International organizations have long waged a campaign against tax base erosion and profit shifting. Hong Kong is part of the battlefront and, as A Plus reports, multinational corporations will have to prepare for BEPS requirements – by adapting to new rules or even by changing their business models
Illustrations by Ester Zirilli
Hong Kong last month edged closer to the full implementation of the Organization for Economic Cooperation and Development and Group of 20’s Base Erosion and Profit Shifting Package, known as BEPS, which is designed to eliminate taxation avoidance strategies that artificially shift profits to low or no-tax locations.
The Inland Revenue (Amendment) (No. 2) Ordinance 2017 was gazetted on 16 June and came into effect on 1 July. Under the amendment, financial institutions will automatically report taxpayer information to the Inland Revenue Department under a sharing agreement with 75 other jurisdictions.
Then outgoing Secretary for Financial Services and the Treasury K.C. Chan said the amendment was part of Hong Kong’s commitment “to enhancing tax transparency and combating cross-border tax evasion” with the 67 other signatories to the OECD Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS.
On 7 June, Chinese officials – acting on Hong Kong’s behalf – signed the convention, which is also referred to as Action 14, and which forms the basis for negotiating changes to tax treaties to address cross-border dispute resolution and improve mutual agreement procedures.
The treaty is one of Hong Kong’s four “actions” to implement BEPS. The others include countering harmful tax practices (Action 5); preventing treaty abuse (Action 6); and imposing country-by-country reporting requirements (Action 13). “Hong Kong is making good progress in implementing its commitments,” says Pascal Saint-Amans, Director of the OECD Centre for Tax Policy and Administration in Paris.
The Hong Kong government is moving rapidly to fulfil the remaining commitments. As well as the amendment ordinance on exchange of information, it will amend future comprehensive double taxation agreements, and introduce country-by-country reporting rules for accounting periods beginning on or after 1 January 2018.
Rewriting Hong Kong legislation will also require amendments to transfer pricing language in the Inland Revenue Ordinance. Companies have long exploited transfer pricing setting prices of goods and services among divisions within an enterprise – to avoid tax. “The timetable for implementing the BEPS package is very tight,” Inland Revenue Commissioner Richard Wong told the Legislative Council in February.
Although BEPS has been in the works since 2012, some tax experts fear Hong Kong is unready. “Since Hong Kong has not had transfer pricing documentation requirements, or random tax audits, in the past, in general Hong Kong taxpayers are less prepared for BEPS,” says Philip Wong, International Tax Services Partner at Deloitte and a Hong Kong Institute of CPAs member.
High level scrutiny
BEPS is an internationally led development that is forcing a rethink of Hong Kong’s simple, low-tax regime. “Low tax rates should not be the only way for Hong Kong to stay competitive,” observes PwC Hong Kong Tax Partner Agnes Wong, an Institute member.
Such challenges helped prompt the government to announce the establishment of a Tax Policy Unit under the 2017-2018 budget to cope with a transforming economy. Hong Kong, says PwC Hong Kong Tax Partner Jeremy Choi, needs to formulate a more diversified and effective tax policy.
“It’s a right direction for the government to set up the Tax Policy Unit,” says Choi, also an Institute member. “However, the unit needs to have the right focus, roles and composition to make it effective.”
“Low tax rates should not be the only way for Hong Kong to stay competitive.”
Participation from the business sector, as well as from finance and accounting professionals, is crucial to the formulation of tax policies that would help boost economic growth, Choi adds. “Furthermore, it also requires cross-departmental coordination and liaison for timely, effective and consistent implementation.”
One task for the unit will be to examine Hong Kong’s transfer pricing policies for multinational enterprises. After all, most of the BEPS compliance burden is likely to fall on corporations that operate in multiple tax jurisdictions.
“They’re aiming to target large enterprises,” says Wong at Deloitte. “The main impact will likely be on those multinational enterprises that have aggressive tax planning or complex transfer pricing arrangements without proper transfer pricing policy. They will probably need to take a holistic review of their existing tax arrangements to identify the risk areas and take appropriate actions.”
Under the BEPS system, the country-by-country report will indicate the level of revenue, profits and tax paid for each jurisdiction in which a multinational enterprise operates. This would apply to multinational enterprises with annual consolidated group revenue of €750 million (HK$6.8 billion) or more, which is the OECD’s recommended threshold.
“We plan to require relevant multinational enterprises to gather the information from 2018 onwards and file their first country-by-country reports to the IRD in 2019, so as to tie in with the OECD’s global review in 2020,” says Wong, the tax commissioner. The country-by-country reports would be filed within 12 months from the last day of the fiscal year and failure to submit could result in a fine of up to HK$100,000 under the consultation proposals.
