Transfer Pricing and AEOI Reporting in Hong Kong

Transfer Pricing

The Inland Revenue (Amendment) (No. 6) Ordinance 2018 (“the Amendment Ordinance”) establishes a comprehensive transfer pricing regime in Hong Kong. It codifies the transfer pricing principles, implements specific measures under the Base Erosion and Profit Shifting (BEPS) package, and aligns the provisions in the Inland Revenue Ordinance (Cap. 112) with international tax requirements.

Contributing Advisor

Jennifer Lu

Partner

Fundamental transfer pricing rules (FTPR)

Based on the arm’s length principle, the Amendment Ordinance introduced fundamental transfer pricing rules (FTPR) that further empower the Inland Revenue Department. This amendment includes the ability to adjust the profits or losses of an enterprise where the actual provision made or imposed between two associated persons departs from the provision that would have been made between independent persons and has created a tax advantage.

Transfer pricing obligation

The Amendment Bill does not contain safe harbor rules due to the FTPR. It means that taxpayers of all sizes engaged in domestic and/or cross-border intercompany transactions of any size will be required to ensure the prices are at arm’s length.

When is your company at risk?

It's important to be aware of specific areas where increased scrutiny is applied, apart from the general regulations mentioned earlier, especially to multinational companies exhibiting the following characteristics:

• Prolonged financial losses.
• Sudden drops in gross profit or net profit ratios.
• Significant transactions involving tax havens.

Furthermore, two specific types of transactions are particularly vulnerable to scrutiny:

• Inter-company trading: Hong Kong operates under a territorial tax system, which means that profits generated outside of Hong Kong are exempt from profit tax. This makes Hong Kong an attractive location for trading companies. However, if the trading profits are deemed to have no source in Hong Kong, they may not be subject to profit tax. This has led multinational corporations to consider shifting their trading profits to a Hong Kong-based trading company. But be cautious: the Inland Revenue Department (IRD) may challenge this arrangement. Beyond the factual circumstances, the presence of transfer pricing documentation will play a crucial role in this discussion.
• Management services: Hong Kong hosts numerous global and regional headquarters, which often charge fees to their affiliated enterprises for services such as HR, legal, and group accounting. In many cases, the IRD argues that the management fees charged should be higher, resulting in more profits being attributed to Hong Kong.

Penalties

You could be penalized if the IRD determines that transfer prices are incorrect. These penalties may include a fine of HKD 10,000 (US$1,200) and an additional charge of 100 to 300 percent of the underpaid taxes.

In cases of deliberate wrongdoing, the taxpayer may face even more severe consequences, including a HK$50,000 (US$6,300) fine, an additional charge of 100 percent to 300 percent of the underpaid taxes, and a potential prison sentence of up to three years.

The IRD must adhere to a statute of limitations when making corrections. Typically, this statute of limitations expires six years from the end of the assessment year related to the transfer pricing issues. However, it's important to note that there is no time limit in fraud or tax evasion cases.

Transfer pricing documentation

The Amendment Ordinance introduced mandatory documentation requirements based on the three-tiered approach of Country-by-Country (CbC) Reporting, Master File, and Local File.

Requirements and exemption thresholds for Master File and Local File

Hong Kong group entity will be required to prepare a Master File and a Local File for each accounting period beginning on or after April 1, 2018. The Master File and Local File must be prepared within nine months after the end of the entity’s accounting period and be retained for no less than seven years after the end of the entity's accounting period. The information items included within the Master and Local files largely align with the Organization for Economic Co-operation and Development (OECD) guidance.

Taxpayers will not be required to prepare Master and Local Files if they meet either of the following two sets of exemptions:

If all of the controlled transactions are exempted from the above-related party transaction criteria, the entity is not required to prepare both the Master File and the Local File.

Country-by-Country reporting

Country-by-country (CbC) Reporting is a minimum standard formulated by the OECD under Action 13 of the Base Erosion and Profit Shifting (BEPS) Package. The requirements for filing a CbC Return, which includes a CbC Report, only apply to a multinational enterprises group (MNE group) whose annual consolidated group revenue reaches the specified threshold amount, i.e., HK$6.8 billion (US$767 million) (Reportable Group).

Regarding the Reportable Group, the primary obligation of filing a CbC Return is on the ultimate parent entity (UPE) resident in Hong Kong and not on any other constituent entities resident in Hong Kong (Hong Kong Entities). The Hong Kong UPE must file a CbC Return for each accounting period beginning on or after January 1, 2018.

A Hong Kong Entity of a Reportable Group whose UPE is not resident in Hong Kong is subject to a secondary obligation of filing a CbC Return under certain conditions. Each Hong Kong entity of a Reportable Group must file a written notification informing within three months after the end of the accounting period.

The deadline for filing a CbC Return is 12 months after the end of the relevant accounting period or the date specified in the assessor’s notice, whichever is earlier. A service provider (SP) may be engaged to file a CbC Return or the related notification.

AEOI reporting

Under the Automatic Exchange of Financial Account Information (AEOI) standard, financial institutions must identify financial accounts held by tax residents of reportable jurisdictions or passive non-financial entities whose controlling persons are tax residents of reportable jurisdictions in accordance with due diligence procedures.

Required information on these accounts must be collected and furnished to the Department. Such information will be exchanged on an annual basis. Tax residents of reportable jurisdictions” refer to those who are liable to tax because of residence in the jurisdictions.

In general, whether or not an individual is a tax resident of a jurisdiction is determined by having regard to the person’s physical presence or stay in a place (e.g., whether over 183 days within a tax year) or, in the case of a company, the place of incorporation or the place where the central management and control of the entity is exercised. Account holders may be requested to provide self-certifications on their personal information, including tax residence, to enable financial institutions to identify the reportable accounts.

