In July 2019, the Inland Revenue Department (IRD) issued its Departmental Interpretation Practice Notes no.58 (DIPN 58), setting out transfer pricing documentation requirements under Hong Kong law. The policy matches the transfer pricing documentation requirements that the the Organization for Economic Co-operation and Development (OECD) published in their Transfer Pricing Documentation and Country by Country Reporting, Action 13 – 2015 Final Report, requiring companies to provide a master file, local file, and country-by-country (CbC) report. The new transfer pricing documentation rules will affect all companies and enterprises in Hong Kong that operate through multinational entities or subsidiaries. CbC reporting information will be exchanged automatically between tax authorities in jurisdictions with exchange arrangements and used for high level transfer pricing risk assessments, assessment of other base erosion and profit shifting risks and economic statistical analysis where appropriate.
A multinational enterprise (MNE) group must specify their value drivers and provide a detailed profile of their global operations. Reports should show the value generated by the group as a whole, with a functional breakdown of individual subsidiary roles and specific contributions to revenue.
Master file: the executive summary of the MNE group’s global operations and policies
The master file consists of five categories: the group’s organizational structure, business, intangible assets, intercompany financial activities and financial and tax positions. The master file’s main purpose for authorities is to ascertain any potential risks involving a group’s transfer pricing practices. This documentation reflects the enterprise at the international level.
Local file: detailed transfer pricing records for individual entities within the group
All material controlled transactions involving services provided, loans extended, rights licensed as well as goods purchased and sold should be documented with item amounts and transfer pricing analysis. The local file should clearly demonstrate that transactions within the group are carried out with the arm’s length principle, or market pricing similar to unrelated companies.
Exemptions from preparing Master Files and Local Files:
Exemptions from the documentation requirements may be available based on the size of the business, and the amount of controlled transactions. Specified domestic transactions and grandfathered transactions prior to July 13, 2018 can be excluded from the local file but the IRD may still apply the general anti avoidance rules (section 61A), if they argue that the transactions appear to be made solely for tax avoidance purposes.
Business size: An entity of a group with revenue under HKD 400 million, assets under 300 million and less than 100 employees on average at subsidiaries does not need to prepare master files and local files (during the accounting period when any two of these conditions are met).
Controlled transactions: If the amount of a particular type of controlled transaction does not exceed the prescribed thresholds, an entity of a group is exempt from preparing a local file for that type of controlled transaction. The thresholds are HKD 220 million for transfers of tangible property, and HKD 110 million for transfers of intangible assets like franchises, patents and licenses, and HKD 110 million for transactions in respect of financial assets. The threshold for all other types of controlled transactions is HKD 44 million.
A Hong Kong entity must keep its master file and local file and submit them upon request by the IRD. The master file and local file paperwork should be completed within 9 months after the end of the relevant accounting period. Transactions should be kept separate and aggregates should be calculated from arm’s length amounts. Noncompliance could result in a level 5 fine of HKD 50,000, and a court order to present documentation. Failure to comply with the court order results in a level 6 fine, HKD 100,000
The IRD also requires CbC reports according to OECD standards. Revenue amounts, profit before income tax, income tax, total employment, capital, retained earnings and tangible assets for each jurisdiction in which the reportable group carries on business should be filed by a Hong Kong entity for the MNE group. If the ultimate parent company is tax resident in Hong Kong, the threshold for exemption from this requirement is 6.8 billion HKD. If the ultimate parent company is resident in another jurisdiction with CbC reporting requirements, the exemption threshold should meet local requirements in that jurisdiction.
If the ultimate parent company is tax resident in jurisdiction other than Hong Kong without CbC reporting requirements, the threshold is EUR 750 million. The reports should be filed within 12 months after the end of the accounting period. Notification should be filed within 3 months after the end of the accounting period, via the IRD’s online reporting portal. The reports are automatically shared with other jurisdictions which have exchange agreements with Hong Kong and in where the entities of the group operate and pay taxes. The noncompliance penalty for country-by-country reports is HKD 50,000, with additional HKD 500 per day until the issue is resolved. Not informing the IRD of incorrect CbC Reports containing misleading, false or inaccurate information is punishable by a HKD 50,000 fine. Falsifying information in CbC reports is punishable by a fine and up to 3 years imprisonment.
Proper transfer pricing documentation is essential to demonstrate adherence to the arm’s length principle. It is strongly recommended that all Hong Kong companies that are part of a MNE group proactively prepare proper documentation to this effect. The Inland Revenue Department encourages all companies to keep records whether or not their accounts indicate that they exceed the threshold in order to prevent any ambiguity. Local files for Hong Kong companies should document transfer pricing for all intercompany transactions that generate foreign-sourced income despite the territorial principle of taxation in Hong Kong. Income from these transactions will not affect a company’s Hong Kong tax bill but omission of proper documentation will likely trigger detailed examination of offshore exemption claims.
Our accounting, audit and assurance services can prepare documentation with granular detail, keeping multinational financial reporting airtight and ready for review. Our tax team has experience successfully dealing with IRD field audits and investigations. Having handled such cases we know what to expect. By staying ahead of all developments, we steer our clients clear of any possible liabilities. Should you have any enquiries regarding transfer pricing for Hong Kong companies, please don’t hesitate to contact us for a consultation.
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