Hong Kong Transfer Pricing Guidelines
Five differences apply between the OECD Transfer Pricing Guidelines and the Hong Kong Transfer Pricing Guidelines: The Hong Kong Transfer Pricing Guidelines expand the documentation provisions, expand the services provisions, narrow the permanent establishment provisions, greatly expand the anti-tax evasion process, and greatly expand the profit split method.
The Commissioner will consider transactions actually undertaken by associated enterprises except where the economic substance differs from the form of the transaction, or where the structure is not one that “commercially rational independent enterprises” would arrange. Associated enterprise provisions apply if, in either case, two enterprises make or impose conditions between themselves as to their “commercial or financial relations.” The Commissioner can consider requests for an “appropriate adjustment to the amount of tax charged” to eliminate double taxation cases in Hong Kong. The Commissioner, when making the “appropriate adjustment,” would adjust the profits charged for tax purposes or is payable for the Hong Kong enterprise.
The Hong Kong Transfer Pricing Guidelines provide eight steps to the permanent establishment process, beginning with the indentification of the “economically significant activities and responsibilities” of the non-resident enterprise. The Guidelines apply the “functionally separate approach” to determine taxability of the permanent establishment. The Commissioner, in making an attribution of profits, is to consider the significant “people functions” of the permanent establishment and the “key entrepreneurial risk-taking functions” of the permanent establishment.
The Hong Kong tax authorities look to a “reasonable allocation of profits and income” standard, so that application of the arm’s length principle would produce a “reasonable allocation of profits and income” within a multinational enterprise. The Guidelines apply an “economic significance” test to evaluate the functions that the enterprise performed. The Guidelines address the application of global price lists as a transfer pricing objective.
The Transfer Pricing Guidelines were exceedingly forthright as to abusive tax schemes and the remedies to these schemes the Hong Kong Inland Revenue would pursue. The simplest method of diverting profit, according to the Guidelines, is by sending skimmed income to the international business company’s offshore account. The Hong Kong Commissioner combats such abusive tax schemes. The Guidelines address an extreme form of abusive tax schemes, i.e., where the representations of the international business companies could be entirely fictitious.
An indirect charge method applies where the enterprise cannot reliably track the costs it incurs on behalf of one or more associates. The indirect charge method necessitates the enterprise collect together all costs together and share these combined costs among its beneficiaries. Enterprises normally make allocations through “keys.”