This article outlines the new rules in Hong Kong regarding transfer pricing documentation and the disclosure of information to local and overseas tax authorities. It covers Country-by-Country reporting, the exchange of information, and the implications of exchange.
The Country-by-Country (CbC) report requires selected financial items from the profit and loss statements and balance sheets of a multinational enterprise (MNE), which would allow the tax authorities to have a clearer picture of the MNE group’s global allocation of income and taxes paid in each country.
Hong Kong formally introduced its transfer pricing regulatory regime and transfer pricing documentation requirement into Hong Kong legislation on 13 July, 2018. The new tax legislation is known as the Inland Revenue (Amendment) (No. 6) Ordinance 2018 (the BEPS and TP Ordinance). It embraces the base erosion and profit shifting (BEPS) initiatives taken by the OECD and implements certain minimum standards under the OECD’s BEPS Action Plan in Hong Kong.
Hong Kong’s practices
The transfer pricing documentation requirement in Hong Kong consists of three tiers:
1. Master File
2. Local File
3. CbC report
The Master File and Local File require taxpayers of certain business size with related party transactions exceeding certain amounts, to disclose information focusing on the group in the Master File and information focusing on the specific legal entity in the Local File. Each Hong Kong taxpayer is required to prepare Master File and Local File for accounting periods beginning on or after 1 April, 2018, within nine months after the end of that accounting period, unless it qualifies for exemptions from preparing these documents.
A CbC report has to be prepared for Hong Kong-headquartered taxpayers with consolidated group revenues greater than HK$6.8 billion in the prior year, in respect of accounting periods beginning or after 1 January, 2018, and is generally due for filing within 12 months after the end of the accounting period to which the report relates.
The CbC report also contains other information such as headcount and main business activity (or activities) of each constituent entity, which may entail information owned by non-finance and accounting functions such as human resources and operations.
Hong Kong taxpayers that are constituent entities (i.e. not an ultimate parent entity (UPE) of the group) will generally not have an obligation to prepare CbC reports, but will instead have an obligation to file CbC notification to the Inland Revenue Department (IRD) within three months after the end of the accounting period to which the UPE’s CbC report relates. The information in the CbC notification should contain sufficient information for Hong Kong to obtain the CbC report directly from the Hong Kong taxpayer’s UPE or surrogate parent entity (SPE) that has filed the CbC report under the automatic exchange of information of CbC reports.
In the event that a Hong Kong taxpayer is part of a reportable MNE group that has not filed a CbC report under its UPE or SPE filing obligations in its own tax residence jurisdiction, or if Hong Kong is not able to obtain the CbC report from that jurisdiction, then the Hong Kong taxpayer would be required to file a CbC report in Hong Kong.
Exchange of transfer pricing documentation
The information collected by IRD from Master File and Local File may be exchanged with other tax jurisdictions upon request under comprehensive double tax agreements, Tax Information Exchange Agreements or the Convention on Mutual Administrative Assistance in Tax Matters (Convention).
The Convention, together with the Multilateral Competent Authority Agreement on the Exchange of CbC reports (CbC MCAA), is the main platform for Hong Kong’s automatic exchange of CbC reports with other jurisdictions. As of 5 December, 2018, there were 74 signatories to the CbC MCAA, including Hong Kong, with varying numbers of activated exchange relationships depending on the jurisdiction. Hong Kong has currently activated exchange relationships with 39 selected countries to automatically exchange CbC reports for taxable periods starting on or after 1 January, 2019. These include Hong Kong’s four bilateral arrangements for the exchange of CbC reports starting from 2016, including France, Ireland, South Africa and the United Kingdom.
CbC reports will be automatically exchanged with relevant jurisdictions upon their activation of the exchange relationships under CbC MCAA or bilateral agreements. Even locations traditionally viewed as taxpayer friendly – such as the Cayman Islands, Bermuda and the British Virgin Islands – have implemented local CbC report requirements, with Bermuda and the Cayman Islands able to exchange with 52 and 53 other countries, respectively.
Under the automatic exchange of information, tax authorities would exchange information on a regular basis using the OECD’s standardised electronic format for the exchange of CbC reports between countries, known as CbC XML Schema. Other examples of XML that are already in use include the OECD’s Common Reporting Standard XML Schema and the United States’ FATCA XML Schema.
As the CbC report contains sensitive information like the global allocation of income and taxes paid, taxpayers may have concerns on privacy and confidentiality of information exchanged. The IRD, as well as overseas tax authorities, would only automatically exchange CbC reports when an activated relationship under CbC MCAA or bilateral agreement is in place to provide the basis for the exchange. Taxpayers will not know if, and when, their information would be exchanged, and should expect that it would be exchanged as a matter of course.
However, IRD may suspend or cease the automatic exchange with other countries if there is substantial non-compliance with information confidentiality and data safeguards. The safeguards have been provided to protect taxpayers’ privacy and confidentiality of information exchanged as prescribed under the international standard.
MNEs should ensure that they have sufficient resources to collect and collate data which is accurate and complete, and in a timely manner, for the preparation of the CbC report under the applicable CbC report filing and CbC report notification requirements of each jurisdiction in which they have a presence.
In Hong Kong, there are still many uncertainties as to the interpretation and practical application of the provisions in the BEPS and TP Ordinance. Hong Kong taxpayers should follow updates and announcements from the IRD on a regular basis. We expect that further guidance will be issued shortly by the IRD.