On 29 December 2017, the Hong Kong Government gazetted the Inland Revenue (Amendment) (No.6) Bill 2017 (Bill), proposing the codification of transfer pricing principles into law.

Whilst transfer pricing is not a new concept in Hong Kong, before the introduction of the Bill, Hong Kong did not have any specific transfer pricing legislation and had been relying on general provisions in the Hong Kong Inland Revenue Ordinance, non-legally binding Practice Notes issued by the Inland Revenue Department and case law.

The Bill introduces new rules and requirements to ensure that Hong Kong's transfer pricing legislation meets the international standards promulgated by the Organisation for Economic Co-operation and Development (OECD). Hong Kong joined the inclusive framework as a BEPS Associate, requiring Hong Kong to comply with the four BEPS minimum standards.

The Bill, when enacted, will impose legally binding transfer pricing obligations on multinational companies (MNC). It also signals Hong Kong's intention to increasingly and more aggressively enforce the arm's length principle. Taxpayers should ensure they conduct thorough and defensible transfer pricing analysis to substantiate the arm's length nature of their transactions, and prepare and retain appropriate documentation.

1. The Arm's Length Principle

The Bill stipulates that a transaction or a series of transactions made between two associated persons (including, companies, partnerships, incorporated or unincorporated trustees or bodies of persons) must be made on arm's length basis. This applies to both domestic and cross-border transaction(s). Further, "transaction" has a meaning wider than its ordinary meaning and includes any operation, scheme, arrangement, understanding or mutual practice (whether express or implied, and whether or not enforceable).

If a taxpayer fails to prove that the transaction was conducted at arm's length (e.g., by providing transfer pricing documentation), the tax assessor may make an adjustment to the taxpayer's taxable profits.

In this regard, the Bill provides that two persons are associated where one person participates in the management, control or capital of the other person, and controls the other person. Control, amongst other things, includes where a person has the power to secure that the affairs of the other person are conducted in accordance with the wishes of the person due to a direct or indirect beneficial interest in the other person of more than 50%, entitlement to exercise more than 50% of the voting rights in the other person or powers conferred by constitutional documents regulating the other person.

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