Hong Kong transfer pricing laws align with the Guidelines set by the Organization for Economic Co-operation and Development (OECD). They are incorporated within Departmental Interpretation and Practice Note (DIPN) No. 46, named “Transfer Pricing Guidelines — Methodologies and Related Issues”. Further, the transfer pricing regulatory framework was supplemented with DIPNs, as follows:
- 58 – “Transfer Pricing Documentation and Country-By-Country Reports”
- 59 – “Transfer Pricing between Associated Persons”
- 60 – “Attribution of Profits to Permanent Establishments in Hong Kong”
Arm’s Length Principle
In Hong Kong, when two related companies (called associated persons) do business with each other, such as selling goods, providing services, or lending money, they must follow the arm’s length principle. This means they should deal with each other as if they were independent companies, using fair market prices.
Related Party Definition
In Hong Kong, the definition of related parties for transfer pricing purposes generally follows the principles set out in the OECD Transfer Pricing Guidelines. Under Hong Kong’s transfer pricing rules, the term “associated” refers to the “participation condition”, that is met if:
- Management, Control, or Capital: One of the affected persons participates in the management, control, or capital of the other, or both are managed, controlled, or capitalized by a third person.
- Control Criteria: Control means having more than 50% beneficial interest or voting rights, having powers through constitutional documents, or directing business affairs.
- Beneficial Interest: The concept includes direct or indirect control over a corporation, partnership, trustee, or other entities. Calculations for indirect control are made by multiplying the percentages of beneficial interest along the chain of control.
Transfer Pricing Methods
The methods that can be used to determine the arm’s length price are:
- Comparable Uncontrolled Price Method (CUP)
- Resale Price Method (RPM)
- Cost Plus Method (CPM)
- Transactional Net Margin Method (TNMM)
- Profit Split Method (PSM)
The preferred methods are typically the traditional transaction methods (CUP, RPM, CPM), as they directly compare controlled transactions with uncontrolled ones. However, if transactional profit methods (TNMM and PSM) are more appropriate based on a comparability analysis, they may be applied. The Commissioner also allows multinational enterprises the flexibility to use other methods, provided they satisfy the arm’s length principle and are well-documented with reasons for their use.
Comparability Analysis
The Inland Revenue Department (IRD) doesn’t require a specific database for transfer pricing studies, but using the databases they already use (such as Osiris or Orbis) it’s easier and faster for the IRD to check the data. If other databases are used, companies should provide enough supporting evidence.
The IRD also doesn’t require companies to use local comparables. But in practice, local data is often limited, so Pan-Asian or regional comparables are commonly used. The IRD has accepted this approach in advance pricing agreements (APAs), especially when using the Osiris and Oriana databases.
Documentation Requirements
Transfer pricing documentation requirements in Hong Kong are based on the three-tiered approach set forth by the OECD. This requires multinational groups to submit the following documentation to the tax authorities:
- Master File;
- Local File, and
- Country-by-Country (CbC) report.
Master and Local Files
For accounting periods starting on or after April 1, 2018, Hong Kong entities that are part of multinational enterprises (MNEs) must prepare these files if they meet certain thresholds related to revenue and cross-border intercompany transactions. The Master File provides an overview of the MNE’s global business operations, while the Local File contains detailed information on the local entity’s intercompany transactions. These files must be submitted within nine months after the end of the accounting period.
Country-by-Country Reporting
Hong Kong follows the OECD’s three-tiered approach to transfer pricing documentation. Companies with over HKD 6.8 billion in revenue must submit a Country-by-Country Report (CbCR) within 12 months after the accounting period starts in 2018.
Advance Pricing Agreements (APA) and Mutual Agreement Program (MAP)
An Advance Pricing Agreement (APA) is a formal agreement between a taxpayer and the Hong Kong tax authority in which they agree in advance on the pricing of related-party transactions.
There are three types of APAs available:
- Unilateral (between the taxpayer and the Inland Revenue Department (IRD)),
- Bilateral (with IRD and one foreign tax authority), and
- Multilateral (with IRD and two or more foreign tax authorities).
A taxpayer can apply for an APA if the annual value of transactions exceeds HK$80 million for goods, HK$40 million for services, HK$20 million for royalties, or HK$20 million in business profits for permanent establishments in Hong Kong.
Mutual Agreement Program (MAP)
If a resident of Hong Kong or in a country that has an agreement with Hong Kong to avoid double taxation, and they are not taxed following the DTA (Double Tax Agreement), they can approach the tax authorities in Hong Kong through the Mutual Agreement Procedure within that DTA. Hong Kong tax authority has the right to work together with the tax department of another country to find a solution. MAP is an additional option to the person’s right to object or appeal. The person can also use MAP to establish an advance pricing agreement. For further information, they can refer to Hong Kong’s tax resources or contact the tax department directly.
Approach to Transfer Pricing Audits
In Hong Kong, the tax authority uses a “file first, review later” approach. Companies submit their tax returns, and the Inland Revenue Department (IRD) may later review and ask questions if needed.
Transfer pricing audits are increasing, especially for:
- Companies with unstable profit margins,
- Cross-border payments (royalties or service fees),
- Transactions with related parties in tax havens.
Due to the OECD’s BEPS rules, many multinationals are now adjusting their overpaid profits to Hong Kong subsidiaries. So, more transfer pricing audits and advance pricing arrangements (APAs) are expected in the future.
Penalties
If a company doesn’t follow arm’s length rules for related-party transactions, it can face a penalty tax under Hong Kong law. This penalty can be up to the amount of tax underpaid.
However, no penalty will apply if the company can prove it made reasonable efforts to set fair (arm’s length) prices. This means:
- Having proper transfer pricing documentation,
- Using a clear method to decide prices,
- Analyzing the business properly.
If these things are missing, the Inland Revenue Department may decide the company didn’t make a reasonable effort and apply a penalty.
Taxation at a Glance
Hong Kong operates under a simple and low-tax system. The city imposes a profits tax on income earned from businesses carried out in Hong Kong and a salaries tax on income derived from employment or pensions within the region. Notably, there is no value-added tax, sales tax, or capital gains tax. With low tax rates and no foreign exchange controls, Hong Kong offers a free and open investment environment, making it attractive for international businesses and investors.
The currency of Hong Kong is the Hong Kong Dollar (HKD).
The official name of the Hong Kong tax authority is the Inland Revenue Department.
The table below provides a summary of the main taxation rates related to businesses:
Tax Type | Tax Rate |
Corporate Tax | 8.25% to 15% |
VAT | N/A |
Withholding tax on dividends to non-residents | 0% |
Withholding tax on interest to non-residents | 0% |
Withholding tax on royalties to non-residents | 2.475 to 4.95 % |
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