Global Tax Alert | 4 August 2017

Hong Kong releases Consultation Report on Measures to Counter Base Erosion and Profit Shifting

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Executive summary

On 31 July 2017, the Government of Hong Kong (the Government) released the Consultation Report on Measures to Counter Base Erosion and Profit Shifting (BEPS) (the Consultation Report), published on the Financial Services and the Treasury Bureau’s (FSTB) website. The Consultation Report provides the conclusions of the Government on each of the issues covered during the consultation process on BEPS that was held from 26 October to 31 December 2016,1 as well as a description of the expected implementation process for each of the Government’s proposals.

The Consultation Report consists of six chapters, namely:

  • Chapter 1: Introduction
  • Chapter 2: Transfer pricing regulatory regime
  • Chapter 3: Transfer pricing documentation and country-by-country reporting
  • Chapter 4: Multilateral Instrument
  • Chapter 5: Other related matters
  • Chapter 6: Way forward

The Consultation Report indicates that the Government received broad support during the consultation process for its implementation strategy regarding the BEPS package, which focuses on implementing the four BEPS minimum standards set by the Organisation for Economic Co-operation and Development (OECD) while maintaining Hong Kong’s simple and low tax regime. In that regard, a majority of respondents agreed that the pragmatic and progressive approach adopted by the Government would minimize the regulatory burden and compliance cost on businesses, in particular for small and medium entities (SMEs).

The Consultation Report also specifies that the Government will remain guided by the same principles in drawing up the legislative proposals associated with each measure. In light of the upcoming peer reviews on the four minimum standards, the Consultation Report indicates that the Government will however need to act expediently and introduce an amendment bill at the Legislative Council (LegCo) by the end of 2017.

Detailed discussion


In June 2016, the Government announced that Hong Kong had joined the inclusive framework for implementation of the OECD BEPS package of measures (Inclusive Framework) as an Associate to the BEPS Project, and had committed for this purpose to implementing the comprehensive BEPS Package (including the four BEPS minimum standards). On 26 October 2016, the FSTB of Hong Kong launched a public consultation process on proposed measures to counter BEPS strategies that ended on 31 December 2016.

The paper that initiated the consultation process (Consultation Paper) included detailed explanations of Hong Kong’s proposed strategy for implementing the comprehensive BEPS Package. The Consultation Paper included proposals in relation to the four BEPS minimum standards on: (i) countering harmful tax practices (Action 5); (ii) preventing treaty abuse (Action 6); (iii) imposing the County-by-Country (CbC) reporting requirement (Action 13); and (iv) improving cross-border dispute resolution mechanism (Action 14) (collectively, the “minimum standards”).

The Consultation Paper also included proposals not related to the minimum standards. For example, the Consultation Paper proposed the introduction of statutory transfer pricing rules in accordance with Actions 8, 9, and 10. Further, the Consultation Paper indicated that Hong Kong was prepared to become a party to the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (referred to as the “Multilateral Instrument” or “MLI”) developed under Action 15 in order to implement the treaty-related BEPS measures.

The stated general policy objective pursued by the Government under the Consultation Paper was to put in place a model for change that would ensure the satisfAction of Hong Kong’s international obligations without compromising Hong Kong’s simple and low tax regime.

The following sections summarize the main issues covered in the Consultation Report:

1. Transfer pricing regulatory regime

2. Transfer pricing documentation and CbC reporting

3. Multilateral Instrument

4. Other related matters

5. Legislative implementation

Transfer pricing regulatory regime

The Consultation Report reiterates the proposed codification of the arm’s length principle into the Inland Revenue Ordinance (IRO), in order to formalize the existing requirement that related parties must transact with each other at arm’s length.

This objective would be achieved by introducing into the IRO a fundamental transfer pricing rule (fundamental rule), based on the arm’s length principle found in Article 9 of the OECD Model Tax Convention. The fundamental rule would empower the Hong Kong Inland Revenue Department (IRD) to adjust the profits or losses of an enterprise in a non-arm’s-length situation. Related parties would be defined based on tests of participation in the management, control, and capital of another or of common participation by a third party. The OECD’s transfer pricing guidelines will be relied on to provide guidance on how the transfer pricing principles should be interpreted, and a legal basis for its application will likely be provided for in the IRO. The applicable version of the OECD’s transfer pricing guidelines will be included within the legislation itself. In addition, in response to concerns raised about the definitions and need for clarity on the fundamental rule, a Departmental Interpretation and Practice Note (DIPN) will be issued to provide further guidance.

The fundamental rule, as stated in the Consultation Paper, would be applicable to transactions of assets, services, as well as financial or business arrangements. Furthermore, the fundamental rule will apply to dealings between different parts of a single enterprise (such as dealings between a head office and a foreign permanent establishment).

