The Inclusive Framework on BEPS (IF) have released documents in the last quarter of Year 2020, setting out detailed proposals for the two “Pillars” to address deficiencies of the international tax system, especially focusing on participants in digital economy (targeting large MNE group with annual consolidated revenue of not less than EUR750M). The new international tax rules being developed within the two pillars are frequently referred to as “BEPS 2.0”.

Key content of the two Pillars are:

Pillar 1 – Reallocating taxing rights to market / user jurisdictions

Pillar 1 aims to achieve a reallocation of taxing rights among countries. The allocation mechanism includes the following steps

  • Determine the total profit of an MNE group;
  • Exclude deemed routine profit to determine deemed residual profit; and
  • Split deemed residual profit and allocate the profits to market jurisdictions based on sales, customers’ location, marketing tools / intangible assets’ location, etc.

Pillar 2 – Setting a minimum effective tax rate requirements on profits of MNE groups

Pillar 2 aims to ensure that all large internationally operating businesses pay at least a minimum level of tax at the location where value is added. The document introduces rules to tax income of MNE groups at the minimum rate, and to allocate the taxing right to parent entity jurisdiction, payer jurisdiction or source jurisdiction.

Points to Note

The proposal mainly focuses on participants in digital economy, but it is clear that the location of “value creation” is once again emphasized and the jurisdictions where the enterprise has “value creation” activities should have the taxing rights on certain profits of that enterprise.

The IRD is increasingly aggressive to utilise “value creation” approach to impose Profits Tax on corporations incorporated outside Hong Kong. Besides the focus on PE as mentioned in Point 1 above, Section 15F of the Inland Revenue Ordinance has been recently enacted to target nonresident intellectual property owners. We expect the IRD would continue to propose similar rules to non-residents. Taxpayers should closely monitor their Double Taxation risks.

Lastly, Hong Kong taxpayers should also review their offshore claim status as it could be contradictory to the minimum tax rate requirement set out in Pillar 2. Taxpayers should consider whether they should change their strategies to set up economic substance in Hong Kong and thus become a Hong Kong tax resident to fully utilise the low tax rates.

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