Hong Kong Tax News

The Inland Revenue (Amendment) (No.6) Bill 2017 (the “Bill”), was passed by the Legislative Council on 4 July 2018 and came into force on 13 July 2018.

The Bill amends the Inland Revenue Ordinance (Cap. 112) (“IRO”) to:

1. codify rules (the arm’s length principle) on transfer pricing;
2. implement the three-tiered TP documentation;
3. introduce the deeming provision on income from intellectual property;
4. codify the advanced pricing arrangement (“APA”) regime;
5. introduce a statutory dispute resolution mechanism for cross-border tax treaty-related disputes;
6. extend the period for claiming tax credits; and
7. revise the eligibility criteria for certain profits tax concessions.

In summary the new legislation has the following implication on the companies in Hong Kong.

1.    The TP Regulatory Regime

The Bill codifies the arm’s length principle into the IRO and empowers the IRD to impose TP adjustments on either income or expense arising from non-arm’s length transactions between associated persons that give rise to a potential Hong Kong tax advantage. This applies to cross-border transactions and domestic transactions; while certain domestic transactions that do not give rise to any actual Hong Kong tax difference will be specially exempted provided that certain prescribed conditions are met. This will apply retrospectively to years of assessment beginning on or after 1 April 2018, that is, from the year of assessment 2018/19.

2.    TP Documentation Requirement

The Bill introduces a mandatory three-tiered TP documentation requirement in Hong Kong: the Master File, the Local File and the Country-by-Country (CbC) report.

Master File and Local File

A Hong Kong company will be required to prepare a master file and a local file if the company’s related party transactions exceed any of the thresholds for the following categories of transactions during a year:

Transfer of properties (other than financial assets and intangibles) of HK$220 million or more;

Transactions involving financial assets of HK$110 million or more;

Transfer of intangibles of HK$110 million or more; or

Any other transactions (e.g. services and royalty income) in aggregate of HK$44 million or more.

However, a company with related party transactions exceeding the above-mentioned thresholds will be exempt from preparing a master file and local file if it satisfies two of the three following criteria:

Revenue of not more than HK$400 million;

Total assets of not more than HK$300 million;

Employees of not more than 100 on average.

This reporting requirement commences for accounting periods beginning on or after 1 April 2018. The files should be prepared within nine months after the end of the relevant accounting period, and retained for seven years. Failure to comply to this requirement without reasonable excuse would be subject to penalty from HK$50,000 to HK$100,000.

3.    Deeming Provision on Income from Intellectual Property (IP)

A new section 15F of the IRO is introduced such that where a person has contributed in Hong Kong to the development, enhancement, maintenance, protection or exploitation (DEMPE) of an IP and income from such IPs accrues to a non-resident who is an associate of that person from the use of or a right to use such IP outside Hong Kong, the part of the income that is attributable to the value creation contributions in Hong Kong will be regarded as a taxable trading receipts arising in or derived from a trade or business carried on in Hong Kong; that is, the new deeming provision will deem the income from IP accruing to the associated non-resident IP owner, but attributable to the DEMPE functions performed and assets deployed in Hong Kong, to be taxable receipts of the Hong Kong taxpayer.

The commencement of the deeming provision on IPs will be postponed by 12 months, i.e. applicable to years of assessment beginning on or after 1 April 2019.

B.   Tax deduction on Qualifying research and development (R&D) activities

On 24 October 2018, Hong Kong’s Legislative Council passed the bill (the Bill) for the new legislation (the New Law) to grant an increase in tax deductions for qualifying research and development (R&D) activities. The New Law is expected to be enacted on 2 November 2018. The Bill retains the original form, other than one amendment.1 In addition, the Hong Kong Government has clarified certain provisions of the New Law during the legislative process. Detailed discussion Overview Under the New Law, effective for expenditure incurred on or after 1 April 2018, qualifying R&D expenditure on a qualifying R&D activity will be eligible for a 300% deduction for the first HK$2 million, and the remainder, deductible at 200% without limitation. R&D expenditure that does not qualify for the above deduction will continue to be eligible for the normal 100% deduction.

With respect to subcontracted out qualifying R&D activities, the payments must be made to a “designated local research institution” to qualify for the additional deductions. For in-house qualifying R&D activities, the R&D activities must be undertaken and carried on by a taxpayer wholly within Hong Kong to be eligible for the additional tax deductions. Amendment The amendment relates to a payment made by a taxpayer to another institution for a subcontracted out R&D activity. It provides that if an institution is designated by the Commissioner for Innovation and Technology in Hong Kong as a designated local research institution within six months after the payment was made, the payment will retroactively qualify as a payment to a designated local research institution

Should you would like to know more details on the above, please contact Kenneth Au, Tax Managing Director at kennetha@zetland.biz or +852 3552 9093.