Hong Kong: Hong Kong see new tax reforms to kick start 2018

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January 30 2018

In line with its pledge to boost Hong Kong's competitiveness and comply with its international obligations, the Hong Kong government has recently introduced two tax reforms.

Base erosion profit shifting and transfer pricing

On December 29 2017, a mandatory transfer pricing regime and anti-base erosion and profit shifting changes were introduced in Hong Kong.

The Hong Kong government proposes fundamental transfer pricing rules which empowers the Inland Revenue Department (IRD) to adjust the profits or losses of an enterprise where the actual provision made or imposed between two associated persons departs from the provision which would have been made between independent persons and has created a tax advantage.

Mandatory transfer pricing documentation has also been introduced based on the three-tiered approach provided that certain thresholds are met.

The new provisions uphold Hong Kong's commitment to combating tax evasion. This is crucial in preserving Hong Kong's competitiveness and reputation as an international financial centre. The so-called 'BEPS bill' will be formally introduced into the Legislative Council on January 10 2018.

Two-tiered Profits Tax regime

On December 29 2017, the Hong Kong government introduced a two-tiered profits tax regime. The key objective is to maintain a competitive tax system to promote economic development.

The profits tax regime will apply to corporations and unincorporated businesses commencing from the year of assessment 2018/19 (i.e., on or after 1 April 2018):

For corporations, the first HK$2 million ($256,000) of profits earned by a company will be taxed at half the current tax rate (i.e., 8.25%) while the remaining profits will continue to be taxed at the existing 16.5% tax rate.
For unincorporated businesses, the first HK$2 million of profits earned will be taxed at half of the current tax rate (i.e., 7.5%) whilst the remaining profits thereafter will be taxed at the existing 15% tax rate.

There will be an anti-fragmentation measure to prevent corporate activities from being artificially divided among a large number of companies who could benefit from the lower tax rate. Each group will have to nominate only one company in the group of companies to benefit from the progressive rate.

The profits tax bill is a welcome enhancement to small and medium enterprises in Hong Kong and to the Hong Kong tax system to maintain its position as Asia's leading international business centre. The profits tax bill will be formally introduced into the Legislative Council on January 10 2018.

Landmark US tax reform

The US tax reform, commonly known as Tax Cuts and Jobs Act (TCJA) was signed into law on December 22 2017. The TCJA has significant implications for global businesses, including those operating in Hong Kong.

In particular, many Hong Kong investors investing in the US may see increased after-tax returns where the US federal effective tax rate on their investments reduced from 54.5% to 44.7% (inclusive of the US 30% dividend withholding tax)

The base erosion anti-abuse tax (BEAT) limits the tax benefit of certain outbound related party payments using a 5% minimum tax for 2018 tax year only. The effect is that 'base eroding payments' are permitted to reduce taxable income by up to 52%. The BEAT's provisions may impact on the incentives for large MNEs with US operations to outsource group service activities to foreign related parties and may prompt these MNEs to restructure.

Future developments

As Hong Kong's new chief executive has signalled that tax reform will be a key aim, this is a promising start to the new year.

Looking forward to the upcoming budget and beyond, more tax incentives are likely to be introduced by the Hong Kong government to increase Hong Kong's level of competitiveness with competitors within the region.