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Hong Kong Publishes Consultation Report on Measures to Counter BEPS

On 31 July 2017, the Hong Kong Financial Services and the Treasury Bureau published the Consultation Report on Measures to Counter Base Erosion and Profit Shifting. The report notes the results of the consultation held 26 October to 31 December 2016 on the legislative proposals to implement the BEPS package and the planned approach for implementation going forward. Key points are summarized as follows:

  • A legal basis will be provided in the Inland Revenue Ordinance (IRO) for the application of the OECD’s Transfer Pricing Guidelines, which will apply for both cross-border and domestic transactions;
  • There is no intention to introduce thin capitalization rules and no express threshold will be set in terms of an entity’s debt-to-equity ratio and the maximum amount of deductible interest;
  • Specific provisions will be introduced in the IRO to ensure that a person carrying on the functions of development, enhancement, maintenance, protection, and exploitation (DEMPE) for IP in Hong Kong will be compensated with a return on an arm’s length basis consistent with the latest guidance in the BEPS Actions 8-10 Reports;
  • Specific penalties will be introduced for filing tax returns with incorrect information on transfer pricing without reasonable excuse and/or with willful intent to evade tax, with no broad penalty protection for taxpayers who have prepared OECD-compliant transfer pricing documentation;
  • A statutory basis will be provided for the advance pricing arrangement (APA) regime, including for unilateral, bilateral, and multilateral APAs;
  • Master and Local file documentation requirements based on OECD guidance will be introduced, with an exemption for enterprises meeting either of the following exemption conditions:
    • Exemption based on the size of business: An enterprise which satisfies any two of the three conditions below will not be required to prepare a Master file and Local file:
      • total annual revenue not more than HKD 200 million;
      • total assets not more than HKD 200 million; and
      • not more than 100 employees.
    • Exemption based on related party transactions: If the amount of a category of related party transactions for the relevant accounting period is below the proposed 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):
      • transfer of properties (other than financial assets and intangibles): HKD 220 million;
      • transaction of financial assets: HKD 110 million;
      • transfer of intangibles: HKD 110 million; and
      • any other transaction (e.g., service income and royalty income): HKD 44 million.
  • With respect to Country-by-Country (CbC) reporting:
    • CbC reporting requirement will be introduced, including a primary filing obligation for ultimate parent entities of the MNEs that are resident in Hong Kong, as well as a secondary filing obligation for constituent entities of MNEs in Hong Kong if the ultimate parent entities are in jurisdictions that neither require the filing of CbC reports nor exchange such reports with Hong Kong;
    • A reporting entity will be allowed to engage a service provider to furnish a CbC report and give relevant notifications on its behalf, with penalty provisions introduced in respect of misleading, false, or inaccurate information in the CbC reports furnished by the service provider;
    • The legal framework for CbC reporting will be put in place as soon as possible, with a transitional arrangement for CbC reporting for parent surrogate filing for the accounting period commencing between 1 January 2016 and 31 December 2017 - initial guidelines are already published (previous coverage) and a Departmental Interpretation and Practice Note is to be published to further address implementation issues; and
    • CbC report exchange will be conducted on the basis of bilateral income tax arrangements and tax information exchange agreements. Agreement has also been reached in principle with the Chinese Central Government to extend the application of the Mutual Assistance Convention to Hong Kong so reports may also be exchanged under the multilateral CbC exchange agreement;
  • The BEPS Multilateral Instrument for treaty-related measures (MLI) was signed by China on behalf of Hong Kong via a territorial extension on 7 June 2017;
  • To prepare for the OECD’s peer review on dispute resolution mechanism, a legal and administrative framework for MAP will be formulated in a manner consistent with the OECD’s Model Tax Convention, the BEPS Action 14 Report, and the relevant peer review documents;
  • Spontaneous tax ruling exchange will be conducted under the exchange provision of existing bilateral agreements together with the Mutual Assistance Convention (once application extended);
  • The period for claiming tax credits will be lengthened, including that a tax credit may be claimed (a) within six years after the end of relevant year of assessment; or (b) six months after the date of notice of assessment which imposes liability or additional liability to tax under the IRO in respect of the income on which foreign tax has been assessed, whichever is later; and
  • Hong Kong tax regimes that may be considered harmful are being reviewed and legislative amendments will be considered where necessary.

The specific proposals will be further refined, with the required legislation in relation to transfer pricing, CbC reporting, and dispute resolution to be submitted to the Legislative Council by the end of 2017. Required legislation for the Mutual Assistance Convention and BEPS MLI is to be submitted by the end of 2017 and around mid-2018, respectively.

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