Quick Summary of BEPS Pillar 2 Implementation and Hong Kong's Approach to Global Minimum Tax and HKMTT.
Large-scale Shareholding Restructuring is Expected to Take Place for Non-listed Entities
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Prepared by Mr. Henry Kwong, Senior Tax Advisor of ONC Lawyers
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1. Introduction to BEPS Pillar 2 and Global Tax Reforms
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The OECD's Base Erosion and Profit Shifting (BEPS) initiative, specifically Pillar Two, represents a significant shift in international taxation. Aimed at addressing the challenges of the digital economy and globalization, Pillar Two focuses on ensuring that multinational enterprises (MNEs) pay a fair share of taxes. The core of this initiative is the establishment of a global minimum tax, targeting MNEs with consolidated group revenues exceeding EUR 750 million (or HK$6.8 billion). This measure is designed to prevent profit shifting to low-tax jurisdictions, thus safeguarding countries' tax bases. The minimum effective tax rate under this initiative is set at 15%, which is seen as a balance between discouraging profit shifting and maintaining a competitive tax environment for businesses.
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2. Hong Kong's Consultation on Pillar Two Measures
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On 20 December 2023, Hong Kong launched a consultation to discuss the implementation of Pillar Two measures, specifically focusing on the Income Inclusion Rule (IIR) and the Undertaxed Profits Rule (UTPR), along with the Hong Kong Minimum Top-Up Tax (HKMTT). This consultation, aligned with the OECD's GloBE (Global Anti-Base Erosion) model rules, is a proactive step towards integrating these international tax reforms into Hong Kong's tax system. The proposed rules are set to apply from fiscal years beginning on or after 1 January 2025. This initiative reflects Hong Kong's commitment to global tax reforms while balancing the needs to maintain its position as a competitive and attractive business hub. The government has highlighted its intention to uphold Hong Kong's simple tax regime and incorporate business-friendly measures to minimize compliance burdens for companies operating in the region.
2. Details of the Income Inclusion Rule (IIR) and Undertaxed Profits Rule (UTPR)
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The IIR and UTPR are critical elements of the Pillar Two framework. The IIR (please refer to footnote for detailed definition) mandates that the ultimate parent entity of an MNE group pay a top-up tax if the effective tax rate in any jurisdiction where the group operates is below the global minimum rate of 15%. This rule essentially ensures that profits are taxed at a minimum rate regardless of where they are earned.
The UTPR (please refer to footnote for detailed definition) serves as a secondary mechanism, designed to function when the IIR does not fully address low-tax operations within an MNE group. It allocates additional tax to jurisdictions participating in the system, ensuring that profits are not undertaxed (also below minimum rate of 15%). These rules collectively aim to mitigate the risk of profit shifting and base erosion, ensuring a fair distribution of tax revenues among countries where MNEs operate.
4. Hong Kong's Domestic Minimum Top-Up Tax (HKMTT) Framework
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The HKMTT (please refer to footnote for detailed definition) is proposed as a crucial component of Hong Kong's adaptation of the global minimum tax regime. It is designed to apply to Hong Kong constituent entities of MNE groups, effectively ensuring that profits are taxed at a minimum rate of 15%. The HKMTT aligns with the GloBE rules and includes provisions for a Qualified Domestic Minimum Top-Up Tax (QDMTT) and offers safe harbors to facilitate compliance. These measures are intended to integrate seamlessly with Hong Kong's existing tax system, respecting the principles of simplicity and efficiency that have long characterized the territory's tax policy. The proposals suggest business-friendly features such as the use of local financial accounting standards for HKMTT computation and considerations for entities in the initial phase of international activity.
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5. Safe Harbour Rules
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The consultation paper also outlines simplification measures for GloBE rules compliance. It introduces jurisdictional safe harbours, reducing the burden of detailed calculations for Multinational Enterprises (MNEs). Transitional safe harbours use simplified revenue and tax data to determine top-up tax liabilities during initial implementation years. The Qualified Domestic Minimum Top-Up Tax (QDMTT) safe harbour is proposed to reconcile differences between QDMTT and GloBE rules, requiring a single calculation and exempting MNEs from additional GloBE rules in specific jurisdictions. Additionally, a simplified calculation safe harbour for non-material entities is discussed. Hong Kong's adaptation includes the transitional CbCR safe harbour but excludes the UTPR safe harbour due to its lower corporate tax rate.
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6. Tax Compliance and Administration Challenges
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Under the GloBE rules, every constituent entity of an in-scope Multinational Enterprise (MNE) group must file a standardized GloBE Information Return (GIR) in its jurisdiction. Following the OECD's July 2023 release of the GIR template, the GIR contains extensive data on the group’s structure, safe harbours, Effective Tax Rate (ETR) computations, and top-up tax calculations. While local filing is the default, centralized filing in one jurisdiction is also possible for coordinated information exchange.
