The last issue of Tax Tips explained what constitutes “Base Erosion and Profit Shifting” (BEPS) and mentioned that one of the main objectives of the Inland Revenue (Amendment) (No. 6) Bill 2017 (the Bill) is to incorporate the BEPS Minimum Standard into the Inland Revenue Ordinance.
The Inland Revenue Ordinance affects everyone in Hong Kong. What would be the impact on the Hong Kong people? One should first understand the concept and goal of the BEPS program.
The concept of the BEPS program is to establish a modern international tax framework that allows companies to pay tax at the location of their real business activities and value creation. The goal is to create a more equitable international tax system to combat BEPS. The BEPS program identified 15 Actions along three fundamental pillars:
introducing coherence in the domestic rules that affect cross-border activities, reinforcing substance requirements in the existing international standards and improving transparency, as well as certainty for businesses that do not take aggressive positions.
A small sidetrack before we continue. The example of interest-bearing loans in the last issue of Tax Tips [see attached diagram] is, in fact, Case 1.1 of the BEPS Action 2, “Neutralising the Effects of Hybrid Mismatch Arrangements”. In Action 2, OECD proposed that country B should not allow interest deduction. If Country B allows the interest expense deduction, Country A should regard the income as taxable income in order to “ensure coherence of domestic laws and regulations on cross-border transactions”.
In short, OECD is asking jurisdictions to amend the tax code. Logically, Country A and Country B themselves must determine their own tax treatment according to their laws and may be tax cases (where applicable). The laws, regulations and tax cases must have been formulated by history, circumstances and people’s empowerment of the respective countries. Large and small enterprises are only acting according to the laws and regulations. Going forward, would all jurisdictions determine their tax treatments based on how the other countries rule?
Since it is an international tax framework, in theory, all 15 BEPS Actions should be unanimously implemented globally. However, it is obviously a very difficult task. Each jurisdiction has its own tax laws and legal process in amending legislation, which could take years to complete.
Even the G20 countries would unlikely be able to incorporate all Actions into their own laws in one go. In order to put the most important actions into practice, the G20 and the OECD set out four Actions that cover the above three pillars to be the Minimum Standards and require all countries to join the Inclusive Framework (thus declaring their commitment to implementing the Minimum Standard). Hong Kong joined the Inclusive Framework in 2016. At present, there are more than 110 countries or regions who have “joined the club”. The Minimum Standard covers:
Action 5: Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance
Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances
Action 13: Guidance on Transfer Pricing Documentation and Country-by-Country Reporting
Action 14: Making Dispute Resolution Mechanisms More Effective
Actually, implementation of Action 6 has already started. The OECD implemented Action 15 “Developing a Multilateral Instrument to Modify Bilateral Tax Treaties” and published last year the “Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting” (“Multilateral Convention”). As one of the purposes of the convention is to prevent abuse of preferential tax treaties, the amendment will make it harder for taxpayers to obtain treaty benefits.
In June 2017, Hong Kong signed the “Multilateral Convention” by representatives of Mainland’s State Administration of Taxation in order to amend the bilateral tax arrangements signed by Hong Kong and other countries or regions in one go. As of 20 December 2017, 72 countries or regions have signed the “Multilateral Convention”, and the OECD expects that as early as the beginning of 2018, as the parties to the convention completed their respective legislative formalities related to the “Multilateral Convention,” thousands of bilateral tax treaties would be amended swiftly and implement the measures against BEPS.
According to the Consultation Report on Measures to Counter BEPS released by the Financial Services and Treasury Bureau in July last year, Hong Kong plans to submit the relevant amendment bill to the Legislative Council by mid-2018 for the implementation of the Multilateral Convention.
Tax Tips: The tax arrangement that Hong Kong people are most concerned about must be the Double Tax Arrangement (“DTA”) between Hong Kong and the Mainland. The Multilateral Convention signed by the Mainland on behalf of Hong Kong does not cover the DTA between Hong Kong and the Mainland. Does it mean that the DTA will not be amended? No. It is expected that Hong Kong and the Mainland will announce how to amend (tighten) the DTA, and Hong Kong will then carry out the legislative procedures to implement the Multilateral Convention. As for what changes are in store? Stay-tuned.
HK FSTB BEPS Consultation Paper: http://www.fstb.gov.hk/tb/en/docs/BEPS-ConsultationPaper-e.pdf
HK FSTB BEPS Consultation Report: http://www.fstb.gov.hk/tb/en/docs/BEPS-ConsultationReport-e.pdf
BEPS Framework https://www.ird.gov.hk/eng/ppr/archives/16102602.htm
BEPS Inclusive Framework membership Jan 2018: http://www.oecd.org/tax/beps/inclusive-framework-on-beps-composition.pdf
MLI signatories up to 20Dec17 http://www.oecd.org/tax/treaties/beps-mli-signatories-and-parties.pdf
About the Author:
This article is contributed by Edwin Bin. Edwin is a seasoned Hong Kong tax consultant with more than 20 years of professional experience. He is a Council Member (2018/19) of the TIHK, a member of the Tax Policy Committee, China Tax Committee and International Tax Committee of TIHK and a member of the Tax-Subcommittee of ACCA.