as provided in the new schedule, will apply. The new Schedule also provides an interpretation of closely related for the purpose of the Schedule, including that a person is closely related to another person if one has control of the other or directly or indirectly holds more than a specified interest in the other, or a third person or enterprise controls or holds more than a specified interest in both persons. Specified interest means 50% of the beneficial interest in a person or, if the person is a company, 50% of the aggregate vote and value of the company's shares or of the beneficial equity interest in the company.

Penalties for Failing to Make Returns, Making Incorrect Returns, etc.

Changes are made in the penalties for failing to make returns, making incorrect returns, etc. This includes a change from a penalty of treble the amount of undercharged tax to just the undercharged amount (level 3 fine maintained – HKD 10,000), as well as new offences for failing to comply with various provisions, including in respect of double taxation and other relief, mutual agreement procedures, advance pricing agreements, and recordkeeping.

Master and Local File

Master file and Local file requirements are introduced in line with OECD guidelines for accounting periods beginning on or after 1 April 2018. The documentation must be prepared within 9 months following an accounting period in English or Chinese and kept for at least seven years. Taxpayers are generally required to prepare the documentation if engaged in controlled transactions, with exemptions applying as follows:

  • Exemption for specified domestic transactions: A Local file is not required to cover specified domestic transactions between associated enterprises, subject to certain conditions, and such transactions are not included in determining the controlled transaction amounts below;
  • Exemption based on the size of business: An entity that satisfies any two of the three conditions below will not be required to prepare a Master file or Local file:
    • The total revenue of the entity during the accounting period is not more than HKD 400 million;
    • The total assets of the entity at the end of the period is not more than HKD 300 million; and
    • The average number of the entity's employees during the period is not more than 100 employees;
  • Exemption based on controlled transactions: If the amount of a category of controlled transactions for the relevant accounting period is below the prescribed threshold, an enterprise will not be required to prepare a Local file for that particular category of transactions (if threshold not met in respect of all categories, exemption from Master file also applies):
    • Transfers of properties (whether movable or immovable but excluding financial assets and intangibles): HKD 220 million;
    • Transactions in respect of financial assets: HKD 110 million;
    • Transfer of intangibles: HKD 110 million;
    • Other transactions (e.g., service income and royalty income): HKD 44 million.

CbC Reporting

Country-by-Country (CbC) reporting requirements are introduced from 1 January 2018. Key points of the requirements are as follows:

  • If the ultimate parent is resident in Hong Kong, the CbC reporting requirement applies for MNE groups meeting an HKD 6.8 billion annual consolidated group revenue in the previous accounting period;
  • If the ultimate parent is not resident in Hong Kong, the requirement applies based on either the threshold specified by the ultimate parent's jurisdiction or, if there is no CbC reporting requirement in the ultimate parent's jurisdiction, the EUR 750 million equivalent of the currency of the ultimate parent's jurisdiction as at January 2015;
  • A primary filing obligation applies for ultimate parents resident in Hong Kong, and a secondary (local) filing obligation applies for constituent entities in Hong Kong if:
    • The ultimate parent entity is resident in a jurisdiction that does not require the filing of CbC reports;
    • The ultimate parent's jurisdiction has an international agreement with Hong Kong providing for automatic exchange, but does not have an agreement for the exchange of CbC reports by the filing deadline; or
    • There has been a systemic failure for exchange, and this has been notified to the Hong Kong constituent entity;
  • The local filing obligation will not apply if a CbC report is filed by another group entity in Hong Kong or a CbC report is filed by a surrogate parent in another jurisdiction and that jurisdiction has a CbC report exchange arrangement with Hong Kong;
  • All group entities in Hong Kong must file a notification within 3 months after the end of the accounting period that includes details of the group entities in Hong Kong, including whether an entity is the ultimate parent, surrogate parent, or otherwise required to file a CbC report, as well as details of the foreign ultimate parent and surrogate parent if applicable (a Hong Kong entity is not required to file notification if another entity has filed by the deadline);
  • The content of the CbC report is in line with the OECD guidelines, and the report must be filed electronically (CbC notification also filed electronically);
  • The deadline to file CbC reports is 12 months after the accounting period or the deadline as may be set in a notice from the tax authority;
  • Sufficient records to enable the accuracy and completeness of the CbC report must be kept and maintained for at least six years;
  • A voluntary filing arrangement is provided whereby the ultimate parent entity of an MNE group that is resident in Hong Kong is allowed to voluntarily file its CbC reports in respect of an accounting period beginning on or after 1 January 2016 but before 1 January 2018;
  • Specific administrative penalties apply for failing to comply with the CbC reporting and notification requirements, including a level 5 fine (HKD 50,000) for failing to file or filing incorrect information, a level 6 fine (HKD 100,000) if failing to file after a court order, and imprisonment up to three years when there is intent to defraud (similar penalties also provided for service providers).

Dispute Resolution

A statutory dispute resolution mechanism is introduced to replace the current mechanism that relies on administrative rules in the Departmental Interpretation and Practice Notes of the Inland Revenue Department (IRD). This allows a taxpayer to present a case for MAP and/or arbitration under a relevant tax treaty and provides that the Commissioner must give effect to any solution unilaterally arrived at by the Commissioner or agreement reached with the other tax authority concerned in the course of the MAP or arbitration, and any decision delivered by arbitrators in the case of arbitration.

Double Taxation Relief

The tax credit system is enhanced to address double taxation, including:

  • An extension of the period for claiming a tax credit from two years to six years;
  • The requirement that a taxpayer minimize its foreign tax liability by making full use of all other available relief under applicable tax treaties and the local legislation of foreign jurisdictions before resorting to tax credits;
  • The requirement that taxpayers notify IRD of any adjustment to their foreign tax payments that may result in a tax credit granted being excessive; and
  • The removal of the option for unilateral relief in the form of an exclusion in cases where there is an applicable tax treaty and a credit for foreign tax paid is provided.

Countering Harmful Tax Practices

Certain changes are made with regard to BEPS Action 5 (Countering Harmful Tax Practices). This includes the amendment of the preferential tax regimes for corporate treasury centres (CTC), professional reinsurance, and captive insurance by extending the half-rate concessions of these regimes that applied only to profits derived from foreign transactions to also apply to profits derived from domestic transactions from the year of assessment 2018/19 onwards. Further, the IRD Commissioner is empowered to issue a notice on the introduction of substantial activities requirements in the tax regimes for CTC, professional reinsurers, captive insurers, ship-owners, aircraft lessors and aircraft leasing managers, which will entail detailed thresholds (i.e. minimum number of full-time qualified employees and minimum amount of operating expenditure).

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