In keeping with international norm and in line with the IRD’s prevailing practice under DIPN 46, the Consultation Report is clear that the fundamental rule will also apply to domestic tax-neutral transactions. This has also been done with consideration to the point that tax regimes, and the domestic transactions involved, would need to adhere to the international transfer pricing principles, particularly given that these transactions will fall under the purview of issues related to countering harmful tax practices.

With regard to the application of the fundamental rule to loan transactions, the Consultation Report clarifies that there is no intention to introduce any debt-to-equity ratio or limits on the maximum amount of deductible interest (i.e., there will be no thin capitalization rules). Instead the focus will be on ensuring that intra-group borrowings are made on an arm’s length basis, with regard to the borrowing capacity of the enterprise concerned as a standalone entity.

There will be no safe harbor rules implemented with respect to the applicability of the fundamental rule. Therefore, the arm’s length principle will apply to transactions between related parties, regardless of the size and nature of the enterprises concerned. However, there will be safe harbor thresholds that apply to documentation requirements (which are described in the following section on documentation).

With respect to intellectual property (IP), the Consultation Report states that there is an intention to introduce specific provisions in the IRO to address the unique nature of IP, which may not be appropriately addressed by the proposed fundamental rule.

Proposed penalty provisions regarding failure to comply with the arm’s length principle are expected to remain. Specifically, penalties would be imposed where a tax return was made with incorrect information on transfer pricing without a reasonable rational or with the intent to evade tax. The views of respondents to the Consultation Report, related to the levels of penalty, will be taken into consideration when formulating the legislative proposal. However, the IRD has stated that the availability of OECD-compliant transfer pricing documentation alone will not qualify for an exemption from penalties, but will be considered in determining whether individual taxpayers have a “reasonable excuse” to be exempt from the penalties.

In terms of Advance Pricing Arrangements (APA), the Consultation Report states that the regime will cover unilateral, bilateral and multilateral APAs. This is in contrast with the prevailing approach where the IRD has indicated that they will only consider bilateral or multilateral APA applications (as stated in the IRD website on APAs). The Consultation Report also restates that the Commissioner will only exercise her/his power to revoke, cancel or revise an APA under specific circumstances (such as changes in material conditions or incorrect information). The provisions of the APA in the IRO will be limited to general rules, with further details elaborated in a DIPN.

Transfer pricing documentation and CbC reporting

The Consultation Report continues to adopt the OECD’s recommended three-tiered documentation structure, comprising a master file, local file and the CbC report.

However, in response to requests for increasing the exemption threshold, the Consultation Report has revised the previous exemption based on business size and also introduced an additional exemption based on related party transAction volumes. Specifically, an enterprise will not be required to prepare master and local files if they can meet either one of the following exemptions.

  • Exemption based on size of business: Taxpayers meeting any two of the three following conditions are not required to prepare the master file and local files:
    • Total annual revenue not more than HK$200 million;
    • Total assets not more than HK$200 million; or
    • No more than 100 employees.
  • Exemption based on related party transactions: If the amount of a category of related party transactions for the relevant accounting period is below the proposed threshold, an enterprise will not be required to prepare a local file for that particular category of transactions:
    • Transfer of properties (other than financial assets and intangibles): HK$220 million;
    • TransAction of financial assets: HK$110 million;
    • Transfer of intangibles: HK$110 million; or
    • Any other transAction (e.g., service income and royalty income): HK$44 million.

The information to be included in the master and local files, as mandated by the OECD, will be specified in the legislation and the operational details will be included in a DIPN. The documentation rules will apply to domestic transactions, and domestic transactions must be included in the calculation of the exemption thresholds. Taxpayers must retain documentation for at least seven years.

The CbC report filing threshold would remain the same as previous proposal, which was set in accordance with the OECD recommendation, i.e., €750 million which is approximately HK$6.8 billion.

The primary obligation of filing CbC reports will fall on the ultimate parent entities (UPEs) of the multinational groups that are resident in Hong Kong. But the Consultation Report continues to also embrace the OECD’s mandate in relation to the implementation of ”secondary” and ”surrogate” filing mechanisms. The information to be included in CbC reports will be in line with the OECD’s requirements.

On 22 December 2016, the IRD announced a transitional arrangement for accepting voluntary filing of CbC reports for taxpayers with a UPE located in Hong Kong. These voluntary filings will cover accounting periods commencing between 1 January 2016 and 31 December 2017. The Consultation Report continues to support this transitional arrangement, and states that the IRD will put in place the required legal framework as soon as possible and will provide taxpayers with the necessary assistance.

Penalty provisions in respect of misleading, false or inaccurate information in the CbC reports will be introduced.

