Is your firm is doing business in Asia? Then here is a big chance that Hong Kong is involved. It is important to understand what types of risks there are with regards to transfer pricing in Hong Kong.
After reading this article, you understand exactly what transfer pricing rules and requirements there are in Hong Kong, what risks there are for your firm, and how you can make sure you don’t break the law.
What you need to know about transfer pricing in Hong Kong
Low taxation, flexible rules and ease of doing business have made Hong Kong the main business platform in Asia. The Hong Kong tax authorities, the Inland Revenue Department (IRD), have always been mindful of this position.
For this reason, there hasn’t been much focus on anti-tax-abuse regulation. This also applied to transfer pricing rules. However, this is changing rapidly, mainly because of BEPS developments.
What are your obligations in Hong Kong?
Hong Kong does not require you to have full-fledged transfer pricing documentation. However, there should be proof that the transfer pricing you use is at arm’s length. It is recommended to have (at the very least) documentation that explains how your transfer pricing has been determined.
In case the IRD requests a substantiation of the transfer pricing, documentation must be provided within 30 days of a request. In addition to that, you have to disclose in the annual profits-tax-return the amounts of controlled transactions and the related parties involved.
When are you at risk?
Besides the general requirements mentioned, it is worth noting that there are a number of areas where scrutiny has increased. This includes multinational companies with:
- sustained losses
- sudden falls in the gross profit or net profit ratio
- significant transactions with tax havens
In addition to that, there are two types of controlled transactions that are at more risk than others: inter-company trading and management services.
Hong Kong operates a territorial tax system which exempts profits that do not have a “source” in Hong Kong. This can be attractive for trading companies based in Hong Kong. If the trading profits do not have a Hong Kong source, there is no profit tax due.
The results is that within multinational enterprises there is an incentive to shift trading profits to a Hong Kong trading company. The IRD however, wants to have a piece of the cake and it may deny the claim.
Do you as a tax-payer want to make a successful claim? Besides the factual circumstances, the presence of transfer pricing documentation will be included in the discussion.
Hong Kong is home to many global and regional head offices. These offices generally charge fees to associated enterprises for services provided to them. Examples are HR, legal and group accounting. Often the IRD takes the position that the management fee charged should be higher (= more profits in Hong Kong).
How tight is government control?
As of now, Hong Kong has transfer pricing rules although these are not as extensive as in other countries (like China). However, times are changing and the IRD is focusing more on compliance of these rules. Penalties because of transfer pricing corrections can be very expensive.
It is therefore recommended to make sure that there is a solid foundation for the transfer pricing used in controlled transactions. As mentioned, controlled transactions that are more at risk than others are inter-company trading and management services.
What penalties do you risk when not complying with the rules?
In case the IRD deems transfer prices incorrect, it can impose a penalty of HKD 10.000 and 100% to 300% of tax undercharged. In the case of wilful intent, the taxpayer faces a fine of HKD50.000, 100% to 300% of tax undercharged and up to three years of imprisonment.
The IRD is bound to a statue of limitation to make corrections. Normally, this statute of limitation ends 6 years from the end of the year of assessment to which the transfer pricing issues relates. This the different in case of fraud or tax evasion there is no time limit.
So yes, with transfer pricing in Hong Kong there are rules to take into account.
Do you want to be sure?
Do you want to be sure that your transfer pricing policy is compliant with regulations in Hong Kong? Does your firm have inter-company transactions and do you want to be sure you charge the right prices?
…Then we provide you with a short-cut to getting your questions answered.
We are Transfer Pricing Asia, a boutique transfer pricing firm based in Asia. We assist multi-nationals en medium sized businesses with all matters related to transfer pricing.
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Relevant regulations and rulings transfer pricing in Hong Kong
Hong Kong does not have specific transfer pricing rules. However, the IRD can make use of general anti-tax avoidance rules to challenge incorrect transfer pricing.
- Section 16 of the IRO about deductibility of expenses in arriving at assessable profits
- Section 17 of the IRO about prohibited deductions
- Section 20 of the IRO about basis for taxation of closely connected, non-resident persons
- Section 61A of the IRO about transactions designed to avoid tax liability
Next to this, the IRD has issued four Department Interpretation and Practice Notes (DIPN) related to transfer pricing.
- DIPN 45: Relief from Double Taxation due to Transfer Pricing or Profit Reallocation Adjustments, issued in April 2009
- DIPN 46: Transfer Pricing Guidelines – Methodologies and Related Issues, issued in December 2009
- DIPN 48: Advance Pricing Arrangement, issued in March 2012
- DIPN 49: Part B: Taxation of royalties derived from licensing of intellectual property right, issued in July 2012.
OECD compatibility transfer pricing Hong Kong
It is important to note that for transfer pricing in Hong Kong the IRD generally follows the transfer pricing recommendations of the OECD.