Hong Kong New Transfer Pricing Laws

Hong Kong's transfer pricing (TP) laws were passed on 04.07.2018 with the Inland Revenue (Amendment) (No. 6) Bill 2017 (Amendment Bill), which comes into force on 13.07.2018. This affirms Hong Kong's commitment to implement OECD's Base Erosion and Profit Shifting (BEPS) initiatives. In the following, Deloitte summaries the important points that businesses should pay attention to as they consider the implications of the changes, and plan for future regulatory compliance.

Hong Kong passes BEPS and Transfer Pricing laws
Hong Kong's Legislative Council on 04.07.2018 passed the Inland Revenue (Amendment) (No. 6) Bill 2017 (Amendment Bill), which comes into force on 13.07.2018 after being signed by the Chief Executive and published in the Gazette. The passing of the Amendment Bill completes the long awaited codification of Hong Kong's transfer pricing (TP) laws, and affirms Hong Kong's commitment to implement OECD's Base Erosion and Profit Shifting (BEPS) initiatives.

The Amendment Bill has been amended since the draft that was issued in December 2017, with a number of amendments made through the Bills Committee Stage, in response to comments received from submitters on the original draft. The Amendment Bill will not be the last word on Hong Kong's TP regulations – the Report of the Bills Committee on this Bill has identified several areas for which further guidance would be issued by the Inland Revenue Department (IRD) through Departmental Interpretation and Practice Notes (DIPN)1 . These are expected to be issued within the coming months, and we will issue tax newsletters on these once they are released.

Our comments below are focused on the key changes since that original draft – as well as important points that businesses should pay attention to as they consider the implications of the changes, and plan for future regulatory compliance.

TP regulatory framework
The Bill codifies Hong Kong's transfer pricing regulations for the first time, and requires that TP regulations in Hong Kong are interpreted in a way that ensures consistency with the OECD TP Guidelines – specifically the 2017 Transfer Pricing Guidelines and Model Tax Convention which incorporate the changes following the BEPS initiatives.

Hong Kong will adopt the three-tier documentation framework from the OECD BEPS Action 13, bringing formal TP documentation regulations to Hong Kong for the first time. Certain domestic related party transactions will not be subject to the TP regulations. Fewer companies will need to prepare documentation than was originally expected due to relaxation of the exemption threshold introduced during the Bills Committee Stage – further details are provided below.
Through adoption of the OECD Guidelines, important concepts that were introduced following the BEPS project, such as the alignment of value creation with economic returns, are now part of the Hong Kong TP framework. In particular, Section 15F requires that the entities which perform the DEMPE (i.e. development, enhancement, maintenance, protection or exploitation) activities or deploy the DEMPE assets should be entitled to the associated returns. Taxpayers will need to consider the implications of this concept in situations where contractual obligations may not be entirely aligned with economic value creation. Specifically, taxpayers should turn their mind to whether transactions have been delineated appropriately before considering the preparation of the Hong Kong TP documentation.
The Bills Committee confirmed that the territorial source principle of taxation will not be changed by the new regulations. Taxpayers should first compute income and profits on an arm's length basis, and then apply the territorial source principle to determine if such income or profits arise in or are derived from Hong Kong. The IRD will provide more guidance in a DIPN.