In December 2009, the Inland Revenue Department (“IRD”) issued its Practice Note No. 46 – “Transfer Pricing Guidelines – Methodologies and Related Issues”. The 35-page document plus 17-page appendix provide a detailed insight into the approach the IRD will take to negate perceived Hong Kong tax benefits derived from abusive transfer pricing arrangements. Two approaches are advocated, their use being dependent on whether a comprehensive double taxation treaty (“CDTT”) has been concluded with the country of residence of the counterparty. Where this is the case, it is clear that the IRD will adopt the well documented transfer pricing guidelines issued by the Organization for Economic Co-operation and Development (“OECD”).
Where the transactions are with a country with which HK does not have a CDTT, the IRD will revert to those provisions of the Inland Revenue Ordinance that it considers are capable of capturing the revenue lost through the implementation of a tax-driven scheme.
The relevant sections are:
Section 16 IRO this section restricts the deduction of outgoings and expenses to the extent to which they are not incurred in the production of assessable profits.
Section 17 IRO prohibits deductions for “any disbursements or expenses not being money expended for the purposes of producing such profits”
Section 20 and 20A IRO Transactions between a Hong Kong company and an offshore company not conducted on an arm’s-length basis.
Section 61 IRO Seeks to negate tax benefits derived from artificial and fictitious transactions
Section 61A IRO Contains Hong Kong’s general anti-avoidance provisions
Whilst these provisions do not necessarily have the sophistication of the Associated Enterprise Article and other related provisions found in CDTTs, they are capable of achieving the IRD’s objective that there should be no loss of tax revenues due to transfer pricing policies that are considered to be conducted at non-arm’s-length prices.
Although Hong Kong does not have any mandatory requirements to provide documentary evidence of pricing policies, Section 51C does require a person to keep sufficient records to enable the IRD to evaluate the appropriateness of the assessable profit ascribed to a Hong Kong business.
It’s unlikely that there will be any change in the IRD’s approach to the policing of transfer pricing policies, but taxpayers should always remember that at the end of the day, it is their own responsibility to prove that the pricing policies they adopt are considered to be comparable to those that would have been used by independent parties carrying on business at arm’s-length prices.
