Base Erosion and Profit Shifting (BEPS) Implementation in Hong Kong

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Author: Dominik Stuiber

The BEPS Project is the brainchild of the Organisation for Economic Co-operation and Development (The OECD) and the G20 and is a series of 15 Action Plans aimed at preventing tax avoidance caused by base erosion and profit shifting by multinationals.

An insight into the tax planning strategies of multi-national corporations was given through the publication of the Luxembourg Leaks (LuxLeaks) documents. The LuxLeaks was followed by public and political outcry over the “unfair” methods, structures and arrangements MNCs such as Amazon, Apple, AXA, Burberry, Pepsi, and many others establish to lower their tax dues in high tax jurisdictions and instead move profits to places with significantly lower, or even no tax.

Simply put, com­panies have long exploited transfer pricing to avoid tax; with Hong Kong being at the receiving end of aggressive transfer pricing strategies due to its simple and low tax regime.

Recognising the urgent need to tackle Base Erosion and Profit Shifting (BEPS) practiced by some multinational enterprises (MNEs) through aggressive tax planning and artificially shifting profits to low or no-tax regions, countries and jurisdictions worldwide including Hong Kong have committed to join the inclusive framework on BEPS and adhere to the new global standards.

The BEPS framework is built around four minimum standards:
·        Countering harmful tax practices (Action 5)
·        Preventing treaty abuse (Action 6)
·        Imposing country-by-country reporting requirements (Action 13)
·        Improving cross-border dispute resolution mechanism (Action 14)

On 7th June 2017, Hong Kong joined the OECD Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (Action 15), implementing minimum standard Actions 6 and 14, as well as Actions 2 (hybrid mismatch arrangements) and 7 (definition of permanent establishment).

Rewriting Hong Kong’s legislation to accommodate BEPS will require amendments to transfer pricing regulations (Actions 8-10). With no statutory transfer pricing regulations in place, Hong Kong’s IRD relies on general anti-abuse provisions of the Inland Revenue Ordinance (IRO) and its Departmental Interpretation and Practice Notes (DIPN). Thus, codifying transfer pricing rules in law will allow for a wider application beyond the general anti-abuse provisions.

BEPS is understood to: ‘undermine the fairness and integrity of tax systems because businesses that operate across borders can use BEPS to gain a competitive advantage over enterprises that operate at a domestic level. Moreover, when taxpayers see multinational corporations legally avoiding income tax, it undermines voluntary compliance by all tax payers.’

In essence, BEPS is about more than just drafting new tax rules, it’s a project that aims to fundamentally change the behaviour of multinational organisations with a view to realigning taxation with economic substance and value creation. However, SMEs below a certain threshold will be exempt from preparing the complex transfer pricing documentation and country-by-country (CbC) reports; nevertheless, the codification of transfer pricing rules will require even SMEs to review their practice and documentation.

The transfer pricing rules will impose a requirement on businesses to consider whether taxable profits or allowable losses arising from their transactions with associated parties have to be adjusted when filing their tax returns. Any non-compliance with transfer pricing rules will render the tax returns incorrect and if made wilfully with the intent to evade tax, or without any reasonable excuses, the taxpayers concerned will be liable to a penalty.

The BEPS framework aims to tax profits where the economic activity and value creation occurs. This determination can be challenging for the digital economy offering products and services across borders. Here, E-commerce businesses providing digital services or products may be more affected by the BEPS concept than traditional businesses.

Take a Software-as-a-Service (SaaS) provider, who’s digital solution can be accessed from anywhere in the world. Is the value creation at the place where the software is developed, or where its servers are based? Is the place of economic activity where the administration and sales office is located, or where its customers are? The answers to these questions and what is to be understood as ‘fair’ tax might not only increase the administrative burden for SMEs, but existentially affect their business. It seems, for now, the road to greater tax transparency and certainty is paved with manifold uncertainties. 

The LuxLeaks lists 548 tax rulings obtained by over 350 companies from the Luxembourg tax authorities.