Hong Kong: Consultation paper on implementation of Pillar Two global minimum tax

The Hong Kong government on 21 December 2023 published a consultation paper on implementation of the Pillar Two global minimum tax in Hong Kong.

The government indicated in the 2023/24 Budget that it plans to implement the global minimum tax (i.e., an income inclusion rule (IIR), undertaxed profits rule (UTPR), and domestic minimum top-up tax (DMTT)) in Hong Kong from 2025 onwards.

The consultation period lasts for three months and closes 20 March 2024. 

Implementation of the GloBE rules

There is generally no room for deviating from the internationally agreed global anti-base erosion (GloBE) rules for domestic implementation in Hong Kong. As such, the consultation focused on the legislative approach and administrative framework rather than the technical aspect of the GloBE rules. Note that the subject-to-tax rule (STTR) is not within the scope of the consultation.

The key government proposals contained in the consultation paper include:

•  Effective fiscal year: The HKMTT would apply to accounting periods commencing on or after 1 January 2025.
• Legislative approach:
  • The GloBE model rules would be incorporated into the Inland Revenue Ordinance (IRO) as far as practicable with limited adaptations and would be applied consistently with the OECD’s commentary and administrative guidance (AG) that are in force immediately before the enactment
  • Top-up tax charged under the GloBE rules and the HKMTT would be treated as profits tax.
  • Specific provisions may be added to deal with the interaction between the enacted GloBE rules and the existing provisions of the IRO.
• Definition of Hong Kong resident entity: An entity incorporated / constituted in Hong Kong or an entity incorporated / constituted outside Hong Kong but normally managed or controlled in Hong Kong would be a Hong Kong resident entity. The above definition would apply retroactively from 1 January 2024 given that some jurisdictions apply the IIR from 2024. The tax residency of an entity would affect the application of the GloBE rules in various aspects (e.g., it determines the location of a constituent entity (CE) for the purposes of computing the jurisdictional blended effective tax rate (ETR) and ascertaining where top-up tax has to be paid).
• Open issues for domestic implementation include whether to:
  • Only apply the IIR to Hong Kong headquartered multinational entity (MNE) groups that meet the consolidated revenue threshold
  • Adopt the Euro threshold instead of an equivalent Hong Kong dollar threshold for applying the GloBE rules to avoid annual rebasing of the threshold to Euro
  • Charge the UTPR top-up tax in the form of an additional cash tax instead of a denial of a deduction without any carry-forward of UTPR top-up tax
  • Allocate the UTPR top-up tax among Hong Kong CEs based on their respective number of employees and value of tangible assets by default (would not apply if an in-scope MNE group designates one or more Hong Kong CEs to pay the UTPR top-up tax)
•  Other views sought include whether there are any uncertainties in the:
  • Calculation of the ETR
  • Calculation of the GloBE top-up tax
  • Operation of the transitional rules that could be clarified in the Inland Revenue Department (IRD)’s administrative guidance

Design and implementation of the HKMTT

Below are the key government proposals on the design and administration of the HKMTT:

• The HKMTT would be designed to enable it to qualify as a qualified DMTT (QDMTT) and the QDMTT safe harbor.
• Both Hong Kong and foreign headquartered in-scope MNE groups would be subject to the HKMTT.
• The HKMTT would be imposed on the whole amount of the total top-up tax computed in respect of all Hong Kong CEs under the GloBE rules, irrespective of the ownership interest held in the CEs by the parent entities.
• Joint ventures (JVs) and JV subsidiaries held by an in-scope MNE group would be subject to the HKMTT and the HKMTT attributable to such JVs and their JV subsidiaries would be directly imposed on the JVs and JV subsidiaries instead of being allocated to other Hong Kong CEs of the group.
• The use of the local financial accounting standard for computing the HKMTT would be required when the specified conditions are met.
• The HKMTT payable among Hong Kong CEs would be allocated based on the ratio of the GloBE income of the Hong Kong CE to the aggregate GloBE income of all Hong Kong CEs of the group by default (would not apply if the group designates one or more Hong Kong CEs to pay the HKMTT).
• An exclusion from the HKMTT would be allowed for in-scope MNE groups that are in the initial phase of international activity, limited to groups in which no parent entity is required to apply a qualified IIR with respect to Hong Kong CEs of the group.

Adoption of other safe harbors

Other than the permanent QDMTT safe harbor, the consultation paper also discusses:

• Transitional country-by-country (CbC) report safe harbor
• Transitional UTPR safe harbor (which would not be applicable to Hong Kong)
• Permanent simplified calculation safe harbor

Tax compliance and administration framework

The consultation paper seeks views on the below proposed tax compliance and administration framework:

• An electronic platform would be developed for account registration, submission of notifications and returns and communications with the IRD. A service provider could be engaged to furnish a top-up tax notification or a top-up tax return through the platform.
• An in-scope MNE group: 
  • Would need to file an annual top-up tax notification on its obligation of filing top-up tax return within six months after the end of the fiscal year
  • Would need to file a single top-up tax return for the purposes of the GloBE rules and HKMTT no later than 15 months after the end of the fiscal year (extended to 18 months in the first / transitional year)
  • Could designate one Hong Kong CE to be the designated local entity for filing top-up tax notifications and top-up tax returns
• The same “assessment first audit later” approach would be adopted for top-up tax. 
• No provisional top-up tax would be charged.  
• The top-up tax under the IIR would be charged on the UPE. For top-up tax under the UTPR or HKMTT, an in-scope MNE group could designate one or more Hong Kong CEs as the paying entities but in such case, all Hong Kong CEs would be jointly and severally liable for the whole amount of the top-up tax payable.
• Top-up tax payments made by a paying entity on behalf of other Hong Kong CEs would not be allowed as deductions for profits tax purposes but reimbursement of such tax payments received by the paying entity would not be treated as receipts for profits tax purpose.
• The existing administrative provisions in the IRO relating to anti-avoidance, objection and appeal, tax collection, record keeping and penalties (including penalties for service providers) would apply.
• The existing approach of allowing a taxpayer to make representations before imposing an administrative penalty under section 82A will apply and the reasonable measures for complying with the GloBE rules discussed by the OECD in respect of transitional penalty relief would be taken into account by the IRD in considering whether there is any reasonable excuse for non-compliance. 

Mandatory e-filing of profits tax returns

The government also seek views on its plan to launch the first phase of mandatory electronic filing (e-filing) of profits tax returns. The government proposes to require all Hong Kong CEs of MNE groups that are within the scope of Pillar Two to e-file their profits tax returns for a year of assessment commencing on or after 1 April 2025 (i.e., from year of assessment 2025/2026).

Next steps

The government plans to develop the Pillar Two legislative proposal for submission to the Legislative Council in the second half of 2024. 

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

Burcin Nee | bnee@kpmg.com