The global outbreak of Covid-19 is posing unparalleled challenges throughout the world and Hong Kong is no exception. In response to the HKSAR Government’s preventive measures, the Inland Revenue Department (IRD) implemented a limited service arrangement in the first quarter of 2020. It is not difficult to notice the immediate impacts of the IRD’s office closure on its handling of general enquiries and tax audit cases.
From the corporates’ perspective, the compulsory quarantine arrangement and border restrictions have also substantially affected businesses. On one hand, it would definitely create pressures on corporates’ cash flow position and their profitability. On the other hand, these uncertainties may also bring a profound impact on the exercising of taxing rights by tax authorities in cross-border activities.
In view of such unprecedented changes, how can taxpayers overcome all these uncertainties in handling tax dispute cases?
Immediate changes to IRD’s practice
To ease the immediate financial burden and cash flow of businesses, the IRD has introduced certain relief measures, including automatic extension of deadlines for 2018/19 tax payments, lodgement of objections and holdover applications, submission of tax returns, waiver of surcharges for approved instalment plans for tax payment, exemption of Anti-epidemic Fund from tax (subject to certain conditions), etc.
Apart from these administrative changes, below are some observations of the IRD’s recent practice and concerns in handling tax dispute cases:
Due to the implementation of the prolonged limited service arrangement early this year, the IRD has accumulated a large backlog pending clearance. Thus, the IRD’s progress in handling general enquires and tax audit cases has inevitably slowed down in recent months. It is, therefore, advisable for taxpayers to take a proactive approach to closely follow up their cases with the responsible officers so as to expedite the resolution of the IRD’s enquiries and tax audit cases.
2) Interview arrangement for tax audit cases
Based on our past experience, there will be an initial interview for field audit and investigation cases for the IRD to gather information. The interview would normally be conducted in the taxpayers’ business premises or office. However, in view of Covid-19, the IRD will not go to the taxpayers’ premises nor will they be using virtual meetings. Instead, the IRD will arrange the initial interview with taxpayers in Revenue Tower. Therefore, taxpayers are advised to arrange the initial interview as soon as possible, if they prefer the interview to be conducted in Revenue Tower.
In addition, on the resumption of its public services, the IRD has introduced additional measures to practise social distancing. Visitors to Revenue Tower will have their body temperature measured and are required to wear a face mask. Plexiglass table dividers have also been installed between visitors and IRD officers in all the IRD’s interview rooms.
3) Special considerations
In view of the pandemic, if taxpayers encounter financial difficulties, they may wish to apply to pay their taxes by instalments. Taxpayers are advised to keep proper business records and documentary evidence in order to prove their cash flow position or financial hardships. With reasonable grounds and sufficient supporting documents, the case officers would be more willing to consider special requests on a case-by-case basis.
Tax practice on cross-border activities during pandemic
In light of travel restrictions and various quarantine measures implemented by governments around the world, there are concerns on whether temporary change of work location and arrangement of individuals would lead to creation of Permanent Establishment (PE) or change in the tax residence status of the relevant corporates or individuals.
Up to now, there has not been any official statement issued by the IRD to address the above concerns arising from the exceptional circumstance. Nevertheless, it is expected that the IRD would generally follow the views and commentaries of the Organisation for Economic Co-operation and Development (OECD) in interpreting and applying tax treaties unless they are contrary to the provisions under the domestic law of Hong Kong. With reference to the OECD’s recent analysis titled “OECD Secretariat Analysis of Tax treaties and the Impact of the Covid-19 Crisis” published in early April, some key points are summarised as follows:
- Creation of PE – The exceptional and temporary change of work location are unlikely to create a fixed PE or agency PE for corporates, but the period of temporary interruption of activities on a construction site should be included in determining the duration of the construction site for PE assessment purposes.
- Corporates’ tax residence status – Temporary relocation or inability to travel by corporates’ executives should not trigger a change in the tax residency (place of effective management) of the corporates in general under the tie-breaker rule.
- Individuals’ tax residence status – Temporary dislocation of individuals will also unlikely change an individual’s tax residency when the tie-breaker rule is applied.
Although the OECD Analysis provides influential and useful guidance on interpreting the international tax treaty rules, please note that it is not legally binding, and it only addresses the issues where a tax treaty is applicable. The domestic law will apply in a non-treaty context. In addition, corporates and individuals should carefully assess whether their business activities or unintended stay in Hong Kong due to Covid-19 would trigger domestic tax reporting or filing obligations in Hong Kong, even though they may not have any tax exposure in Hong Kong ultimately due to domestic tax exemption or protection under the applicable tax treaty.
Beyond the pandemic
Whatever the ultimate changes in tax policies will be as a result of the pandemic, what is certain is that under the inevitable global economic downturn and dramatic rise in governments’ spending, the upcoming pressure on public finances and tax revenues is foreseeable.
As announced in the 2020/21 Budget, the HKSAR Government ran a fiscal deficit in 2019/20, the first time in 15 years. Deficits are also forecasted for the next five years. It is reasonable to expect that while the Government will continue to introduce different remedies to support corporates and individuals with cash flow problems, it would also take a more stringent approach in reviewing taxpayers’ affairs.
Meanwhile, from a global perspective, it is also anticipated that the OECD will expedite the implementation of Pillars 1 and 2, so as to close the existing gaps for profits shifting. The OECD estimates that the combined effect of both Pillars would lead to an increase of up to 4% of global corporate income tax revenues, or approximately US$100 billion per annum. Taxpayers should keep a close eye on this latest development.
Last but not least, the Covid-19 crisis has given the biggest ever boost to nearly all industries for digital transformation and conducting business online or virtually. Taxpayers are therefore urged to re-examine their business’ mode of operation. They should also conduct a comprehensive tax health check or upfront tax arrangements, so as to cope with any potential tax challenges arising from the ongoing digitalisation of the global economy.
Kenneth Wong (left), Leader, Hong Kong Tax Controversy Services, and Philip Hung, Director, Hong Kong Tax Controversy Services, PwC Hong Kong