As stated in the Consultation Report on Measures to Counter Base Erosion and Profit Shifting (BEPS) issued by the Hong Kong Government, a new transfer pricing regulation is proposed and an amendment bill for the new transfer pricing regulation is to be introduced into the Legislative Council by the end of 2017. The proposed new transfer pricing regulation stipulates that enterprises operating in Hong Kong transact with their associated enterprises (including head office and branches within the same entity) in and outside Hong Kong on an arm’s length basis. The Inland Revenue Department will issue a practice note to provide a better understanding of the new transfer pricing regulations upon passage of the amendment bill.
Among other things, the proposed new transfer pricing regulations require the preparation of transfer pricing documentation (i.e. master file, local file and country-by-country (“CbC”) report). The master file provides a high-level overview of the group of enterprises, including the global business operations, transfer pricing policies and global allocation of income, whereas the local file provides detailed transactional transfer pricing information specific to the enterprise. The CbC report, which is to be exchanged automatically between tax administrations under qualifying competent authority agreements, provides certain information relating to the tax jurisdictions in which the multinational enterprise group operates.
The proposed new transfer pricing regulations shall require enterprises operating in Hong Kong that engage in transactions with their associated enterprises to prepare annual master and local files, but such preparation in relation to the accounting year is exempt if the following criteria are satisfied:
(a) Exemption based on size of business
The enterprise will be exempt from preparing master and local files if any two of the three conditions below for the relevant accounting year are satisfied:
(i) Total annual revenue not more than HK$200 million;
(ii) Total assets not more than HK$200 million;
(iii) Not more than 100 employees.
(b) Exemption based on related party transactions
If the amount of a category of related party transactions for the relevant accounting year is below the proposed threshold as noted below, the enterprise will not be required to prepare a local file for that particular category of related party transactions.
- Transfer of properties (other than financial assets and intangibles): HK$220 million;
- Transaction of financial assets: HK$110 million;
- Transfer of intangibles: HK$110 million;
- Any other transaction (e.g. service income and royalty income): HK$44 million.
If the enterprise is fully exempt from preparing a local file (i.e. its related party transactions of all categories are below the prescribed thresholds), it will not be required to prepare the master file either.
It is proposed that the CbC report will only have to be filed by the multinational enterprise group in relation to an accounting year if the consolidated group revenue for the preceding accounting year is at least EUR750 million (or HK$6.8 billion based on the exchange rate as of January 2015), and the group has constituent entities or operations in two or more jurisdictions. The Hong Kong entity will be the entity filing the CbC report if it is the ultimate holding company of the group, whilst the Hong Kong constituent entities of the group could be subject to secondary filing obligations if the ultimate parent entity is in a jurisdiction that neither requires the filing of CbC reports nor exchanges such reports with Hong Kong.
Penalties for non-compliance
The proposed new transfer pricing regulations will also contain a penalty provision under which non-compliance will render the tax returns incorrect. The penalties proposed (per offence) are up to HK$10,000 plus 3 times the tax undercharged for filing tax returns with incorrect information on transfer pricing without reasonable excuse, and up to HK$50,000 plus 3 times the tax undercharged and three years’ imprisonment for filing tax returns with incorrect information on transfer pricing willfully with intent to evade tax.
As the proposed thresholds for transfer pricing documentation are relatively high, it is expected that the majority of enterprises operating in Hong Kong would be exempt from preparing transfer pricing documentation if the new transfer pricing legislation is enacted. Nevertheless, taxpayers should ensure that their related party transactions are conducted on an arm’s length basis.
How CW CPA can help
CW CPA can assist overseas companies in analysing the implications that changes in transfer pricing legislation can have on their operations and in ensuring meticulous compliance with the relevant regulations and reporting requirements. With unrivalled technical expertise, CW CPA is well-positioned to advise companies on how best to manage their tax exposure efficiently.
Further questions can be addressed to Ms Sally Leung (email@example.com).