With the overhaul of international tax rules, including the BEPS 2.0 initiative, and tax treaty negotiations slowed down due to COVID-19, panellists at this year’s Annual Taxation Conference discussed how Hong Kong should take on the challenges and prepare for what comes next. Eric Chiang and Paul Smith report
Photography by Calvin Sit
Conference speakers: (from left) Brian Chiu, Deputy Commissioner (Technical), Inland Revenue Department, William Chan, Partner, Grant Thornton Tax Services and Chair, Institute’s Taxation Faculty Executive Committee and Michael Olesnicky, Senior Consultant, Tax, Baker McKenzie
Thanks to this social distancing world, the Hong Kong Institute of CPAs’ Annual Taxation Conference looked a little different this year. One of the highlights of the year for the Institute, the affair is usually well-attended, with lively discussions mixed in with presentations and members networking at break-out sessions. This year’s conference was well “attended,” albeit virtually, and without some of the personal connections.
Nevertheless, the panellists still entertained and informed the virtual attendees with their knowledge and insights into the challenges facing Hong Kong due to the changing international tax landscape and COVID-19 – the topic of the first panel discussion.
Moderator Jo-An Yee, Partner, EY and a member of the Institute’s Taxation Faculty Executive Committee (TFEC), began the discussion by asking Jonathan Culver, Tax Partner, Deloitte China, about why the European Union is looking at territorial regimes and the focus of its reviews. Hong Kong is on the list of jurisdictions that will be subject to review.
He noted that the E.U.’s Code of Conduct Group (COCG) was established as a unified body to represent the wishes of all member states. “Taxpayers may be able to negotiate a more favourable outcome for their tax planning with a single member state, or simply move between member states, but this is harder when the group acts through one body representing all member states,” he said. Regarding the review, Culver commented that the primary objective was to check whether territorial regimes constitute harmful tax practices focusing on two aspects, passive income and active income associated with permanent establishments (PE).
“Passive income is important because it is possible for it to be allocated to a legal entity with not much substance. Income is effectively paid from one jurisdiction to another. Is that income actually going to be taxed?” he noted.
As for active income for PE, revenues are normally attributed based on internal allocation rules. “Hong Kong has a best-in-class PE definition, which provides some comfort, however, because income attributed to a PE can still be offshore sourced, it will be interesting to see what the COCG concludes,” he said.
Hong Kong’s response
Yee asked Brian Chiu, Deputy Commissioner (Technical), Inland Revenue Department, three questions about the E.U. review. “Firstly, what are the major challenges to Hong Kong? Secondly, how can Hong Kong defend itself during the review? Finally, what will we change in the tax legislation after the review?”
“We have corresponded with the COCG and we are still waiting for the response. We will study the details and may consult stakeholders before we take any steps,” Chiu responded.
Regarding whether income is taxed, he commented that for passive income, “if there is no nexus between a tax jurisdiction and an income then theoretically the tax jurisdiction has no right to tax or not to tax the income. Hence, double non-taxation may arise if the income is booked in a tax jurisdiction with which the income has no nexus.”
For active income, the definition used for PEs is a key issue. “For example, if a PO box could be regarded as a PE, companies may allocate huge revenue to the PE. If the allocated revenue is not taxed or lowly taxed, this would concern the E.U.,” Chiu said.
Chiu finished by agreeing with Culver’s assessment of Hong Kong’s PE definition. “We will undertake FAR analysis to review the function, asset and risk of the PE to judge if the revenue allocated to it is reasonable. Therefore, I don’t think this would be a concern for both the E.U. and us as Hong Kong transfer pricing rules are up to the international standard.”
Michael Olesnicky, Senior Consultant, Tax, Baker McKenzie, agreed that it was premature to conclude now what impact the E.U. review will bring to the Hong Kong tax system. He noted that the E.U. set out that an overly broad definition of income excluded from tax could be a concern. “We will need to clarify if this would only apply to specific categories of income, or if it is applicable to the Hong Kong territorial regime more generally,” he noted.
For active income, Olesnicky noted that Hong Kong’s territorial source regime may lead to non-taxation. “While we can ensure that the amount allocated to the Hong Kong PE is appropriate by using FAR analysis, part of the profit could still be offshore in nature and not subject to Hong Kong tax.” This may allow taxpayers to secure offshore claims if they have limited operations in Hong Kong. “The E.U. expects to see substance. The two sets of testing parameters seem to be going to two extremes,” he said.
Culver agreed, suggesting that the E.U.’s substance requirement and how Hong Kong exempts offshore income could be a problem. “We should keep an eye on how the E.U. would view the headquarters function in Hong Kong, particularly where there are a lot of fund flows through Hong Kong entities.”
“It takes two to tango, and we need to be very careful about cooperation arrangements with other countries. Cooperation is always possible if it is in our interests.”
