Thoughts from the Fiscal Front
New Transfer Pricing Rules
Transfer pricing

By Martin Richter, Hong Kong Transfer Pricing Leader, Ernst & Young Tax Services

On 29 December 2017, the HKSAR Government gazetted the long-awaited Inland Revenue (Amendment) (No.6) Bill 2017. The first reading and commencement of second reading debate of this Amendment Bill were held at the Legislative Council on 10 January 2018. 

The main objectives of the Amendment Bill are to codify certain transfer pricing principles into the Inland Revenue Ordinance (Cap.112), introduce transfer pricing documentation requirements, and implement other minimum standards of the Base Erosion and Profits Shifting (BEPS) package promulgated by the OECD. These include improving dispute resolution mechanisms and amending any incentive programs that may be perceived as having harmful characteristics. 

Transfer pricing regulatory regime
Core to the transfer pricing regulatory regime will be the introduction of a Fundamental Transfer Pricing Rule (FTPR), which will require intercompany transactions between associated enterprises (as well as dealings between a head office and its branches) to be conducted at arm’s length. In other words, they must be consistent with arrangements that would be expected to prevail between independent parties operating at arm’s length from each other engaged in similar transactions. 

The arm’s length principle should be defined and determined in a manner consistent with the 2017 version of the OECD Transfer Pricing Guidelines and the 2014 OECD Model Tax Convention. The FTPR will apply from assessment periods on or after 1 April 2018.

In applying the FTPR, the Inland Revenue Department (IRD) will be empowered to adjust a taxpayer’s profits upwards and losses downwards on non-arm’s length transactions with an associated person, where the taxpayer is considered to have gained a Hong Kong tax advantage from such non-arm’s length arrangements. 

The scope of the proposed provisions will apply to both domestic and cross-border transactions involving tangible assets, intangible assets, financial assets, services, as well as financial and business arrangements between different parts of an enterprise. No safe harbors will apply with respect to the FTPR, meaning that any taxpayer, whether small or large, engaged in intercompany transactions of any size, will be required to ensure that transfer prices are at arm’s length.

Where taxpayers are assessed to have filed returns with transfer prices not consistent with the arm’s length principle, new penalty provisions will apply. These will comprise of administrative penalties (ranging from Level 3 HK$10,000 to Level 6 HK$100,000) plus an adjustment amount up to the amount of tax adjusted. These penalty arrangements are less than those typical for other tax offenses, which offer an adjustment up to three times of the amount of tax adjusted.

Transfer pricing documentation
A further pillar of the Amendment Bill is the adoption of the OECD’s recommended three-tiered documentation structure comprising of a country-by-country reporting (CbCR), master file (MF) and local file (LF). 

All three forms of documentation are to be prepared in a manner consistent with the content requirements and formats outlined by the OECD Transfer Pricing Guidelines. Ultimate parent entities (UPE) of multinational groups that are resident in Hong Kong with consolidated turnover of HK$6.8 billion (i.e. reportable groups) will be required to prepare and submit CbCR for accounting periods beginning on or after 1 January 2018, for filing 12 months after the end of the accounting period. 

The CbCR filing mechanism also extends to a Hong Kong constituent entity (HKCE) of a reportable group being nominated as the surrogate parent entity (i.e. surrogate filing) and HKCE of a reportable group that is not the UPE under certain circumstances (i.e. secondary filing). A written notification containing information relevant for determining the obligation for filing a CbCR must be filed to the IRD within three months after the end of the relevant accounting period. 

As for MF and LF, all companies carrying on a trade or business in Hong Kong are required to prepare these reports for accounting periods beginning on or after 1 April 2018, and be ready within six months of the year end unless they meet one of the exemptions available. MF and LF reports can be prepared in either in English or Chinese, and should be retained by taxpayers for at least seven years. Failure to prepare such documentation and/or providing misleading, false or inaccurate information may render criminal and/or civil penalties.


Advanced Pricing Arrangement 
The Amendment Bill puts in place a statutory Advanced Pricing Arrangement (APA) regime which allows for unilateral, bilateral and multilateral APA applications. Certain changes have been made to introduce fees chargeable by the IRD to applicants, including hourly service charges for time spent by IRD officials processing applications.

Foreign tax credit claim and Mutual Agreement Procedures 
The Amendment Bill proposes to enhance the current tax credit system by extending the period of claiming tax credit from two years to six years, provided that a taxpayer has taken all reasonable steps to minimize the amount of foreign tax payable before resorting to tax credit.

In addition, the introduction of a statutory dispute resolution mechanism in the Amendment Bill mandates the Commissioner to give effect to any solution and agreement reached in a Mutual Agreement Procedure.

Incentive programs
The Amendment Bill also outlines provisions to amend the structure of certain incentive programs available in Hong Kong, including corporate treasury centers, professional reinsurers, captive insurers, ship owners, aircraft lessors and aircraft leasing managers. In particular, the Amendment Bill seeks to remove any ring fencing of such incentives such that there is an extension of coverage to domestic profits, and to introduce certain substantial activities requirements. 

Viewed broadly, the Amendment Bill will provide clearer regulations on the implementation and enforcement of Hong Kong’s transfer pricing regime. It is a significant development that demonstrates Hong Kong’s commitment to combat cross-border tax avoidance, ensuring Hong Kong will avoid being placed on any international blacklists by the OECD or European Union. 

Nevertheless, while the legislative changes are intended to be aligned with the BEPS package without compromising Hong Kong’s simple and low tax regime, the Amendment Bill is significantly more comprehensive and complex than expected. Going forward, it is expected that the IRD will issue more in-depth guidance. Yet, another point to note is whether the IRD has sufficient resources to implement and safeguard such changes.  

The harmonization of transfer pricing documentation into an OECD-compliant MF and LF will require additional efforts from multinational groups and likely result in an increase in the compliance burden. 

Multinational corporations or any enterprises with intercompany activities should review their existing operating and tax/transfer pricing structures to evaluate their ability to manage the new rules and obligations, as well as seek professional advice if necessary. 

This article contains information in summary form and is intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Member firms of the global EY organization cannot accept responsibility for loss to any person relying on this article. 


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