Hong Kong has expanded the list of reportable jurisdictions to cover 100 reportable jurisdictions for the more effective implementation of the arrangement relating to AEOI. These jurisdictions include all EU member states, all of Hong Kong’s tax treaty partners that have committed to CRS, and other jurisdictions that have expressed an interest to the OECD in exchanging CRS information with Hong Kong.

Hong Kong will only conduct AEOI with a reportable jurisdiction when an arrangement is in place with the reportable jurisdiction concerned to provide the basis for exchange.

Hong Kong CRS reporting deadline 2025

Under the Common Reporting Standard (CRS) regime, financial institutions in Hong Kong are required to report financial account information for tax residents of reportable jurisdictions to the Inland Revenue Department (IRD). The CRS initiative, introduced by the OECD, aims to combat tax evasion by ensuring transparency and exchange of financial account information between jurisdictions.

For the year 2025, the CRS reporting deadline in Hong Kong for financial institutions remains consistent with previous years. All financial institutions must submit their CRS reports to the IRD by May 31, 2025. The CRS reporting period covers the previous calendar year, meaning that the report filed in 2025 should include account information for the entire year of 2024.

Important details to note:

• Financial institutions must follow due diligence procedures to identify accounts held by tax residents of reportable jurisdictions.
• Collected information includes account balances, interest, dividends, and proceeds from the sale of financial assets.
• Non-compliance or late submission of CRS reports can result in penalties imposed by the IRD.

As part of ongoing compliance efforts, Hong Kong has expanded its list of reportable jurisdictions to include over 100 countries. Financial institutions are encouraged to ensure that their CRS processes are up to date, given the significance of meeting the reporting deadlines in 2025.

BEPS 2.0

Hong Kong has joined over 130 jurisdictions in supporting the OECD’s two-pillar solution to address base erosion and profit shifting (BEPS) risks arising from digitalization. To meet international commitments and safeguard its taxing rights, the 2024-25 Budget confirmed Hong Kong’s adoption of the BEPS 2.0 framework, including the global minimum tax and the Hong Kong minimum top-up tax (HKMTT), both effective from 2025. 

Scope and application

Under BEPS 2.0 Pillar Two, a 15 percent global minimum tax applies to multinational enterprise (MNE) groups with annual consolidated revenue of at least EUR 750 million in any two of the past four fiscal years. This is enforced through two mechanisms:

• Income Inclusion Rule (IIR): Targets parent entities of low-taxed subsidiaries.

• Undertaxed Profits Rule (UTPR): Acts as a fallback where IIR is not applied.
  Together, these form the Global Anti-Base Erosion (GloBE) rules, designed to ensure large MNEs pay a minimum level of tax in each jurisdiction where they operate, curbing avoidance and harmful tax competition.

Implementation in Hong Kong

Hong Kong has adopted the OECD’s GloBE Model Rules into its Inland Revenue Ordinance with limited local modification. Additional provisions address safe harbors, the HKMTT, and administrative matters.

GloBE and HKMTT apply only to qualifying MNE groups. In-scope groups must identify the jurisdiction and income of each constituent entity and compute the effective tax rate (ETR) on a jurisdictional basis, aggregating income and taxes.

Top-up tax calculation
The top-up tax in low-tax jurisdictions is based on:

• Excess profits (total GloBE income minus a substance-based income exclusion); and

• Top-up percentage (15% minus the jurisdiction’s ETR).

Determining location
The definition of a “Hong Kong resident entity” aligns with existing tax treaties. Entities incorporated, constituted, or managed and controlled in Hong Kong are treated as located there for GloBE and HKMTT purposes, effective retrospectively from January 1, 2024.

Charging mechanisms

• IIR: Applies to Hong Kong-based parent entities of in-scope MNE groups for fiscal years beginning on or after January 1, 2025.

• UTPR: Applies via additional tax adjustments unless designated entities are named. Its implementation date will be announced.

• HKMTT: Targets low-taxed Hong Kong entities and takes precedence over IIR and UTPR. Investment and insurance investment entities are excluded to maintain tax neutrality. As a QDMTT, HKMTT qualifies for credit in other jurisdictions. It applies from fiscal years beginning on or after January 1, 2025.

Administrative arrangements
Top-up taxes under GloBE and HKMTT are treated as profits tax under the Inland Revenue Ordinance, utilizing existing systems for assessment, collection, appeals, and dispute resolution under tax treaties.

Safe harbors
To ease compliance, Hong Kong applies OECD-endorsed safe harbors:

• Transitional Country-by-Country reporting.

• Transitional UTPR.

• QDMTT safe harbor.

• Simplified calculations for non-material entities.

Reporting obligations
Each Hong Kong constituent entity in an in-scope MNE group must file a top-up tax return within 15 months (or 18 months for the first year) of the fiscal year-end, unless a qualifying exchange agreement applies. A designated Hong Kong entity may file on behalf of all local entities, with the appointment valid for the relevant fiscal year. Additionally, an annual top-up tax notification must be submitted within six months after fiscal year-end, and this may also be filed by a designated entity.

Assessment and payment
Assessment notices are based on filed returns, with payment due one month after the return deadline or assessment notice, whichever is later. Groups may appoint paying entities; however, if any fail to pay, all local entities are jointly liable. Objections must be raised within two months of assessment.

Penalties and anti-avoidance
Non-compliance may incur penalties, including those applicable to service providers. A targeted anti-avoidance rule, based on the OECD’s main purpose test, applies specifically to the GloBE and HKMTT frameworks; general anti-avoidance provisions under the Inland Revenue Ordinance do not.

Application to other entities
The regime also applies to joint ventures, their subsidiaries, and stateless entities operating in Hong Kong, consistent with the treatment of local constituent entities.