Conference speakers: (back, from left) Jonathan Culver, Tax Partner, Deloitte China, Jo-An Yee, Partner, EY and a member of the Institute’s Taxation Faculty Executive Committee (TFEC), (front, from left) Gwenda Ho, Tax Partner, PwC Hong Kong and a member of TFEC and Patrick Cheung, Partner, Global Transfer Pricing Services, KPMG
The BEPS 2.0 pillars
The Organization for Economic Cooperation and Development (OECD) began its Base Erosion and Profit Shifting (BEPS) 2.0 in 2019 to address the tax challenges linked to the digitalization of the economy. The proposals have two pillars. Pillar One covers the profit allocation and new taxing rights in market jurisdictions, which will grant taxation rights over multinational corporations (MNCs) to locations where users or consumers reside. Pillar Two ensures a minimum level of taxation for MNCs, called the Global Anti-Base Erosion (GloBE) proposal.
Although COVID-19 has delayed international agreement around the initiative, the OECD is targeting a consensus-based agreement by the end of 2020. In June, the Hong Kong government set up its own advisory panel on the initiative, which will review the possible impact of BEPS 2.0 on the competitiveness of Hong Kong’s business environment, and advise the financial secretary on strategies and measures to facilitate the sustainable development of Hong Kong as an international financial, trading and business centre.
Yee began with Pillar Two, asking Patrick Cheung, Partner, Global Transfer Pricing Services, KPMG, “What are the key design features of the GloBE proposal?”
Cheung gave the example of a typical British Virgin Island (BVI) incorporated company. The BVI company is interposed between two operating companies in different jurisdictions, and some profit is booked to this BVI company, which is not taxed. “Under the GloBE proposal, this untaxed profit booked in the BVI company will be taxed somewhere, it could be at the parent company level or the payer level by means of denial of expense deduction claim,” he said. This would be similar to the approach taken through controlled foreign corporations rules or the United States’ Global Intangible Low- Taxed Income (GILTI) rules, which reduce the incentive for MNCs to shift profits into low- or zero-tax jurisdictions.
Given that the proposals are new ideas to the existing international tax ecosystem, changes to the existing international tax protocol is required for successful implementation of the BEPS 2.0 proposals. “To successfully implement GloBE, we need to have structural changes to tax treaties, agree on the loss blending method, harmonize different points of views, and get buy-in from the U.S.,” he said.
Gwenda Ho, Tax Partner, PwC Hong Kong and a member of TFEC, explained that GloBE features four component rules. Firstly, the income inclusion rule, applies a top-up tax to income taxed below a specified minimum rate. Secondly, the switch-over rule, permits in certain instances taxation of otherwise exempt profits when such profits are taxed below the minimum rate. Thirdly, the undertaxed payments rule, denies deductions for related-party payments taxed below the minimum rate. Finally, the subject-to-tax rule, subjects both related- and unrelated-party payments taxed below the minimum rate to withholding and denies treaty benefits thereon.
Yee then asked the panel to share their experience of other countries' preparations for BEPS 2.0. “Everyone is doing consultations now, it seems that the delay to the initiative may not be bad,” said Cheung. He noted that Singapore was working to prepare for BEPS 2.0 as it had a lot of tax incentives to attract foreign investment.
Olesnicky asked Chiu about Hong Kong’s discussions with other countries. “Singapore, Malaysia and a few more countries share common interests, will we work with them together and develop coordinated responses to the OECD?”
While international cooperation is a good idea, Chiu urged caution. “It takes two to tango, and we need to be very careful about cooperation arrangements with other countries. Cooperation is always possible if it is in our interests,” he replied.
“Education and consultation are important. Taxpayers should know that BEPS 2.0 is not just about increasing tax revenues for governments, but is also to ensure a level playing field between jurisdictions.”
Disruption to the initiative
The U.S. had recently paused its BEPS 2.0 Pillar One discussions due to a need to prioritize their resources on the COVID-19 pandemic. “What is the impact of this action?” Yee asked the panel.
“The situation is not ideal, and without the U.S.’s involvement there could be delays in coming to a common consensus. Individual countries are more likely to take unilateral measures such as introducing a digital services tax (DST) to collect tax revenues from digital transactions,” Ho noted. “The U.S. is strongly opposed to the introduction of DST and has called for commensurate measures, for instance, threatening to impose a 25 percent tariff on US$1.3 billion of French goods if France begins collecting DST from U.S. companies next year,” she continued. The two pillars had different backers Cheung said. “The Europeans want Pillar One, but the U.S. wants Pillar Two.
COVID-19 provides the perfect excuse to kick the can down the road,” he said. “Yet the dynamics have not changed. Taxpayers will get caught in between and suffer if there is no agreement. The U.S. is of the view that the problems can be resolved through the BEPS 1.0 action plan. This thinking is not entirely wrong,” he remarked.
