Hong Kong: Transfer pricing regulatory regime and documentation requirements

published on 26 September 2023 | reading time approx. 5 minutes

On 4 July 2018, the Hong Kong Government passed its third and final reading in the Legislative Council of (Amendment) (No. 6) Bill 2017. The bill was gazetted and became law of Hong Kong on 13 July 2018 which codifies certain TP principles, introduces mandatory TP documentation requirements into the Inland Revenue Ordinance. The rule applies to years of assessment beginning on or after 1 April 2018.

Hong Kong transfer pricing regulatory regime

The Amendment stipulates that a transaction or a series of transactions made between two associated persons (including, companies, partnerships, incorporated or unincorporated trustees or bodies of persons) must be made on arm's length basis. This applies to both domestic and cross-border transactions. If a taxpayer fails to prove that a transaction was conducted at arm's length, the tax assessor is empowered to make adjustments to the taxpayer's taxable profits.

Two persons are associated where one person participates in the management, control, or capital of the other person, and controls the other person. Control, amongst other things, includes where a person has the power to secure that the affairs of the other person are conducted in accordance with the wishes of the person due to a direct or indirect beneficial interest in the other person of more than 50 percent.

Specifically, insofar as domestic transactions between associated persons do not give rise to actual tax difference, or domestic transactions involving non-arm’s length loans (e.g. interest-free loans) are not carried out in the ordinary course of money lending or intra-group financial business, and provided that such transactions do not have a tax avoidance purpose, then the relevant persons will not be obliged to compute the income or loss arising from these transactions on the basis of the arm’s length provision in their tax returns and no corresponding assessment on that basis will be made by the IRD.

TP documentation

The amendment adopts the OECD’s recommended three-tiered documentation structure, comprising a master file, local file and country-by-country reporting, details of which are as follows:

Country-by-country report (“CbCR”)

The CbCR according to BEPS 13 has been implemented for the years starting from 2018.
Effective in the laws of Hong Kong for fiscal years as from 1 January 2018.
Threshold: Consolidated group revenue of at least EUR 750 million (or HKD6.8 billion) for the preceding fiscal year.
Deadline for the preparation and submission: Within 12 months after the end of the relevant fiscal year or by the date specified by an assessor, whichever is the earlier.
Languages for filing the CbCR: English or Chinese.
Secondary Filing: A Hong Kong Entity of a Reportable Group whose ultimate parent entity (UPE) is not resident in Hong Kong is subject to a secondary obligation of filing a CbC Return if any of the following conditions is met:
(i) the UPE is not required to file a CbC Report in its jurisdiction of tax residence;
(ii) the jurisdiction has a current international agreement with Hong Kong providing for automatic exchange of tax information but, by the deadline for filing the CbC Return, there is no exchange arrangement in place between the jurisdiction and Hong Kong for CbC Reports;
(iii) there has been a systemic failure to exchange CbC Reports by the jurisdiction, which has been notified to the Hong Kong Entity by the Commissioner.

Even if one of the above conditions is met, the Hong Kong Entity is not required to file a CbC Return if:
(i) CbC Return for the relevant accounting period is filed by another Hong Kong Entity of the Reportable Group; or
(ii) the Reportable Group has authorized a constituent entity as its surrogate parent entity (SPE) to file CbC Report on behalf of the Group, and the CbC Report is filed by the SPE in Hong Kong or a jurisdiction which has an exchange arrangement in place with Hong Kong.
Notification: Every Hong Kong-based entity is required to file a notification containing information relevant for determining the obligation to file the CbCR within 3 months after the end of the relevant fiscal year. The entity will receive a document confirming the filing of such a notification.
Penalties: HKD 100,000

Master file

The Master File concept according to BEPS Action 13 has been implemented.
Thresholds: Applies to a Hong Kong-based entity of a MNE group.
Except for the fiscal years in which two of the following conditions are met:
(i) Entity's total revenue: not more than HKD 400 million;
(ii) Entity's total assets: not more than HKD 300 million;
(iii) Entity's average number of employees: not more than 100.
Deadline for the preparation and retention: Within 9 months after the end of the group's fiscal year.
Duty of notification: not specified.
Languages: English or Chinese.
Penalties: HKD 100,000.
Effective in the laws of Hong Kong for fiscal years as from 1 April 2018.

Local file

Thresholds: Applies to a Hong Kong-based entity of a MNE group.
Except for the fiscal years in which two of the following conditions are met:
(i) Entity's total revenue: not more than HKD 400 million;
(ii) Entity's total assets: not more than HKD 300 million;
(iii) Entity's average number of employees: not more than 100.
If the volume of the following types of controlled transactions does not exceed the following thresholds, no documentation is necessary for that type of the transaction:
(i) Transfer of properties (whether movable or immovable but excluding financial assets and intangibles) is not more than HKD 220 million;
(ii) Transaction in respect of financial assets is not more than HKD 110 million;
(iii) Transfer of intangibles is not more than HKD 110 million;
(iv) Other transactions are not more than HKD 44 million.
Deadline for the preparation and submission, duty of notification, languages and penalties are same as that for the Master File.
Effective in the laws of Hong Kong for fiscal years as from 1 April 2018.

Outlook of future transfer pricing business

As the transfer pricing regulations have been implemented for several years in Hong Kong, the IRD may conduct transfer pricing reviews or audits on taxpayers on a larger scale and on a more regular basis. We also observe that, during the course of issuing enquiry letters to the taxpayers, the IRD may examine the calculation basis of the incomes or expenses in relation to related party transactions and require supporting documents to justify that the aforesaid calculation basis adheres to the arm’s length principle.

In addition, the IRD and overseas tax authorities have become more stringent in reviewing related party transactions and transfer pricing positions of multinational enterprises. Even if a Hong Kong entity is exempt from preparing Master File and Local File, it may still need to prepare transfer pricing documents to justify that its intercompany transactions are in line with the arm’s length principle. It is anticipated that the need of transfer pricing review would be increased.