With respect to the exchange of CbC reports, in addition to the previously announced approaches of using the Comprehensive Double Taxation Agreement (CDTA) or a Tax Information Exchange Agreements (TIEA), the Multilateral Convention on Mutual Administrative Assistance in Tax Matters (MCMAA) will also be relied on by Hong Kong, consistent with the Government’s recent announcement that Hong Kong will seek to join the MCMAA.2 The MCMAA to be applied will be an extension of China’s MCMAA, where the Central People’s Government has recently agreed in-principle to extend the application to Hong Kong.

Multilateral instrument

On 7 June 2017, Hong Kong and 67 other jurisdictions joined the MLI at a signing ceremony hosted by the OECD in Paris. Mainland China represented Hong Kong at the ceremony after agreeing in December 2016 to allow the territorial extension of the application of the MLI to Hong Kong.

The MLI allows Parties to implement swiftly and in a predictable manner the tax treaty-related BEPS measures in relation to four BEPS actions, namely Action 2 (hybrid mismatches), Action 6 (treaty abuse), Action 7 (permanent establishment), and Action 14 (dispute resolution). Two minimum standards can be implemented through the MLI, namely the minimum standard on treaty abuse (Action 6) and the minimum standard on dispute resolution (Action 14).

Hong Kong adopted a minimalist approach for the MLI by agreeing only to the provisions associated to a minimum standard and opting out of all the optional provisions. With respect to the Action 6 minimum standard in particular, the Government agreed only to the inclusion of a Principal Purpose Test (PPT) as anti-treaty abuse rule, as well as the inclusion of new preamble texts for its CDTAs.

The Consultation Report indicates that the Government will continue to maintain the same approach with respect to the MLI. The Consultation Report notes that most respondents during the consultation process were supportive of the “PPT only” approach. The Consultation Report specifies that the funds and asset management industry, in particular, expressed strong concerns over the unnecessary restrictiveness that a Limitation on Benefits (LOB) rule could have on treaty benefits.

Importantly, the Consultation Report confirms that the Government is strongly committed to the “PPT only” approach and will not accept a symmetrical or asymmetrical application of the LOB rule, unless Hong Kong’s CDTA partner registers a reservation to negotiate bilaterally a comprehensive LOB (in which case negotiation becomes mandatory pursuant to the terms of the MLI − but does not entail any obligation to reach an agreement). As noted in the Consultation Report, none of Hong Kong’s CDTA partners has however made such reservation so far.

Other related matters

Dispute resolution mechanism

The Consultation Report indicates that the Government received overwhelming support during the consultation process regarding the introduction of a full-fledged statutory dispute resolution mechanism. The Government confirms in the Consultation Report that a legislative statutory dispute resolution mechanism will be introduced.

In order to preserve the simplicity of the dispute resolution mechanism, the Consultation Report proposes to include only general provisions in the legislation and address the specific details in a DIPN. In order to prepare for the OECD peer review process on dispute resolution, the new legal and administrative framework will be formulated in accordance with the OECD’s Model Tax Convention, BEPS Action 14 and the relevant peer review documents.

Spontaneous exchange of information on tax ruling

The Consultation Report confirms that Hong Kong will be conducting spontaneous exchange of information (EOI) on the six categories of tax rulings covered by the Action 5 minimum standard (countering harmful tax practices). These exchanges will extend to both past and future rulings, in accordance with the minimum standard.

In addition to being conducted with CDTA and TIEA partners as previously announced, EOI on tax rulings will also be conducted through the MCMAA. The Consultation Report notes that great importance will be placed on ensuring the confidentiality of information disclosed by adopting the safeguards provided under the MCMAA, CDTAs and TIEAs.

Double taxation relief

The Government received general support regarding the enhancement of the current tax credit system proposed in the Consultation Paper, in particular with respect to the extension of the period for claiming a tax credit to six years. The Consultation Report now proposes to model the granting of tax credit on section 70A of the IRO in order to allow a tax credit to be claimed: (i) within six years after the end of the relevant year of assessment; or (ii) six months after the date of the notice of assessment imposing the liability or additional liability, whichever is later.

The Consultation Report indicates that the Government has decided against introducing a unilateral tax credit system or extending the tax credit system to Hong Kong branches of foreign enterprises, as proposed by some respondents during the consultation process.

Further, the granting of a tax credit will remain subject to the condition of having made full use of all other available relief, as proposed in the Consultation Paper. However, the Consultation Report clarifies that a taxpayer will only be required to take all reasonable steps to minimize the amount of foreign tax payable before claiming a tax credit. A DIPN will be issued to explain the application of this requirement. A penalty for failure to notify the IRD of adjustment to foreign tax payments will also be introduced.

