Hong Kong's New Transfer Pricing Requirements and What to Do Now
Anna Eriksson, Manager, International Transfer Pricing
In recent years, countries around the world have been issuing new transfer pricing requirements or modifying existing regulations to prevent multinationals from artificially shifting profits to low- or no-tax jurisdictions to avoid paying taxes. The OECD’s Base Erosion and Profit Shifting (BEPS) project, including its final 2015 reports, has in many ways served as a catalyst for changes in local transfer pricing regulations. Over 120 countries, for example, have joined the Inclusive Framework on BEPS to collaborate on the implementation of the BEPS package.
Hong Kong is one of the latest countries to join this trend. Important parts of the new transfer pricing regulations, including the domestic transfer pricing documentation and reporting requirements, are summarized in this post.
The Arm’s Length Principle
Hong Kong’s new transfer pricing legislation incorporates the OECD’s arm’s length principle. The arm’s length principle is set forth in Article 9 of the OECD Model Tax Convention. It provides tax authorities with the option to adjust profits or losses of enterprises in cases where the conditions of commercial or financial relations differ from those that would have been made between independent enterprises, and those conditions have created a tax advantage. The arm’s length principle looks to ensure that associated enterprises (that is, enterprises under the same ownership) engage in cross-border transactions in a manner that reflects market realities.
The inclusion of the arm’s length principle in Hong Kong’s new regulations allows the Inland Revenue Department (IRD) to adjust the profit or loss of a Hong Kong-based company in cases where a tax advantage has emerged due to related-party transactions occurring on non-arm’s length terms. Domestic transactions between associated companies are exempted from the new rules, provided certain criteria are met.
Hong Kong’s Transfer Pricing Documentation and Reporting Requirements
Hong Kong entities must under the new rules prepare master file and local file documentation. As specified in the OECD’s Action 13 Final Report, the master file provides standardized information relevant for all multinational enterprises (MNEs) of a group, including its overall transfer pricing policies and global allocation of income and economic activity. The local file, on the other hand, supplements the master file and provides additional detail about specific intercompany transactions.
To fulfill Hong Kong obligations, master file and local file documentation must be prepared for accounting periods starting on or after April 1, 2018, provided two of the following three business-size thresholds are met:
- The total amount of the entity’s revenue for the year exceeds HK$400 million (about US$51 million)
- The total value of the entity’s assets exceeds HK$300 million (about US$38 million)
- The average number of employees exceeds 100
The new rules also contain certain transaction-size thresholds. A Hong Kong entity is required to prepare transfer pricing documentation for a particular category of transaction only if the following thresholds are met for that particular type of transaction:
- HK$220 million (about US$28 million) for transfers of properties (not including financial assets or intangibles)
- HK$110 million (about US$14 million) for financial asset transactions
- HK$110 million (about US$14 million) for transfers of intangibles
- HK$44 million (about US$5 million) for all other transactions
If the transaction thresholds are not fulfilled for any of the above transaction types, the Hong Kong entity is not required to prepare a master file or local file. If, on the other hand, the business-size thresholds as well as the specific transaction thresholds are met, a master file must be prepared in addition to a local file for those specific transactions.
The documents must be prepared within nine months after the end of the entity’s accounting period. For entities with a December 31 accounting year-end, the first year of application would be the accounting year ending December 31, 2019, with the completion of the transfer pricing documents by September 30 of the following year.
Hong Kong has also implemented country-by-country (CbC) requirements that apply to Hong Kong ultimate parent entities (UPEs) of multinational groups reporting consolidated revenues of at least HK$6.8 billion (about US$868 million). The CbC report must be prepared for accounting periods beginning on or after January 1, 2018. Hong Kong companies, being constituent entities, instead need to file a notification with the local tax authority within three months following the end of the UPE’s accounting period.
What to Do Now
All MNEs with Hong Kong-based operations should review their intra-group positions and specific transfer pricing policies and practices in light of Hong Kong’s new regulations.
Given the global trend of increasing transfer pricing requirements, MNEs should also be aware of the application of these requirements to their domestic and international operations. This is especially critical as tax authorities all over the world are increasing their enforcement efforts.