Hong Kong: What are possible considerations for BEPS 2.0?

Actions by EU and United States may implicate Hong Kong’s consideration of BEPS 2.0

Actions by EU and United States may implicate Hong Kong’s consideration of BEPS 2.0

Recent announcements by the European Commission and the United States are expected to put pressure on Hong Kong to implement BEPS 2.0 and amend domestic tax breaks and incentives that lower its effective corporate tax rate below the level that some expected will be agreed to by the Organisation for Economic Cooperation and Development (OECD). 

Background

  • In recent weeks, there have been major developments in the field of new international tax standards, both from an EU and U.S. perspectives—developments that are likely to have a “knock-on effect” for international business centers, including Hong Kong.
  • On 18 May 2021, the EC unveiled its “Communication on Business Taxation for the 21st Century” that includes short- and long-term tax policy announcements. The EC highlighted an intention to include Pillar Two of the ongoing base erosion and profit shifting (BEPS) 2.0 project1 as a criterion for its notorious list of non-cooperative jurisdictions.
  • On 20 May 2021, the U.S. Treasury Department announced a new position to accept businesses paying a global minimum corporate tax rate of at least 15% on their overseas profits during an OECD tax steering group meeting.
  • Some believe that the G7’s Finance Ministers may indicate their agreement with the proposals as early as 4 June 2021.

1 The OECD/G20 Inclusive Framework on BEPS approved two updated documents (Blueprints) setting out highly detailed proposals for the two BEPS 2.0 “Pillars”—Pillar One focuses on where tax is paid, and aims to achieve a reallocation of taxing rights between countries that would entail the design of a new nexus rule beyond the permanent establishment threshold, whereas Pillar Two concerns the total level of tax and aims for all large internationally operating businesses to pay at least a minimum level of tax. A complex set of interlinking rules would provide that a multinational enterprise (MNE) could not achieve an effective tax rate below a certain level (yet to be fixed but expected to be between 12% and 15%) in any jurisdiction in which it operates. 

Effect of EC proposal for Hong Kong

The EC Communication addresses several complex topics including the EC’s plan to establish a single corporate tax rulebook for the EU and targeted initiatives in the area of corporate taxation.

Concerning the EC’s proposal to introduce Pillar Two as a criterion to assess third (non-EU) countries for purposes of the EU list of non-cooperative jurisdictions and the potential implications for Hong Kong, recall that Hong Kong was placed on the EU’s list of non-cooperative jurisdictions in December 2017. The implications may be greater than the mere stigma. For example, certain EU funding cannot be channeled through entities in a listed country, and there are stricter reporting requirements for MNEs with activities in these jurisdictions.

In response, Hong Kong swiftly took action to counter harmful tax practices, prevent treaty abuse, introduce country-by-country reporting, and improve cross-border dispute resolution mechanisms. Accordingly, in March 2019, Hong Kong was removed from the non-cooperative list, as a result of its successful delivery of these reforms. 

Implications of U.S. Treasury’s announcement

The U.S. Treasury Department proposed an effective corporate tax rate of 15%. From the U.S. perspective, the global minimum tax rate would be viewed as helpful in minimising the impact of a higher U.S. tax rate on the competitiveness of U.S. companies and would be intended to deter them from shifting operations or profits to lower-tax jurisdictions.

The new U.S. proposal of 15% has been welcomed by certain other G7 members (Japan, Italy, France, and Germany). The UK has yet to offer public support for the proposal but has commended U.S. commitment to reaching a solution.

Jurisdictions such as Hong Kong have used lower tax rates to attract corporate business. While the 15% rate proposed by the United States is less than Hong Kong’s headline rate of corporate tax of 16.5%, it may be a cause for concern for some taxpayers. In reality, the effective tax rate in Hong Kong is significantly lower than 15%, due to the availability of various tax breaks and incentives, including the source rule (only Hong Kong-sourced income is subject to profits tax) and the concessionary rate of 8.25% for corporate treasury centres.

KPMG observation

Hong Kong has expressed a commitment to meet international tax standards, which are considered essential to preserve Hong Kong’s competitiveness as an international business center. This commitment, some believer, may pressure Hong Kong to accelerate its implementation of Pillar Two (considering recent developments) to avoid being placed on the EU’s list of non-cooperative jurisdictions again and thus undermine Hong Kong’s recent efforts in the international tax standards sphere.

No public commitments have been made by the Hong Kong government and specific response measures are not expected until after the OECD has finalised the proposals. However, international tax cooperation was addressed in the 2021-2022 budget, with the Hong Kong government emphasising its commitment to maintaining simplicity, certainty, and fairness and to minimising the compliance burden of its tax regime, but at the same time, confirming it will actively implement the BEPS 2.0 proposals “according to international consensus.”


For more information, contact a tax professional with KPMG’s Global Transfer Pricing Services practice:

Mark Martin | +1 713 319 3976 | mrmartin@kpmg.com

 

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