The Inland Revenue (Amendment) (No. 6) Ordinance 2018 establishes a robust transfer pricing regime in Hong Kong. This ordinance codifies transfer pricing principles, implements measures under the Base Erosion and Profit Shifting (BEPS) package, and aligns Hong Kong's tax regulations with international standards.
Fundamental Transfer Pricing Rules (FTPR)
The Amendment Ordinance introduces fundamental transfer pricing rules (FTPR) based on the arm’s length principle. These rules empower the Inland Revenue Department to adjust the profits or losses of enterprises where intercompany transactions differ from those between independent entities, resulting in tax advantages.
Transfer Pricing Obligation
The Amendment Bill does not include safe harbor rules, meaning businesses of all sizes engaged in domestic or cross-border intercompany transactions must ensure compliance with the arm’s length principle.
Identifying Risk Areas
Companies, particularly multinationals, should be vigilant about certain areas where the Inland Revenue Department (IRD) may apply increased scrutiny:
Prolonged financial losses
Sudden drops in profit margins
Significant transactions involving tax havens
Specific transaction types under scrutiny include:
Inter-company trading: Profits generated outside Hong Kong are exempt from profit tax under the territorial tax system. However, if trading profits are deemed to have no source in Hong Kong, they may not be subject to profit tax. The IRD may challenge such arrangements.
Management services: Many global and regional headquarters in Hong Kong charge fees for services like HR, legal, and accounting to affiliated enterprises. The IRD often argues these fees should be higher, attributing more profit to Hong Kong.
Penalties
Incorrect transfer pricing can result in significant penalties, including a fine of HKD 10,000 (US$1,200) and an additional charge of 100% to 300% of underpaid taxes. Deliberate wrongdoing can lead to more severe penalties, including a HK$50,000 (US$6,300) fine, 100% to 300% additional charges on underpaid taxes, and up to three years of imprisonment. The IRD adheres to a statute of limitations of six years, except in cases of fraud or tax evasion.
Transfer Pricing Documentation
The Amendment Ordinance mandates documentation based on the three-tiered approach: Country-by-Country (CbC) Reporting, Master File, and Local File.
Requirements and Exemption Thresholds for Master File and Local File
Entities in Hong Kong must prepare a Master File and Local File for each accounting period starting on or after April 1, 2018. These files must be completed within nine months after the end of the accounting period and retained for at least seven years. Exemptions are available based on business size and controlled transaction thresholds.
Exemption Based on Business Size
Threshold (million HK$) per financial year | Total Revenue | Total Asset | Employees |
≤ 400 | ≤ 300 | ≤ 100 |
Exemption Based on Controlled Transactions
Threshold (million HK$) per financial year | Transfer of Properties | Transactions in Financial Assets | Transfer of Intangibles | Other Transactions (e.g., service income/royalty) |
≤ 220 | ≤ 110 | ≤ 110 | ≤ 44 |
Country-by-Country Reporting
Country-by-Country (CbC) Reporting is a minimum standard under OECD's BEPS Action 13. It applies to multinational enterprise groups (MNE groups) with annual consolidated group revenue of HK$6.8 billion (US$767 million) or more.
The primary obligation to file a CbC Return falls on the ultimate parent entity (UPE) resident in Hong Kong. Hong Kong entities of a Reportable Group with a non-resident UPE must file a CbC Return under certain conditions. Notifications must be filed within three months after the end of the accounting period, and CbC Returns must be filed within 12 months after the end of the relevant accounting period. Service providers may be engaged to file these returns.
Optimize your transfer pricing strategy and ensure compliance with Hong Kong’s stringent regulations to avoid penalties and scrutiny.
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