On July 1, 2021, 130 countries approved a declaration providing a framework for reforming international tax rules. These countries are members of the OECD / G20 Inclusive Framework on BEPS (CI), comprising 139 countries. The statement sets out key terms for an agreement on a two-pillar approach to reforms and calls for a comprehensive deal by the October 2021 G20 finance ministers and central bank governors meeting, with changes coming in. in force in 2023.
The first pillar of the deal is a significant departure from the standard international tax rules of the past 100 years, which largely require physical presence in a country before that country has the right to tax. The second pillar guarantees an unprecedented agreement on an overall minimum level of taxation which has the effect of setting a floor for tax competition between jurisdictions.
The five-page statement reflects high-level agreement on key policy issues and design features of pillars one and two following a two-day IC meeting. The statement departs in many respects from the pillar one and two master plans released by IF in October 2020. However, in several respects the statement builds on the master plans and resolves some of the main open elements of the plans. . Please refer to KPMG’s Initial Response Level Agreement for Pillars 1 and 2 for more details.
What impact will this have on Hong Kong SAR?
The Hong Kong SAR operates a simple and low tax system characterized by a principle of territorial taxation under which a company’s foreign source income is exempt from Hong Kong SAR profit tax , capital gains are not taxed, and the overall corporate tax rate is relatively low. (i.e. currently 16.5%). This can result in a significant reduction in the effective tax rate (ETR) of a business. Hong Kong SAR also currently offers incentives that can also lower a company’s EIR to less than 15%.
With a proposed overall minimum tax rate of 15%, it is expected that a significant number of large multinational enterprise groups (MNEs) (mainly groups with total consolidated turnover exceeding 750 million euros, although parent jurisdictions may choose to apply lower thresholds) with presence in Hong Kong SAR will be affected by the pillar two proposals. Many MNEs operating in Hong Kong SAR may also benefit from tax incentives and reliefs in other jurisdictions, and these will also need to be taken into account to understand the overall impact of the proposals.
Hong Kong SAR entities may effectively be subject to an “additional tax” in the jurisdiction of the MNE parent entity on income that is exempt or subject to a reduced rate of corporate tax in the HKSAR. Hong Kong SAR when the combined ETR of Hong Kong SAR entities is less than the overall minimum tax rate of 15%.
The Tax Liability Rule (STTR) is also expected to impact many Hong Kong SAR entities on their inter-jurisdictional transactions. Where interest, royalties, or certain service payments received from foreign related parties are subject to zero or low tax in Hong Kong SAR, the source jurisdiction may apply withholding tax to bring the total to the minimum STTR rate ( proposed between 7.5% and 9%). There is no jurisdictional combination for this rule, and it is applied on a transaction basis, so it should be considered regardless of whether the entity has an ETR of 15% or more.
Although no public commitments have been made by the Hong Kong SAR government, the Hong Kong SAR government has previously confirmed that it will actively implement the BEPS 2.0 proposals “in accordance with international consensus”, while stressing that it will strive to maintain simplicity, certainty, fairness and minimize the compliance burden of its tax system.
In addition, the EU has raised concerns about exclusions of foreign source income. The combined impact of these initiatives can lead to significant changes in the Hong Kong SAR tax system, at least for large multinationals.
Hong Kong SAR MNEs or foreign MNEs with Hong Kong SAR affiliates should therefore now undertake the necessary preparatory work to be ready to comply with these rules in just over 18 months. Some key activities to be undertaken by Hong Kong SAR tax officials may be:
- Model at a high level the impact of BEPS 2.0 proposals on the existing use of preferential regimes and offshore profits and capital claims and communicate with C-suite and other stakeholders;
- As a consultation process is initiated by the Hong Kong SAR government, engage in the consultation process to stay informed and help shape the evolution of potential response measures in Hong Kong SAR; and
- Begin the process of planning ahead of the necessary changes in legal entity and supply chain structures, as well as the major overhaul of the systems and processes required in order to be ready to comply from 2023.
Partner, KPMG China
Partner, KPMG China
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