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Each jurisdiction implementing GloBE rules and Qualified Domestic Minimum Top-Up Tax (QDMTT) will design its own tax return process. To reduce compliance burdens, the same GIR data will be utilized for both GloBE and QDMTT calculations. The GIR and associated notifications are to be filed with tax authorities no later than 15 months after the fiscal year's end, with an extended 18-month deadline for the transition year.
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In Hong Kong, the Inland Revenue Department (IRD) is setting up a dedicated tax administration framework for GloBE and HKMTT. This includes an electronic platform for submitting notifications and returns. Hong Kong constituent entities of an MNE group must file a single top-up tax return for GloBE and HKMTT within 15 months of the fiscal year-end, or 18 months for the transition year. Additionally, these entities are required to submit an annual notification on their obligation to file a top-up tax return within 6 months after the fiscal year-end.
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7. Future Outlook and Implications for International Tax Landscape
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The implementation of the global minimum tax and HKMTT is set to have far-reaching implications for the international tax landscape. This move marks a paradigm shift in how multinational corporations are taxed, likely affecting cross-border investments, corporate structuring, and international tax planning. Hong Kong's adoption of these measures and its alignment with OECD standards underscore its commitment to a fair and equitable international tax system. This final section will discuss the anticipated global impacts of these changes, the challenges they pose, and the opportunities they present for both Hong Kong and international businesses.
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In conclusion, this extended summary provides a comprehensive and in-depth analysis of the BEPS Pillar 2 initiative and Hong Kong's specific measures to implement the global minimum tax and HKMTT. It addresses the complexities of the new rules, the challenges faced in their implementation, and their broader implications for the global tax environment.
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8. Our Comments
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The implementation of the BEPS Pillar 2 reform is going to cause significant impact to the Hong Kong Taxation System. Traditional tax incentives (e.g., offshore claim, capital gain claim) and new tax incentives (e.g., family office tax concession, R&D enhanced tax deduction) are now at risk for conglomerates with consolidated revenues of over HK$6.8 billion. Corporations with less revenues than the threshold is not affected by the new law.
The OECD has also further discussed the definition of revenues. All operating income (including but not limited to top-line sales) will be included in revenues computation.
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With the new law, it seems Multi-national enterprises with ultimate holding entities in offshore jurisdictions (e.g., British Virgin Island, BVI) cannot escape from new law, as the group with constituent entities in Hong Kong are also covered in this law.
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Hong Kong will remain to be an attractive place for Multi-national enterprises, as the new law will further push Multi-national enterprises to turn from tax heaven countries to low-tax jurisdictions (e.g., Hong Kong).
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While the new law is going to be effective in Hong Kong starting from 1 January 2025, we expect unlisted Multi-national enterprises will undergo large-scale group restructuring to shift from 1 Ultimate parent entity to multiple Ultimate parent entities. Below is our general advice for group restructuring:-
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• The Group should always consider commercial rationale in their business or shareholding restructuring (e.g., separation of business units) to avoid being considered as tax avoidance procedures; and
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• The Group should consider tax implications arising from restructuring (e.g., Stamp Duty, capital gain tax). There is always a misconception that direct of Hong Kong company shares would only trigger Hong Kong tax exposure. It should be noted Indirect transfer of China entities or China asset via Hong Kong holding companies would also trigger China Corporate Income Tax exposure. Same principle may apply in other tax jurisdictions as well.
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Footnotes:
- The Income Inclusion Rule (IIR) functions from a top-down perspective, wherein the tax liability is typically determined and settled by the ultimate parent entity with its national tax authority. This tax is the additional 'top-up' sum required to elevate the total tax on profits across all countries where the group is active, ensuring it reaches the minimum effective tax rate of 15%..
- The Undertaxed Profits Rule (UTPR), also known as the undertaxed payments rule, serves as a supplementary measure. It comes into effect in situations where a country's effective tax rate falls below the 15% minimum, and the Income Inclusion Rule hasn't been completely enforced. In such cases, the additional tax required is distributed among countries that have adopted UTPR, following a specific formula. This implementation can be executed either by disallowing deductions for certain payments or through a corresponding financial adjustment..
- In the context of a Qualified Domestic Minimum Top-Up Tax (QDMTT), any additional taxes due on profits of a group's entities that are taxed below the threshold within a particular country are settled within that country itself. This approach is in contrast to paying these taxes to other countries as per the Income Inclusion Rule or the Undertaxed Profits Rule.
