Hong Kong SAR is expected to implement Pillar Two of the base erosion and profit shifting (BEPS) 2 project this year even as it moves to revise its foreign-sourced income exemption (FSIE) regime after the European Union put Hong Kong on a watchlist.
Tax practitioners discussed the potential impact of the new global tax avoidance rules on Hong Kong’s tax regime as part of a panel discussion during ACCA Hong Kong’s recent annual tax conference, held virtually.
As a trade and commerce hub, Hong Kong has attracted many multinationals
As a trade and commerce hub, Hong Kong has attracted many multinationals that have set up distribution companies, and which may also have limited risk distributors in other locations. The implementation of BEPS 2 will likely impact them.
Desmond Wong ACCA, tax partner at PwC, told conference attendees that BEPS 2 will first impact offshore claims for exemption of profits tax, making them more complicated. The reporting requirement for offshore claims will be higher when contracts are signed abroad or the main business operations take place abroad.
And even if a company does manage to make valid offshore claims for exemption of profits tax, the benefit may be offset under BEPS 2, said Stanley Ho FCCA, co-chairman of ACCA Hong Kong's tax subcommittee.
BEPS 2 will also affect large conglomerates because of the changes it brings for transfer pricing. Under a traditional transfer pricing policy, a multinational conglomerate that earns significant profits in its home country in Europe or North America may have its Hong Kong distribution company charge services fees with a low margin even if its market penetration is high. Under Pillar One of BEPS 2, these companies may need to pay more tax, Wong said.
Another challenge may come from the need to deal with foreign authorities. In such cases, it is always wise to seek professional advice, advised Jenny Hau, group tax manager at PCCW. Hau said companies need to understand what the purpose is behind any letters they receive from authorities.
‘If disputes or appeals arise, companies need to think about how possible it is to win them – and the costs'
When reporting about their businesses elsewhere, companies must provide appropriate information to avoid any misinterpretation by tax authorities. The key here is to give a clear explanation of what any business elsewhere is, Hau said.
‘If disputes or appeals arise, companies need to think about how possible it is to win them – and the costs. Compromise may bring more. Companies need to list the pros and cons and consider everything comprehensively,’ Hau advised.
Another problematic area under BEPS 2 is internal fee arrangements, with crossborder transactions potentially also involving taxes abroad, Ho said.
For example, where Hong Kong is designated a multinational’s regional headquarters, with domestic and foreign subsidiaries, then the enterprise needs to consider how to charge service fees or management fees to subsidiaries to optimise tax arrangements.
‘Thinking traditionally when charging subsidiaries, companies need to consider if the local subsidiaries can get a tax deduction, then decide whether to charge a fee or not,’ said Roy Phan, international tax partner at Deloitte China.
He also suggested another approach: a charge without a tax deduction could end up raising the effective tax rate of the local entity to the 15% minimum tax rate for multinational enterprises set by BEPS 2, which could have a significant impact under Pillar Two.
When multinationals set up IP holding hubs, the first thing to consider is the treaty network
Internal fee management also affects intellectual property (IP) arrangements, which may in turn affect the tax on crossborder transactions.
When multinationals set up IP holding hubs, the first thing to consider is the treaty network, Wong said. Whether or not a double taxation treaty is in place should feed into the decision-making on assessing the jurisdiction’s suitability as an IP holding hub.
‘Because a tax would be generated when companies are doing an outbound transaction, the treaty network is important to reduce the provision for income tax,’ Wong said. He added that the treaty network could also be helpful in securing tax credits.
The many multinationals that have set up corporate treasury centres (CTCs) in Hong Kong could also be affected by BEPS 2, Ho said. Offshore claims and an 8.25% tax concession for qualified CTCs might offset under Pillar Two policies.
Moreover, the EU’s inclusion of Hong Kong on a watch list of potentially harmful tax regimes may eventually require companies to have substantial activity in Hong Kong in order to meet the requirements for offshore profits tax exemptions.
As to whether the 8.25% tax concession will remain attractive, Phan does not see a clear answer.
Also, under Pillar Two, tax deductions for interest on loans may be understood differently.
‘If the Hong Kong company charges interest to the local companies for the loan, and the offshore company can get a local tax deduction, it is a saving, but even if it cannot get the deduction, maybe it can help increase the effective tax rate, which has a good impact,’ said Phan.
Adapt to BEPS 2
With BEPS 2 likely to usher in many changes, companies will need to adapt. Panellists at the annual tax conference offered some practical suggestions for those businesses affected.
‘Companies needs to think of BEPS 2 holistically, because it does not just affect tax departments but also finance departments, IT departments and others,’ Wong said.
Patrick Cheung, tax partner at KPMG China, agreed that companies should consider whether BEPS 2 would indirectly affect other taxes.
Hau advised multinationals to act proactively if they are considering changing tax structures. Ce Wu FCCA, Asia-Pacific tax director at AMS Osram Group, suggested that companies conduct risk assessments.
Panellists also had suggestions for the Hong Kong government.
Hau said Hong Kong could delay the implementation of BEPS 2, given that many countries in the EU are doing the same thing. She also advised the government to give companies some breathing room in the first few years of implementation, provide incentives for companies to develop tax tools, and not impose heavy penalties.
Wu advised the government to offer subsidies for training to companies affected by Pillars One and Two.
Finally, Ho reminded the conference audience to share their views with the Inland Revenue Department and stay on top of the latest changes to tax policy.