Models up for grabs
For global corporations around the world, BEPS is likely to affect far more than tax, according to Brett Weaver, Partner, International Tax, and Partner in Charge of Value Management at KPMG. He says BEPS is one of the key factors driving companies to think about different operating models.
“BEPS is really going after perceived abuse of multinationals not paying their fair share of tax,” says Weaver, an American Institute of CPAs member. “And BEPS’s focus is to cause companies to recognize profits where they actually add value.”
How financial professionals can help their clients, says Weaver, is to find “where the value is and building an operating model, and putting a tax wrapper around all of that to really optimize the efficiency,” noting that companies with end-to-end supply chains are going to be heavily impacted. “As are companies that are heavily reliant on intellectual property,” he adds.
Changing the operating model to accommodate BEPS might require new or additional information technology, or prompt a rethink of outsourcing and supplier relationships as well as consideration of political and cultural environments, Weaver’s team noted in a June report, The BEPS ripple effect: Multinationals are re-evaluating how and where they do business.
The burden for smaller companies remains to be seen. Responses to the government consultation have urged that the threshold at which companies must prepare a master file – a high-level overview of the group’s global business operations and transfer-pricing policies – and a local file – detailing trade or businesses in Hong Kong and transactions with associated enterprises – should not be set too low.
Under the government’s consultations an exemption from preparing a master file and local file would apply if an enterprise meets two of the following three conditions: (a) total annual revenue of not more than HK$100 million; (b) total assets of not more than HK$100 million; and (c) no more than 100 employees. “The proposed thresholds could be unduly burdensome,” Peter Tisman, the Institute’s Director, Advocacy and Practice Development, wrote in response to the government’s call for comment.
Moreover, Tisman pointed out, size whether revenue, assets or employees – is not necessarily the most appropriate aspect. The Institute recommended thresholds should be linked primarily to the level of cross-border related-party transactions carried out. “There could be entities with a turnover of over HK$100 million and over 100 employees, whose cross-border related transactions might be insignificant,” Tisman noted.
The OECD has welcomed Hong Kong’s response and consultation process. “Hong Kong is an important financial centre and we are glad that the Hong Kong authorities are fully committed and involved in our work,” says Saint-Amans at the OECD Centre for Tax Policy and Administration.
“Hong Kong is making good progress in implementing its commitment,” he adds, noting: “It is largely compliant as per the [Global Forum on Transparency and Exchange of Information for Tax Purposes] review and has signed the multilateral instrument to bring its treaties up to date. Legislation is being passed for country by country reporting and potentially harmful regimes are being identified.”
“There could be entities with a turnover of over HK$100 million and over 100 employees, whose cross-border related transactions might be insignificant.”
One aspect for companies to consider under BEPS is a higher profile when it comes to tax. “Individual and corporate taxpayers may need to consider what… under the [automatic exchange of information], whereby their financial and cross-border corporate and transfer pricing profiles would become more transparent and accessible by tax authorities, would impact on them,” Ian McNeill, Managing Partner, Tax, Asia-Pacific, at EY in Hong Kong noted in a recent client briefing.
Greater international scrutiny of tax rates – such as through BEPS – is expected to cause a narrowing of disparities between and within regions and is likely to reduce the need for “tax havens” or “tax treaty shopping hubs.” Saint-Amans noted that the 67 countries that signed the OECD multilateral convention on 7 June included almost all the countries used for treaty shopping purposes. “Mauritius hesitated until 6 July, while Barbados and the United Arab Emirates indicated that they would sign later.”
It is not yet clear how tax regimes will be differentiated in the post-BEPS era for economies that have traditionally competed for investment, such as Hong Kong and Singapore. “Both are key Asia-Pacific players to attract headquarters and financial activities,” says Saint-Amans. “They are obviously in competition and rightfully very sensitive to the level playing field.”
Wong at Deloitte says both cities will need to balance the incoming BEPS obligations with their traditionally business-favourable regimes to attract foreign investments. “Conceptually, they have both developed their taxation system to foster foreign investment as international hubs.”
He says that to remain commercially competitive, both governments will try to ensure that any review of their domestic tax regime and transfer-pricing framework would not damage their commercial attractiveness. “Hence we expect that neither jurisdiction will alter its taxation system fundamentally as a result of BEPS,” says Wong.
Saint-Amans says that as a sovereign nation, Singapore is “more agile and often more fine-tuned to what is going on in the G20 and other similar bodies. Our job is to make sure that the playing field is levelled in spite of these differences.” ◆