Hong Kong Transfer Pricing Update

Hong Kong recently issues a series of Departmental Interpretation and Practice Notes ("DIPNs") which detail and update the transfer pricing rules and documentation requirements that were codified through Inland Revenue (Amendment) (No. 6) Bill 2017 (the "BEPS Bill").

DIPN No. 58 ("DIPN 58") details the updates of the transfer pricing documentation and country-by-country reporting requirements. The DIPN 58 outlines Hong Kong's consistency and alignment with the Organisation for Economic Co-operation and Development's ("OECD") standardized three-tiered approach, including the country-by-country ("CbC") reporting, and the master file and local file requirements. DIPN 58 notes the minimum threshold that a multinational entity ("MNE") must meet in order to prepare a local file. Companies not meeting the threshold requirements for CbC reporting are still encouraged to prepare transfer pricing documentation demonstrating the arm's-length nature of their intercompany transactions. Entities that do not comply with the new transfer pricing documentation rules are subject to a penalty of up to HK$100,000.

DIPN No. 59 ("DIPN 59") details Hong Kong's new transfer pricing rules between associated persons, generally for transactions entered into or effected on or after July 13, 2018. DIPN 59 provides rules and guidance on the arm's-length principle, double taxation agreements, the application of Rule 1 (which requires income or loss from transactions between associated persons to be computed on an arm's-length basis), exempted domestic transactions, grandfathered transactions, determination of the arm's-length price, transfer pricing methodologies and the most appropriate method, comparability analysis, and additional tax (including penalties and fines).

DIPN No. 60 ("DIPN 60") provides an overview of Hong Kong's attribution rules, which apply in relation to a year of assessment beginning on or after April 1, 2019. DIPN 60 discusses the definition of permanent establishment and provides guidance on how to ascertain profits attributable to a permanent establishment in Hong Kong. DIPN 60 details Rule 2, which is the effective adoption of the OECD's authorized approach for attributing profits to a permanent establishment ("PE"). Rule 2 requires the income or loss of a non-Hong Kong resident person attributable to the person's PE in Hong Kong to be determined as if the PE were a distinct and separate enterprise. This will likely effect Hong Kong branches of foreign banks.

Collectively, these new DIPNs will provide a path for entities that operate with or in Hong Kong. With the new transfer pricing guidelines that align with the OECD transfer pricing guidelines, multinational entities that perform business with or in Hong Kong will be able to cohesively manage their transfer pricing documentation. While Hong Kong has only implemented transfer pricing legislation in recent years with their BEPS Bill, it is rapidly catching up. As most of Hong Kong's trading partners have already established their own transfer pricing rules, Hong Kong has implemented transfer pricing policies that align with other countries' adoption of BEPS and CbC reporting. If you are operating in Hong Kong, make sure that your transfer pricing documentation aligns with these new rules and regulations and you adequately support your transfer pricing position so as to avoid any penalties.