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Hong Kong Publishes Draft Legislation to Implement BEPS Measures and Two-Tiered Profits Tax Rate

On 29 December 2017, the Inland Revenue (Amendment) (No. 6) Bill 2017 (Amendment Bill No. 6) and the Inland Revenue (Amendment) (No. 7) Bill 2017 (Amendment Bill No. 7) were introduced in Hong Kong's Legislative Council. The first reading for both Bills will take place on 10 January 2017.

Amendment Bill No. 6

Amendment Bill No. 6 includes measures in relation to Hong Kong's commitment to implement the four minimum standards of the BEPS package. These measures include:

  • The Codification of the OECD’s transfer pricing rules into the Inland Revenue Ordinance (IRO) so that the transactions between associated enterprises in Hong Kong will be taxed on the basis that they are effected at arm’s length;
  • The introduction of specific provisions in the IRO to ensure that a person carrying out the functions of development, enhancement, maintenance, protection or exploitation (DEMPE) for an IP in Hong Kong will be taxed on the basis of that person’s contribution in carrying out such functions;
  • The introduction of specific administrative penalties relating to transfer pricing by way of additional tax not exceeding the amount of tax undercharged, with the possibility of imposing more stringent penalty or initiating criminal prosecutions on blatant cases in accordance with relevant provisions of the IRO;
  • The introduction of statutory APA regime to cater for unilateral, bilateral, and multilateral APAs;
  • The introduction of Master file and Local file requirements for accounting periods beginning on or after 1 April 2018, which must be prepared within 6 months following an accounting period in English or Chinese, with an exemption from preparing one or both if meeting one of the following exemption criteria:
    • Exemption based on the size of business: An enterprise that satisfies any two of the three conditions below will not be required to prepare a Master file or 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 prescribed 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;
  • The introduction of Country-by-Country (CbC) reporting requirement for MNEs with annual consolidated group revenue not less than EUR750 million (or HKD 6.8 billion) that will apply for accounting periods beginning from 1 January 2018, including:
    • A primary filing obligation for ultimate parents resident in Hong Kong, as well as a secondary filing obligation for constituent entities in Hong Kong if the ultimate parent entity is in a jurisdiction that does not require the filing of CbC reports or does not exchange such reports with Hong Kong, with a deadline of 12 months after the accounting period; and
    • A voluntary filing arrangement whereby the ultimate parent entity of an MNE group that is resident in Hong Kong is allowed to voluntarily submit its CbC reports in respect of an accounting period commencing between 1 January 2016 and 31 December 2017;
  • The introduction of a statutory dispute resolution mechanism to replace the current mechanism that relies on administrative rules in the Departmental Interpretation and Practice Notes of the Inland Revenue Department (IRD), which allows a taxpayer to present a case for MAP and/or arbitration under a relevant tax treaty and provides that the Commissioner must give effect to any solution unilaterally arrived at by the Commissioner or agreement reached with the other tax authority concerned in the course of the MAP or arbitration, and any decision delivered by arbitrators in the case of arbitration;
  • The enhancement of the current tax credit system to address double taxation by:
    • Extending the period for claiming a tax credit from two years to six years;
    • Requiring a taxpayer to minimize its foreign tax liability by making full use of all other available relief under applicable tax treaties and the local legislation of foreign jurisdictions before resorting to tax credits; and
    • Mandating taxpayers to notify IRD of any adjustment to their foreign tax payments that may result in a tax credit granted being excessive;
  • The amendment of the preferential tax regimes for corporate treasury centres (CTC), professional reinsurance, and captive insurance in order to comply with OECD standards, which will include extending the half-rate concessions of these regimes that currently only apply to profits derived from foreign transactions to also apply to profits derived from domestic transactions from the year of assessment 2018/19 onwards; and
  • The introduction of  substantial activities requirements in the tax regimes for CTC, professional reinsurers, captive insurers, ship owners, aircraft lessors and aircraft leasing managers, which will entail detailed thresholds (i.e. minimum number of full-time qualified employees and minimum amount of operating expenditure) that will be provided in a notice (subsidiary legislation).

Amendment Bill No. 7

Amendment Bill No. 7 includes measures to introduce a two-tiered profits tax rate regime for corporations and unincorporated businesses for any year of assessment commencing on or after 1 April 2018 as follows:

  • Assessable profits up to HKD 2 million - 8.25% for corporations and 7.5% for unincorporated businesses;
  • Assessable profits beyond HKD 2 million - 16.5% for corporations and 15.0% for unincorporated businesses (current rates).

In order to avoid double benefits, the following will be excluded from the two-tiered profits tax rates regime:

  • Those enterprises electing the preferential half-rate tax regimes (e.g. professional reinsurance companies, captive insurance companies, corporate treasury centres, and aircraft leasing companies); and
  • The assessable profits for sums received by or accrued to holders of qualifying debt instruments as interest, gain or profit  which are already taxed at half-rate (continue to be subject to the current applicable tax rates, i.e. 7.5% or 8.25%, as the case may be).

Further, to ensure that the tax benefits will target SMEs, a restriction is included to limit the application of the two-tiered regime to only one enterprise nominated from among those which are connected (under the control of the same enterprise or entity).

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