The Hong Kong Tax Department (CTD) has announced in February 2017 its intention to abolish the practice of accepting pre-agreed minimum profit margins of 0,125% - 0,35% on intra-group and related party financing arrangements that were in the form of back-to-back loans.
It is being reminded that in accordance with Article 33 of the Hong Kong Income Tax Law, all transactions between related parties must, for tax purposes, be made on an arm’s length basis. The CTD has the right to impose tax adjustments to make up for any deviation from the arm’s length principle (usually made in the form of a notional interest income). In the case of back-to-back loans between related parties, the CTD has, by way of practice, accepted such thin spreads / minimum profit margins without challenging the arm’s length applicability.
This current practice, which had been agreed between the CTD and ICPAC during July 2011, is expected to be abolished as from 1 July 2017. From then onwards, any tax rulings that have been issued in relation to such arrangements will become void and shall need to follow the new rules.
Thus, from July 1, 2017 and onwards, all related-party financing transactions will have to be supported by Transfer Pricing (TP) Studies. Such TP studies will be required both for the issuing of tax rulings and for corporate tax calculations and will be prepared by independent experts. The TP rules have not yet officially been concluded within the Hong Kong tax laws, thus it is expected to follow the relevant OECD TP guidelines. Furthermore all relevant rulings issued before 1 July 2017 involving the back-to-back finance regime will cease to be applicable on 1 July 2017. Any back-to-back finance transactions remaining in place after 1 July 2017 will need to be supported by TP Studies for that date and onwards.
The driving force behind this decision is the intention to align the Hong Kong tax treatment of such arrangements with Action Points 8 – 10 (transfer pricing) of the OECD BEPS Action Plan.
Although the transfer pricing rules have not yet officially been concluded within the Hong Kong tax laws, they are expected to follow the relevant OECD transfer pricing guidelines. It is further expected that the CTD will issue more specific guidance on the implementation of the above.
It is certain that a very large number of taxpayers will be affected by these changes. It is therefore recommended that taxpayers undertake a review of their existing financing arrangements and structures in order to assess the impact of the changes and timely take corrective actions in an attempt to ensure their conformity with the new framework.
Our Tax law team, is at your disposal to discuss in deeper how the above developments may affect your business. Send us e-mail for further information.