Hong Kong is under pressure to overhaul its tax laws to cope with uncertainties in the international taxation landscape on the heels of an OECD plan to check profit shifting activities by conglomerates to low-tax jurisdictions to reduce tax bills. Oswald Chan reports from Hong Kong.

A contentious move by the Organization for Economic Co-operation and Development to check conglomerates shifting their profit-making operations to low tax regimes around the world to trim their tax burdens has stirred apprehension among global business centers, including Hong Kong.

It could lead to a sea change in the international tax law environment that could threaten Hong Kong’s position as a popular place to do business, with experts calling for urgent reforms to its tax system to make major corporations stay.

The Paris-based OECD — a 37-member intergovernmental group dedicated to stimulating economic advancement and world trade — began consultations late last year with a view to levying a digital tax, as well as a global minimum tax, on enterprises to address domestic tax base erosion and profit shifting (BEPS) risks. The aim is to stop multinational companies exploiting gaps and mismatches between different countries’ tax systems. Once a consensus is reached by the end of this year, countries are likely to adopt new rules through domestic legislation and changes to tax treaties.

While the digital tax is to deal with taxation of technology companies, the global minimum tax is to tackle profit-shifting activities by conglomerates to low-tax jurisdictions in a bid to slash their tax bills.

“The global minimum tax proposal certainly will create challenges for Hong Kong’s existing tax system. Hong Kong could easily be branded a low tax jurisdiction. This can be serious as it could lead to stiffer overall taxation for multinational corporations operating in Hong Kong,” warned Agnes Cheung, director and head of taxation at global business advisory firm BDO.

The Hong Kong Special Administrative Region government set up the Advisory Panel on BEPS 2.0 to advise the administration on issues relating to the OECD’s move. The panel, chaired by the secretary for financial services and the treasury, has non-official members from the accounting profession and academia, as well as heads of multinational corporations. It will seek the views of big corporations on the OECD proposal’s potential effect on conglomerates operating in Hong Kong. The panel may come up with concrete measures after the OECD has completed its consultations by yearend.

Tax law new rules

One possible solution put forward by the local accounting sector for discussion is the introduction of a new subset of rules in Hong Kong’s tax laws that would allow eligible corporations in the city to choose either to be subject to taxation under the standard profits tax regime or at an alternative minimum tax based on the OECD’s global minimum tax plan.

If the companies choose to pay tax at the alternative minimum rate, Hong Kong’s tax base may potentially be broadened, allowing the Inland Revenue Department to tax multinational firms that may not be subject to much tax under the current profits tax regime. After choosing to be taxed at the alternative minimum tax rate, profits repatriated from corporations operating in Hong Kong should not to be subject to additional taxes or defensive measures imposed by the parent jurisdiction.

This proposed tax change does not involve a great overhaul of the city’s existing tax law, such as amending the territorial basis of taxation.

“If the government fails to respond fast, it’ll create tremendous uncertainties in tax affairs for multinationals operating in Hong Kong. This will be one of the factors for corporations pondering whether to keep their businesses here or not. Multinational groups, generally, would like to move their headquarters to where there’s a higher degree of certainty in tax matters,” said Cheung.

The Hong Kong government introduced a transfer pricing regulatory regime and documentation requirement into the local taxation regime through legislation in July 2018 after the city had passed the Inland Revenue (Amendment) (No 6) Bill 2017 (BEPS Bill). Most of the provisions within this bill will have retrospective effect from the year of assessment (2018-19).

Under the new tax law, HKSAR entities are required to prepare transfer pricing documentation for accounting periods from or after April 1, 2018 unless they meet the exemption threshold specified in the Inland Revenue Ordinance. The two exemption criteria are the business size of the entity and the quantum of related-party transactions.

After the transfer pricing rules were enacted, multinationals in Hong Kong that are within the scope for transfer pricing documentation and/or country-by-country reporting would have already been required to document in-scope intra group transactions worldwide and allocation of group profits and file such information with the IRD.

“Multinational businesses should understand the potential impact of these complex rules on their businesses and operating models/structures, as well as tax management and accounting and control systems. They should also prepare for potential increases in costs with tax management and compliance,” KPMG China Corporate Tax Advisory Partner Alice Leung said.

Tax legislation reform

The response to the OECD’s BEPS initiative does not stop here. Hong Kong also needs other tax legislation reforms to maintain its position as an international business hub. For example, the city still does not have the provisions of tax loss to be carried backward or group tax loss relief in its legislation, which is commonly available in many developed economies. These tax provisions allow corporations to obtain legitimate tax savings which would be one key consideration for multinationals in deciding where to locate their key business entities and/or headquarter operations in Hong Kong.

Leung argued that Hong Kong should strive to be an alternative jurisdiction for parent companies with its extensive network of tax treaties, which will undoubtedly prove attractive to multinationals contemplating such a move.

“If Hong Kong adopts the income inclusion rule (which permits the home jurisdiction of a parent company to tax the income of a foreign branch or a controlled entity if that income is subject to tax at an effective rate that is below a minimum rate), we would expect many corporate groups revisiting their current holding structures to consider moving their group parent companies out of high-risk jurisdictions,” she said.

Billy Mak Sui-choi, associate professor at Hong Kong Baptist University’s Department of Finance and Decision Sciences, said Hong Kong should stock-take its niches that can attract multinational companies besides its low tax advantage. “We have to evaluate our attributes, such as whether talent supply and business efficiency can make big corporations stay. Multinationals also value the proximity of the Chinese mainland market and the accessibility to clients in deciding to locate their business headquarters,” said Mak, who’s also a member of the government advisory panel.

Attracting multinationals is an important conduit for luring foreign direct investment into Hong Kong, according to the UNCTAD World Investment Report 2020. The SAR’s total FDI reached US$68.4 billion last year, ranking seventh worldwide — behind the mainland (US$141.2 billion) and Singapore (US$92.1 billion) in Asia.

In terms of FDI stock, Hong Kong was the world’s third-largest host with US$1.867 trillion after the United States and the United Kingdom, and the world’s sixth-largest investor with US$1.794 trillion in 2019.

Contact the writer at oswald@chinadailyhk.com