MORE INFORMATION REQUIRED FOR HONG KONG PERMANENT ESTABLISHMENT (“PE”) OF A NON-HONG KONG RESIDENT PERSON

In 2019/20 Profits Tax return, the Inland Revenue Department (“IRD”) required taxpayers to confirm whether it is a Hong Kong PE of a non-Hong Kong resident person in Item 3.9 of Form BIR51.

In 2020/21 Profits Tax Return, the IRD amends the wordings in Item 3.9 and further requests the taxpayer to provide additional information if it is a PE of a non-resident, including but not limited to:

• amount of funding, nature, interest rate and interest expense for each funding provided by the non-Hong Kong resident person to the PE;
• amount of free capital attributed to the PE and its computation; and
• amount of capital attribution tax adjustment and its computation

As a recap, although the Hong Kong PE (e.g., Branch) of a non-resident person is not a separate legal entity, it should be treated as a distinct and separate enterprise in attributing profits to the PE. As such, the transactions between the PE and the overseas Headquarters should follow the arm’s length rule. The PE is also expected to have a reasonable level of equity and debt in its capital structure.

Points to Note
Targeting the profits of low-tax jurisdictions (e.g., the BVI, Cayman Island, Bermuda) appears to be the year 2021 focus of the IRD. We have seen several enquiry letters and tax audit carried on taxpayers with significant number of group companies in low-tax jurisdictions, especially when there are transactions between them and the Hong Kong taxpayer. Please refer to our March 2021 Newsletter for definition of “transactions”.

In the context of the PE, the IRD is targeting to identify the following issues:-

Whether the corporations in low-tax jurisdictions maintain a PE or even is a tax resident in Hong Kong; and
Whether the transactions between the Hong Kong PE and the overseas headquarters result in loss of taxable profits in Hong Kong.
In the above case, the IRD will take the following actions:-

Impose Hong Kong Profits Tax on the whole amount of profits of the overseas group companies;
Disallow certain expenses paid by the Hong Kong PE to the overseas entities on the basis that they are not incurred in the production of Hong Kong assessable profits; and
Adjust the basis of calculation of the transactions in order to increase the profits chargeable to Hong Kong Profits Tax.