Hong Kong: Update on profits tax, BEPS 2.0, and e-filing

The minutes of the 2022 annual meeting between the Hong Kong Institute of Certified Public Accountants (HKICPA) and the Inland Revenue Department (IRD) were recently published. The minutes summarize the IRD’s views on various issues related to profits tax, salaries tax, stamp tax, double tax agreements, the OECD’s base erosion and profit shifting (BEPS) 2.0 initiative, and electronic tax filing (e-filing) that were discussed during the meeting.

This report highlights some of the Hong Kong profits tax and international tax issues discussed in the meeting. 

The IRD reiterated that since there is no provision in the Inland Revenue Ordinance (IRO) that grants CBA regarding commercial buildings that are still in use after the 25-year period, it has no authority to grant any CBA or provide any concession to the buyer of such buildings even though a balancing charge may have been made to the seller. The IRD also confirmed that for commercial buildings that have been in use prior to year of assessment (YOA) 1998/1999, YOA 2023/2024 will be the last year in which CBA on such buildings can be claimed.  

The IRD reiterated that in considering whether a Hong Kong certificate of resident status (HK CoR) can be issued to a non-Hong Kong incorporated company, it will examine all the relevant facts and circumstances (e.g., its nature of business, place of business, mode of operations and place of board meetings, etc.) to determine whether the company exercises its management and/or control in the Hong Kong.

The IRD clarified that whether the company has applied for a business registration in Hong Kong is only one of the relevant factors for consideration but not a conclusive factor to consider.  However, in the absence of a business registration in Hong Kong, the HK CoR applicant will need to provide further concrete evidence to establish that it has commercial substance and exercises its management and/or control in Hong Kong.

Schedule 17G of the IRO set out the definitions of “permanent establishment” (PE) of a non-Hong Kong resident person in Hong Kong in tax treaty and non-tax treaty context for the purposes of applying the transfer pricing rules and double tax relief in Hong Kong. Under Schedule 17G, a “non-DTA territory resident person” means “a person who, under the laws of the territory, is liable to tax in the territory by reason of the person’s domicile, residence, place of management or any other criterion of a similar nature…”

The HKICPA raised the issue that the above definition cannot be applied to non-resident persons in jurisdictions that (1) do not impose corporate income tax (such as the British Virgin Islands and the Cayman Islands), or (2) levy tax on a quasi-territorial basis (such as Singapore), and (3) in the US where tax is levied on corporations formed in the United States.

The IRD clarified that the definition of “non-DTA territory resident person” under Schedule 17G is modelled on Article 4 (the resident article) of the 2017 OECD Model Tax Convention but with an adjustment such that persons who are only subject to tax in a jurisdiction in respect of income from sources in that jurisdiction are not excluded from the definition. This means that the residents of jurisdictions adopting a territorial principle (e.g., Singapore) would not be excluded from the definition. For companies incorporated in jurisdictions that do not impose corporate income tax, the IRD considered that these companies are usually managed or controlled in another jurisdiction and subject to tax in that other jurisdiction. 

The IRD also referred to the OECD Commentary on Article 4 and pointed out that in constructing the definition of “resident for tax purposes” in relation to a non-DTA territory, it has adopted the approach of regarding a person as being liable to taxation in a jurisdiction even if the jurisdiction does not in fact impose tax on the person as certain requirements in the tax law are met. 

There was a discussion in the meeting on whether a Hong Kong resident Fund A holding a more than 30% beneficial interest in another Hong Kong resident Fund B (which in turn holds a special purpose vehicle) would trigger the anti-round tripping provisions under the unified fund exemption (UFE) regime, provided that both funds are tax-exempted funds under the UFE regime.

The IRD clarified that a look-through approach would be adopted to identify the beneficial owner of a tax-exempted fund in applying the anti-round tripping provisions under the UFE regime.  In the above case, the IRD held that the participating persons of Fund A, rather than Fund A, would be regarded as the beneficial owners of Fund B. In this regard, the participating persons would be the limited partners (for a fund in the form of a limited partnership) and the shareholders (for a fund in the form of an open-ended fund company) respectively.

The IRD indicated that, to qualify for a tax deduction, the acquisition costs of renewable energy credits/certificates (RECs) or carbon credits have to be a revenue expenditure incurred in the production of chargeable profits (i.e., deductible under section 16(1) of the IRO and not disallowable under section 17(1) of the IRO).  The IRD further emphasized that the degree of connection between the acquisition costs and the profit-earning process of the taxpayer’s trade, profession or business is an important factor to determine whether the acquisition costs are incurred in the production of chargeable profits.   

The IRD indicated that currently there is no definition of “Hong Kong resident person” for the general application of the IRO. The definition of “Hong Kong resident person” is currently included in Part 8AA of the IRO, which only applies for the purposes of transfer pricing and double tax relief, etc. To facilitate the future implementation of GloBE rules under Pillar Two of BEPS 2.0 in Hong Kong, the IRD is considering introducing a definition of “Hong Kong resident person” under the IRO for determining residence under the GloBE rules. 

There was also discussion in the meeting that the current definition of permanent establishment (PE) under the GloBE rules (when there is no applicable tax treaty) does not work under Hong Kong’s territorial tax system since Hong Kong only taxes profits attributable to a PE in Hong Kong that are with a Hong Kong source. The IRD considered that it would be difficult for a person to establish that the profits attributable to a PE in Hong Kong do not arise from its profit-producing activities in Hong Kong. Nevertheless, the IRD indicated that this issue would need to be considered further as the OECD guidance in this area is not available and noted that some other jurisdictions have already raised this issue with the OECD.

For more information, contact the Global Leader of KPMG’s Global Transfer Pricing Services:

Komal Dhall | kdhall@kpmg.com

Consistent with the IRD’s original plan, the IRD indicated that it would consider extending the scope of e-filing of profits tax returns gradually to cover other classes of businesses or entities at a later stage after the roll-out of voluntary e-filing in 2023, and the goal is to achieve full-scale implementation of mandatory e-filing by 2030. The IRD further clarified that even with the implementation of e-filing of profits tax returns in Hong Kong, currently it has no plan to issue notices of assessment or statements of loss to all “inactive” or dormant corporations and partnership businesses annually given the limited resources available. 

For more information contact a KPMG tax professional:

David Ling | davidxling@kpmg.com