Pillar One’s turnover threshold of €750 million is so high that most MNCs caught by it would largely be U.S. tech companies, highlighted Olesnicky. “Clearly Pillar One is not in their favour. Agricultural and financial services, two industries that the Europeans want to protect, are carved out of the initiative,” he said. “It therefore appears that the Pillar One design is very Europe-centric, and may be viewed, to an extreme, as a European attack on the U.S.”
A unilateral approach has been taken by the U.S. said Chiu. “It applies its own rules like Foreign Account Tax Compliance Act, GILTI and Base Erosion and Anti-Abuse Tax,” he said. “Tax jurisdictions that would like to enter a tax treaty with the U.S. has to accept the U.S. model rather than the United Nations or OECD model.” The U.S. introduced new components to its tax regime from time to time, but it is questionable as to whether these measures are acceptable at the international level.
Olesnicky warned about two potential outcomes if the U.S. completely withdrew from the BEPS 2.0 discussions. “Either it’s the death of BEPS 2.0, or the OECD still goes ahead with it. It is always better to have a true global solution,” he said.
The upcoming U.S. election may also complicate matters, said Culver. “While it is not easy to implement Pillar One, this could become part of the political agenda in the upcoming U.S. presidential election.”
Conference speakers: (from left) Lorraine Cheung, Partner, China Tax and Business Advisory Services, EY and a member of the Institute’s China Tax Sub-Committee, Alice Leung, Partner, Corporate Tax Advisory, KPMG China, Cecilia Lee, Partner, Tax Services, Transfer Pricing Services, PwC and a member of the Institute’s China Tax Sub-Committee and Sarah Chan, Partner, Tax and Business Advisory Services, Deloitte China and Deputy Chair, Institute’s Taxation Faculty Executive Committee
Helping Hong Kong
Noting that there was still much to be resolved, Yee asked the panel to share their ideas about how policymakers in Hong Kong can be prepared for the introduction of BEPS 2.0.
“Education and consultation are important. Taxpayers should know that BEPS 2.0 is not just about increasing tax revenues for governments, but is also to ensure a level playing field between jurisdictions,” said Ho. “While certain businesses may be concerned about the potential changes, they may wish to appreciate that some of these changes may help increase their competitiveness against their overseas counterparts.”
Ho finished by saying that concluding more tax treaties with major trading partners and allowing unilateral double tax relief measures would be important to address potential double or multiple taxes, thereby making the Hong Kong tax system more competitive.
For Cheung, clarity and certainty in the tax system are important. “Investors may be reluctant to come and invest in Hong Kong if we lack clarity and certainty,” he said.
Efforts to avoid double taxation were important according to Chiu. “The design of Pillar Two is really a zero sum game so double taxation is unlikely. While for Pillar One, there is a chance of double taxation, and the impact should not be ignored,” he said.
Yee then asked Chiu, “What has the government done in the tax legislation to prepare for BEPS 2.0?” Chiu highlighted the recently passed ship leasing bill. “We intentionally added some provisions there to make it easy to change the legislation if the minimum tax rate is implemented under the BEPS 2.0 bill, if any,” he said.
BEPS 1.0 and 2.0 significantly changed Hong Kong’s tax system, according to Olesnicky. “When we make changes to our tax system to make it fit to the international game rules, we need to keep up with the OECD’s recommendations,” he said.
Increasing its tax take?
The final question Yee asked the panel was whether BEPS 2.0 would lead to more revenue for Hong Kong, noting that the territory was facing a budget deficit.
For Olesnicky, the deficit represented a good time to review the fundamentals of the system. “Shall we keep the source rule in our tax system? What about the possibility of introducing new taxes like a goods and services tax or capital gains tax?” he asked. “Maybe we should do a systematic rather than a piecemeal review,” he concluded.
Culver agreed, saying that BEPS 2.0 would bring big changes to Hong Kong. “It is sensible to conduct a holistic review of the tax system, and ensure that with the implementation of new changes, Hong Kong could be a more attractive place for foreign investors,” he said.
There may even be a win-win for Hong Kong. Ho suggested that if Hong Kong can grasp the taxing right, it may be able to collect some extra global tax revenue, while taxpayers should prefer paying a lower tax rate in Hong Kong than a higher rate in another jurisdiction.
Chiu said that while the tax treaty negotiations have slowed down due to COVID-19, Hong Kong remains committed entering into more tax treaties. “We work to maintain Hong Kong’s status as an international financial hub and enable it to keep on prospering,” he said.
Olesnicky suggested maintaining the source rules, and implementing the minimum BEPS 2.0 rules when finalized. “We just need to take defensive measures to tax those revenues affected by the implementation of BEPS 2.0,” he suggested.
Concluding the panel, Chiu said that the IRD had heard about this proposal but had to ensure that it was acceptable for both the OECD and Hong Kong – a reminder that international agreements require communication and continued engagement.
The full conference is available as an e-Seminar now, featuring presentations on changes in the tax landscape and Board of Review cases and the two panel discussions.