The OECD’s Pillar Two GloBE regime aims to ensure that large multinationals pay a minimum effective tax rate of 15% on revenue above 750 million euro (HK$6 billion), and is likely to come into effect in the next few years. An estimated 300 companies in Hong Kong will be subject to the rules, which are likely to include many in the real estate sector.

So what will the changes mean for major property owners and investors in the city? At a seminar on 11 August, Patrick Yip, Vice Chair and Tax Partner at Deloitte China, and his colleague, Tax Partner Doris Chik, explained the impact of the changes.

Yip noted that the new rules contain a “big jungle” of detail, so he started by giving an overview of the OECD’s proposals. Although Pillar One deals with the digital economy and does not directly affect real estate, it is worth understanding the whole framework. 

Historically, when doing business globally, you only needed to pay tax in another jurisdiction if you had a “permanent establishment” there, Yip explained. But fast-forward to the internet age, and many multinational businesses operate on a mostly digital basis. 

“A lot of the biggest companies in the world by capitalization actually do not need a lot of physical activity in the host countries,” Yip explained. “So they can avoid paying tax in countries where they operate, even though they earn a lot of revenue.”

This has led the OECD to develop other ways of calculating tax for the digital economy, by looking at market revenue rather than permanent establishment. 

Pillar Two has a similar principle: to ensure that multinational companies pay a minimum rate of tax of 15%, wherever they operate.  

“The idea is to steer people away from making business decisions based on how much tax they can save, and prevent them from moving their transactions and legal relationships to low-tax or no-tax jurisdictions,” he said.  

Turning to the real estate sector, he noted that capital gains and offshore income are not taxable in Hong Kong, although they are included in a company’s financial statement income. So if minimum tax under GLoBE is calculated based on financial statement income, a Hong Kong taxpayer may have paid less than 15% tax, and would therefore be liable to pay top-up tax.

Yip noted that Deliotte tax experts have shared some of their concerns with the OECD, which has come up with various elections that will minimize some of the negative tax impacts.  

Chik then shared some more of the technical detail on how Pillar Two will affect the real estate sector. Hong Kong has a corporate tax rate of 16.5%, but, as she explained, it is not so simple.  

“For GLoBE purposes, we are looking at the effective tax rate, not the statutory tax rate,” she said. “As Hong Kong does not tax offshore profits or capital gains, the effective tax rate may be lower.”

Chik noted that the GLoBE rules are complicated, but essentially, if your effective tax rate is below 15%, you will need to pay top-up tax. 

In Hong Kong, there are three different property categories. Trading stock, which is property held for sale in the ordinary course of business, such as by developers, will not be affected by the changes, she explained. However, both investment property and owner-occupied property (which can include offices and manufacturing plants) will be impacted.

For example, the GLoBE rules will affect the amount of tax due on unrealized gains on investment property, and on disposal gains when selling both investment and owner-occupied property. 

“Disposal gain can be a significant amount if the building has been held for many years, because Hong Kong property prices have appreciated a lot over the years,” Chik said. “So the effective tax rate will decrease significantly, making the seller liable for top-up tax.”

Chik then explained some of the elections that can be made to reduce the impact. One of these is the “aggregate asset gain” election, which allows you to spread the gain from selling a property over five years. The aggregate asset gain election can be applied to both investment and owner occupied properties

Another way to mitigate the tax impact is to sell shares in the property, as equity is not taxed, but you must already have an SPV (special purpose vehicle) in place.

In conclusion, Yip said that in the future there will be more complicated rules to ensure that companies pay a minimum amount of tax. 

“The whole world is moving towards a standard where there will be no more tax planning based on location,” he said.