Hong Kong’s Advance Pricing Arrangement Program
May 21, 2018
When combined with aggressive tax planning, Hong Kong’s onshore-offshore tax regime frequently brings about a decreased tax burden for taxpayers that work through Hong Kong companies by pricing intra-group transactions. This has prompted heightened transfer pricing investigation from the Hong Kong Inland Revenue Department as of late.
In order to provide clarity to taxpayers working in Hong Kong on the fitting way in which intragroup transactions should be priced, the Inland Revenue Department released its transfer pricing guidelines in 2009. This was followed by the introduction of the Advance Pricing Arrangement (APA) program in 2012.
The introduction of the APA program is a welcome development for multinational businesses, as it lays out the procedures for enterprises to discover the worthiness of their transfer prices with the Hong Kong and foreign tax authorities.
Negotiating an APA with the Hong Kong Tax Authorities
An APA is an agreement that decides an appropriate set of criteria (e.g. transfer pricing method, external data, appropriate adjustments, critical assumptions as to future events) to decide the pricing of related party transactions over a fixed period of time. This is either three or five years.
The APA is decided up under the Commissioner’s power of general administration under the Inland Revenue Ordinance, including the Double Tax Avoidance Agreements (DTAs) which form a part of Hong Kong’s tax legislation.
Because of resource constraints, the Hong Kong Inland Revenue Department only acknowledges bilateral and multilateral APAs, as opposed to a unilateral APA. A unilateral APA is an agreement that is negotiated exclusively between the Hong Kong citizen and the Hong Kong Commissioner. The bilateral or multilateral APA, then again, is a course of action that not only involves the Commissioner in Hong Kong but also the relevant tax authorities in foreign jurisdictions that have signed a DTA with Hong Kong.
Hong Kong can just begin an APA program with another country after having signed a DTA with that country. This is because of the APA program is viewed as a procedure to determine issues in applying the DTA.
Boundaries have been given by the Inland Revenue Department on the materiality for an APA application. In other words, if the Hong Kong taxpayer does not meet these boundaries, the Inland Revenue Department will consider that the transfer pricing risk isn’t sufficiently enough to be alleviated through an APA.
The APA process is most appropriate for complex controlled transactions with high transfer pricing risk. Examples of this incorporate situations where there are couple of comparable transactions, a lot of tax is involved or a significant amount of profit is moved out of Hong Kong. To this end, the accompanying boundaries have been given under the APA regime:
• Sale or purchase of goods: HK$ 80 million for every year covered under the APA
• Provision or receipt of services: HK$ 40 million every year
• Transactions involving intangible property: HK$ 20 million every year
• The additional reporting requirement for income paid by installment is canceled.
The Inland Revenue Department’s APA process is broadly consistent with the processes adopted by other jurisdictions. They for the most part consist of the following five stages:
2. Formal application
3. Analysis and evaluation
4. Negotiation and agreement
5. Execution and monitoring
• The due date of the payment of withholding tax is relaxed.
Recent APAs Concluded
Despite the fact that the APA regime was presented in 2012, it achieved a milestone when Hong Kong concluded its first bilateral APA with the Netherlands in September 2014. This bilateral APA application was formally presented with both the Hong Kong and Dutch tax authorities in September 2013 and was accepted into the APA program by the respective tax authorities in October 2013. The agreement was actually concluded within nine months, as compared to the 18 – 24 months that the Hong Kong tax authorities had evaluated for concluding bilateral APAs. The timely manner in which this APA was arranged and finished up can be clarified by the following factors:
1. Robust transfer pricing analysis
2. Provision of detailed information requested by both parties
3. Cordial relations between the Dutch and Hong Kong tax authorities
Hong Kong’s second APA, which was with Japan, was closed in January 2015, only 4 months after the conclusion of the first APA. The successive conclusion of bilateral APAs is a testament of the Internal Revenue Department’s responsibility regarding the APA program.
The Internal Revenue Department right now has two committed authorities driving the APA program. Likewise, the APA group works with tax auditors who review the APA applications and data from a domestic perspective and guarantee that the proposed transfer pricing methodology and margins are consistent with the desires of the Internal Revenue Department from a domestic Hong Kong perspective. These suggestions are passed onto the APA group for its negotiations with the foreign tax authority.
Hong Kong is a key trading partner for several countries. Its best five trading partners are China, the U.S., Japan, Taiwan and India. As the APA program was presented, one expected that a bilateral APA would be finished up as a matter of first importance with China. The recent conclusion of the bilateral APA with Japan demonstrates that Hong Kong trading partners are looking at APAs as a compelling method to alleviate transfer pricing risks that may exist in their operations.
In addition, because the substantial tax difference that exists between Hong Kong its top three trading partners China, the U.S. and Japan, the conclusion of bilateral APAs in a positive way may likewise bring in reduced effective tax rates.
Given that the presence of the DTA is a precursor to the application for a bilateral APA, Hong Kong has been extending its DTA network. China’s Special Administrative Region has to date signed 32 comprehensive DTAs with other countries. Likewise, Hong Kong is arranging 13 comprehensive DTAs with different nations, for example, Germany, India and Russia. The considerable increment in the quantity of DTAs will give increased opportunities to multinational organizations to apply for multinational companies to apply for bilateral or multilateral APAs for related party transactions between its companies in Hong Kong and other countries.
The initiatives of the Organization for Economic Co-task and Development (OECD) on base erosion and profit shifting place strong emphasis on rewarding each entity in the group for their business operations. With the increased scrutiny that taxpayers are looking from tax authorities on all aspects of taxation, the APA offers a non-adversarial approach in which taxpayers can connect with tax authorities in a transparent manner to achieve an optimal tax outcome.
For any information regarding the new regulation of Transfer pricing in Hong Kong, please contact our Hong Kong office at + 852 2654 8800.