The Hong Kong Inland Revenue Department (“IRD”) has recently provided some guidance on its approach to tax issues relating to tax residency, permanent establishment and transfer pricing arising from the COVID-19 pandemic. We briefly summarize here below the guidance issued by the IRD.
Tax Residence of Companies
Since the Covid-19 pandemic has restricted international travel, the locations where senior management hold meetings may have been changed. This has brought up concerns about the effect of such change in the tax residence of a company. The IRD expressed the view that a temporary change during this special period would not affect the tax residence status of a company. When the IRD assesses a company’s residence status, it will take into considerations all relevant facts and circumstances.
In case a company is considered to be a dual resident, that is, both a resident of Hong Kong and another jurisdiction, the IRD advised that the tie-breaker rules under the respective tax treaty would apply to determine the jurisdiction where a company is regarded as a resident for the purposes of the treaty. The IRD would generally follow the Updated Guidance on Tax Treaties and the Impact of the COVID-19 Pandemic (“COVID-19 Tax Treaty Guidance”) released by the Organisation for Economic Co-operation and Development (“OECD”) in January 2021, which states that a company’s place of residence determined by the tie-breaker rules under a tax treaty is unlikely to be affected by the fact that the individuals participating in the management and decision-making of the company cannot travel as a result of a public health measure imposed or recommended by at least one of the governments of the jurisdictions involved.
The IRD expressed the view that whether a non-Hong Kong resident person has a permeant establishment in Hong Kong is a question of fact and degree. The IRD would examine all of the relevant facts and circumstances, including the international travel disruption caused by public health measures imposed by governments in response to COVID-19, and is prepared to adopt a flexible approach during this period.
The IRD further advised that it would follow the COVID-19 Tax Treaty Guidance, which explained that the exceptional and temporary change of the location where employees exercise their employment because of the COVID-19 pandemic, such as working from home, should not create new permanent establishments for the employers. Similarly, the temporary conclusion of contracts in the home of employees or agents because of the pandemic should not create permanent establishments for enterprises, though a different approach may be appropriate if the employees or agents were habitually concluding contracts on behalf of the enterprises in their home jurisdictions before the pandemic.
The IRD reminded taxpayers that the above views are relevant only to circumstances arising during the COVID-19 pandemic when travel restrictions are in effect. Where an individual continues to work from home after the cessation of the public health measures, further examination of the facts and circumstances would be required to determine whether a permanent establishment exists.
The IRD’s approach in relation to transfer pricing would generally be in line with the Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic (“the COVID-19 Transfer Pricing Guidance”) released by the OECD in December 2020. The COVID-19 Transfer Pricing Guidance states that the arm’s length principle remains the applicable standard for the purpose of evaluating the transfer pricing of controlled transactions in the face of the pandemic; nevertheless, due regard would be given as to how the outcomes of the economically significant risks controlled by the parties to the transactions have been affected by the COVID-19 pandemic.
The following views are also expressed by the IRD when dealing with transfer pricing issues:
- it may be appropriate to have separate testing periods for the duration of the pandemic or to include loss-making comparables when performing a comparability analysis.
- a limited-risk entity could be accepted to have incurred losses if the losses are found to be incurred at arm’s length.
- the receipt of government assistance may affect the price of a controlled transaction.
- the IRD will uphold existing advance pricing arrangements (APAs), unless a condition leading to the revocation, cancellation or revision of the APA has occurred. Where material changes in economic conditions lead to the breach of the critical assumptions, taxpayers should notify the IRD not later than one month after the breach occurs.
If you have any queries on how these may affect your business, please feel free to contact us.
Chartered Accountant, LL.M.
Tel: (852) 3102 1995
Senior Tax Manager
Tel: (852) 3102 1995
Rooms 501-2, Wilson House
19-27 Wyndham Street
Central, Hong Kong