Harmful tax practice

In light of the recent and expected strengthening of the international standard in the area of harmful tax practice with respect to ring-fencing practices (in particular stemming from the OECD Forum on Harmful Tax Practice (FHTP) and the European Union),3 the Government recently extended the tax regime for offshore aircraft leasing activities to onshore aircraft leasing activities in order to ensure that it would not be ring-fenced from the domestic economy.4

The Consultation Report indicates that the Government is currently reviewing other similar tax regimes in Hong Kong in order to avoid any possible perception of ring-fencing and will consider introducing legislative amendments where necessary. The Consultation Report states that failure to address FHTP’s concerns would jeopardize Hong Kong’s reputation as an international financial center since countering harmful tax practices is one of the four BEPS minimum standards.

Legislative implementation

Because of the upcoming OECD peer reviews on the four minimum standards, the Government needs to act expediently and put in place a legislative framework to implement the measures in relation to each standard.

The Consultation Report specifies that the proposals in respect of transfer pricing, CbC reporting and dispute resolution will be incorporated in an amendment bill that will be introduced at LegCo by the end of 2017. An amendment bill will also be introduced by the end of 2017 to implement the MCMAA.

The Consultation Report indicates that the Government will need more time to work out its legislative approach regarding the implementation of the MLI, such that the changes in relation to the MLI are expected to be introduced at LegCo around mid-2018 via a separate amendment bill.


The IRD continues to emphasize that it wants to be aligned with the BEPS package without compromising its simple and low domestic tax regime. The proposed legislative changes are intended to counter BEPS strategies adopted by multinational groups and to minimize the impact on SMEs.

The Consultation Report shows that positive modifications were made to the Government’s BEPS proposals in response to the consultation process. For example, transfer pricing documentation thresholds were revised to appropriately capture target groups and reduce the compliance burden. In addition, clarity was provided in the area of domestic transactions (which will be covered within the scope of the transfer pricing rules), the penalty regime, the application of the fundamental rule to IP and loan transactions, the APA, and the documentation structure. The IRD’s announcement of releasing DIPNs will further aid with the application of the transfer pricing rules, and providing certainty to the taxpayers. However, there are certain areas that the IRD has not fully addressed. For example, although the IRD has recognized the comments provided on the interAction of Hong Kong’s territorial-based tax regime with transfer pricing principles and the contemporaneous nature and effective date of transfer pricing documentation, the Consultation Paper does not provide further clarity on these points.

Further, the Government also clarified its position regarding the non-acceptance of the LOB. However, shortcomings remain present, such as the absence of detailed guidance on the application of the PPT.

Although the Government has sought to limit the impact of the soon-to-be introduced BEPS-related measures on the regulatory burden and compliance cost for businesses, these measures remain highly complex and could have wide ranging consequences for enterprises doing business in Hong Kong or in other jurisdictions. Provisions such as the PPT will increase the level of uncertainty in the tax treatment of many common transactions and structures, which will affect taxpayers’ ability to properly ascertain their tax obligations. Accordingly, multinational corporations or any enterprises with cross border activities should review their existing operating and tax structures and compliance abilities in light of the reinforced standards that will be imposed in order to determine the presence of any high-risk areas.


1. See EY Global Tax Alert, Hong Kong publishes consultation paper on measures to counter BEPS, dated 28 October 2016.

2. See EY Hong Kong Tax Alert, Hong Kong seeks to exchange tax information with other jurisdictions by way of the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, 2017 Issue No. 9, dated 16 June 2017.

3. “Ring-fencing” refers to the practice of isolating a preferential tax regime from the domestic economy.

4. See EY Global Tax Alert, Hong Kong extends proposed preferential tax regime to onshore aircraft leasing business, dated 24 May 2017.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Tax Services Limited, International Tax Services, Hong Kong
  • James Badenach
    +852 2629 3988
  • Jacqueline Bennett
    +852 2849 9288
  • Cherry Lam
    +852 2849 9563
  • Adam Williams
    +852 2849 9589
Ernst & Young Tax Services Limited, Transfer Pricing Services, Hong Kong
  • Martin Richter
    +852 2629 3938
  • Kenny Wei
    +852 2629 3941
  • Justin Kyte
    +852 2629 3880
Ernst & Young Tax Services Limited, EY Asia-Pacific International Tax Services Leader
  • Alice Chan
    +852 2629 3882
Ernst & Young Tax Services Limited, EY Asia-Pacific Transfer Pricing Leader
  • Curt Kinsky
    +852 2629 3098
Ernst & Young LLP, Hong Kong Tax Desk, New York
  • Charlotte Wong
    +1 212 773 7590

EYG no. 04516-171Gbl