Cheng & Cheng reveals the importance of balancing interests of HKIRD in Transfer Pricing matter
- two common scenarios when the IRD carries out transfer pricing adjustment in Hong Kong;
- the penalties of lacking proper documentation; and
- the reasons of preparing benchmarking studies.
Thanks to the closure of border due to Covid-19 pandemic and skyrocketing inflation across the globe, the year 2022 has undoubtedly been a difficult one for MNCs and Mainland China Enterprises. It can be a real headache for in-house tax specialists to apply their transfer pricing policies as the overall profit margin of the group plunges. As the group will have already entered into either advance pricing arrangements or informal agreements with tax authorities in other operating jurisdictions, they may still have to assign a certain percentage of the profit margin to those jurisdictions, despite the profit slump. In the past, a group was left with no alternatives but to allocate substantial losses to Hong Kong entities of the group. This is now impossible since the IRD is likely to impose transfer pricing adjustments and will not accept the losses.
Scenario 2: Hong Kong as a collection and payment hub
Hong Kong enterprises are commonly assigned to be the "collection and payment hub" of a group to collect and make payments on behalf of its group companies in other jurisdictions to get around foreign exchange control restrictions. From an accounting perspective, these transactions may be booked as sales and cost of sales without any markup. These break-even transactions lower the overall operating profit margin of the Hong Kong entity despite a "nil" effect on the absolute amount of profit. However, the corporation's lower overall profit margin may trigger the attention of tax authorities, especially when the margin is lower than the industry average.
Importance of proper transfer pricing documentation in Hong Kong
As in other jurisdictions, transfer pricing documentation in Hong Kong comprises Master File, Local File and Country-by-Country (CbC) reporting. While following the universal threshold of group consolidated revenue of EUR750 million for a CbC report, the threshold for Master File and Local File in Hong Kong is rather complicated (see Table 1).
Table 1: Threshold for Master File and Local File
| Criteria (A): Based on size of business (any two out of the three below) | Threshold |
(i) | Total annual revenue | > HK$400 Million |
(ii) | Total assets | > HK$300 Million |
(iii) | Employees | >100 |
| Criteria (B): Based on related party transactions (any one out of the four below) | Threshold (HK$) |
(i) | Transfer of properties (excludes financial assets / intangibles) | > HK$220 Million |
(ii) | Transactions in financial assets | > HK$110 Million |
(iii) | Transfers of intangibles | > HK$110 Million |
(iv) | Any other transactions (e. g. service income /royalty income) | > HK$44 Million |
On the other hand, taxpayers should closely adhere to the Deadline of preparing the Transfer Pricing Documentation (see Table 2).
Transfer Pricing Documentation | Deadline |
Country-by-Country Report Notification | 3 Months after the Accounting Year-End |
Country-by-Country Report Filing | 12 Months after the Accounting Year-End |
Master File & Local File | 9 Months after the Accounting Year-End |
Applying the same logic, there is a growing trend for MNCs to prepare benchmarking studies, even when their size does not meet the required threshold, for the following reasons: -
- The IRD is increasingly eager to request a benchmarking study, even if the corporation does not meet the threshold for preparing transfer pricing documentation, especially in the case of high gross profit fluctuation;
- Field investigation by the IRD can be a painful process. A benchmarking study is often very helpful in reaching a compromise settlement, such as in the case of failure to maintain proper accounting records.
- Thanks to its low tax rate, Hong Kong is still a place in which many corporations prefer to allocate more profits. Given the current global situation, many MNCs are considering to shift their location of operations. Making use of this opportunity, they are eager to set up substance in Hong Kong to justify their profit allocation.
Initial Public Offering in Hong Kong
- Authorities now customarily request benchmarking report from corporations wishing to list on the Hong Kong Stock Exchange in order to assess their tax risk after getting listed in Hong Kong.
Hashtag: #Cheng&ChengTaxationServices
The issuer is solely responsible for the content of this announcement.
About Cheng & Cheng Taxation Services
This article is by Henry Kwong, Tax Partner of Cheng & Cheng Taxation Services. Cheng & Cheng is one of the top 20 accounting firms in Hong Kong, with over 300 staff in Hong Kong and the PRC. We are the principal auditor for 15 listed corporations in Hong Kong and the tax advisor for over 80. We specialise in providing Hong Kong, PRC and international tax advisory services, as well as transfer pricing services to international clients. If you would like to know more about transfer pricing in Hong Kong, or seek tax advice from our tax experts, please do not hesitate to contact us by email (henry.kwong@chengtax.com.hk) or phone (+852 3962 0114).