What is BEPS?
There is no doubt that Base Erosion and Profit Shifting (“BEPS”) is a hot topic on the international tax policy agenda.
BEPS, which refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, has always been a major concern of international bodies such as the Group of Twenty (“G20”) and the Organisation for Economic Co-operation and Development ("OECD").
The BEPS package, comprising 15 action plans which seek to realign taxation with economic substance and value creation while preventing double taxation, was first launched by G20 and OECD in 2013.
To ensure a consistent and effective global approach, G20 and OECD have called on all countries and jurisdictions to join the inclusive framework for implementation of the BEPS package. Being an international financial centre and a responsible member of the international community, Hong Kong indicated to OECD in June 2016 our commitment to the BEPS package and its consistent implementation.
The below highlights how BEPS has impacted and substantially changed the Hong Kong tax environment.
1) Automatic Exchange of Financial Account Information (“AEOI”)
The Legislative Council has recently passed a bill amending the Inland Revenue Ordinance to further implement the AEOI arrangement.
The AEOI arrangement is depicted below:-
As at the end of July 2017, there are 75 reportable jurisdictions (which are continuously expanding), including the United Kingdom (“UK”) and France.
When fully implemented, the AEOI arrangement will have without any doubt profound impacts on taxpayers. For example, for an UK tax resident who has a bank account in Hong Kong, the following is going to happen:-
- HKIRD will collect and forward the UK tax resident’s financial information to the UK tax authority (the first exchange is due to commence by the end of 2018 on the condition that the necessary domestic legislation would be in place by 2017);
- Other jurisdictions (which have entered into similar AEOI arrangements) in which the UK tax resident has maintained financial accounts will also collect and forward the UK tax resident’s financial information to the UK tax authority; and
- The UK tax authority will tax the UK tax resident on his / her worldwide income based on the information provided (if not already taxed).
Action required by taxpayers
To assess the AEOI impact and reconsider his / her tax residency.
Please refer to our article dated 21 March 2017 for a detailed discussion of the AEOI arrangement.
2) Additional Transfer Pricing documentation requirement
Typical cross-border intercompany transactions of businesses with presence in more than one tax jurisdiction are depicted below:-
(1) The administrative function (such as IT, human resources etc) will be managed by the Group Company on a centralised basis and the Group Company will charge its overseas subsidiaries (HK Company and other overseas company) management fees for the provision of the administrative services.
(2) In cases where the Group wishes to take advantage of the lower tax rate in Hong Kong (for example, in case that the Group has an active business in Japan which has an effective tax rate of 34% compared with the effective tax rate in Hong Kong of 16.5%), the Group can arrange for the Hong Kong Company to own the relevant intellectual properties of the Group and impose royalties fee on the grant of the license to the Japanese company. That way the profit generated by the Japanese company will be diverted to Hong Kong Company.
To tackle non-arm’s length intercompany transactions and to counter BEPS, the Hong Kong Government has proposed to introduce a new 3-tiered standardised transfer pricing documentation as per below:-
(1) Local File: Enterprises with cross-border intercompany transactions would be required to keep a local file which provides detailed transactional transfer pricing information such as details of the transactions, amount involved in the transactions and a transfer pricing analysis.
(2) Master File: Enterprises with cross-border intercompany transactions would be required to provide a high-level overview of the group, including documenting the global business operations, transfer pricing policies and global allocation of income.
(3) Country-by-country Report (“CbC Report”): A CbC report should be filed by the ultimate parent entity of a multinational enterprise (“MNE”) in its tax jurisdiction which sets out the amounts of revenue, profits and tax paid as well as certain indicators of economic activity such as number of employees, stated capital, retained earnings and tangible assets for each jurisdiction in which a MNE operates.
Accordingly, for the above group structure, unless they qualify for the exemption, the local operations in the overseas companies and Hong Kong will each require to submit a local file and a master file. And the parent company will need to submit the CbC report.
Exemptions to the 3-tiered standardized transfer pricing documentation
For local and master files:
Upon satisfying 1 of the 2 following exemptions:-
(a) Exemption based on size of business
An enterprise which satisfies any 2 of the 3 below conditions will not be required to prepare local and master files:-
- Total annual revenue not more than HK$200 million;
- Total assets not more than HK$200 million; or
- 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 period is below the proposed threshold, an enterprise will not be required to prepare a local file for that particular category of 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; and
- any other transaction (e.g. service income and royalty income): HK$44 million.
If the enterprise concerned is fully exempted from preparing a local file, it will not be required to prepare the master file either.
For CbC Reports:
- Annual consolidated group revenue ≤ EUR750 million (i.e. approx. HK$6.8 billion)
More on CbC Reports
CbC reports are to be exchanged automatically between tax authorities of different jurisdiction of which Hong Kong has concluded a Comprehensive Double Taxation Agreement (“CDTA”) and and Tax Information Exchange Agreement ("TIEA") with, including China and the United States.
Action required by taxpayers
- To review the arm’s length basis of the intercompany transactions and conduct transfer pricing analysis.
(3) No More “Tax Treaty Shopping”?
The development of a multilateral instrument
It is beyond doubt that “tax treaty shopping” is an important source of BEPS. Rather than making amendments to each bilateral treaty (with more than 3,000 bilateral treaties around the world), the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the “Multilateral Instrument”), one of the outcomes of the BEPS Project, operates to modify tax treaties between two or more parties to the Multilateral Instrument in a synchronised and efficient manner. It will not function in the same way as an amending protocol to a single existing treaty, which would directly amend the text of the treaty; instead, it will be applied alongside existing tax treaties, modifying their application in order to implement the BEPS measures.
The Multilateral Instrument, however, does not modify all tax treaties in the same manner. Apart from the minimum standards (namely the prevention of treaty abuse including defining a company’s taxable presence in a tax jurisdiction (Action 6 of the BEPS action plans) and the improvement of dispute resolution (Action 14 of the BEPS action plans)) which can be satisfied in different ways, the Multilateral Instrument is a flexible instrument which will modify tax treaties according to a jurisdictions’ policy preferences with respect to the implementation of the tax treaty-related BEPS measures.
As of 11 July 2017, 70 jurisdictions (including China and Hong Kong) have signed up for the Multilateral Instrument, with additional jurisdictions expressing their intention to sign the Multilateral Instrument or already preparing for signature of the Multilateral Instrument.
How does the Multilateral Instrument impact on the CDTAs?
Apart from the double tax arrangement with China, all of the CDTAs with 36 countries would be covered by the Multilateral Instrument.
In brief, Hong Kong has chosen to-opt in with respect to the provisions of the Multilateral Instrument that represent the minimum standards and has chosen to-opt out with respect to other provisions that are not mandatory. In particular, Hong Kong has indicated that it will adopt the principal purposes test rule which means that the treaty benefit should not be available where one of the principal purposes of arrangements or transactions is to secure a benefit under a tax treaty and obtaining that benefit in these circumstances would be contrary to the object and purpose of the relevant provisions of the tax treaty.
Action required by taxpayers
- To assess whether their business operations in Hong Kong do have proper business purposes in order to continue to enjoy the treaty benefits available under the relevant double tax agreements.
For a detailed discussion or any enquiry, please contact one of our members of the Tax Advisory team.