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Guidance on granting relief from double taxation
With increasing cross-border operations, especially those with China, there has been a call for practical guidance from the Hong Kong Inland Revenue Department ("IRD") in dealing with double taxation issues, especially those arising from transfer pricing adjustments. On 30 April 2009, the IRD issued the long-awaited Departmental Interpretation and Practice Notes No. 45 - "Relief from Double Taxation due to Transfer Pricing or Profit Reallocation Adjustments" ("DIPN 45"). DIPN 45 is generally welcomed as providing a formal IRD view on how relief from double taxation may be obtained and the detailed procedures involved for taxpayers in seeking relief under a double taxation agreement ("DTA").
In this issue of News Flash, we are going to discuss the details of DIPN 45 and our observations on its implications. Before looking into the details of DIPN 45, one key "big picture" message coming out from the issue of DIPN 45, as well as another forthcoming DIPN on wider transfer pricing issues, is that transfer pricing is definitely on the IRD's agenda and it is time for companies with cross-border operations to reconsider both their transfer pricing housekeeping, and the risks and opportunities in their existing operations.
DIPN 45
Whilst DIPN 45 aims at providing guidance on handling double taxation when a DTA exists, it is also clear from DIPN 45 that in the absence of a DTA, there is no relief by way of a tax credit under section 50 of the Inland Revenue Ordinance ("IRO") and no bilateral procedures for relief from double taxation are in place. In such situation, any double taxation issues will and can only be dealt with according to the existing provisions in the IRO (other than section 50). Effectively since there is no provision in the IRO permitting the IRD to make any adjustment of the properly assessed profits, there is no legitimate basis for the IRD to provide any relief from double taxation in the absence of a DTA. Accordingly, relief from double taxation will only be considered by the IRD where a DTA exists and this is the scope of DIPN 45.
- Situations where international double taxation arises
- Possible relief from double taxation
- Mechanism for granting double tax relief by the IRD for adjustments made by the tax administration of a DTA state
- Economic double taxation
- Juridical double taxation
- Adjustments by the Commissioner
- The mutual agreement procedure ("MAP")
PwC observations
- DIPN on transfer pricing
- Double taxation resulting from application of domestic law
- Retrospective adjustments
- Time limits for applying relief or invoking the MAP (and care on when double taxation is arising)
- Invoking the MAP in other situations
- Interaction with anti-avoidance provisions in the IRO
Concluding remarks
With an increased focus of the IRD on transfer pricing related issues, companies with significant cross-border transactions should revisit their transfer pricing or profits allocation policy and arrangements with respect to transactions with related parties to ensure that the pricing adopted is justifiable and on an arm's length basis. This will involve planning as well as housekeeping policies on both documentation and monitoring relief time limits.
While the existence of a mechanism for providing relief from double taxation under a DTA will definitely be welcome by taxpayers, one should bear in mind that there is a cost to pay for seeking such relief e.g. substantial cost and time may be incurred in dealing with the IRD and the competent authority of a DTA state in seeking a relief, detailed information of the related party transactions and the parties involved will need to be disclosed to the competent authorities if the MAP is applied, etc. Therefore, it is invariably commercially better for companies to get well prepared for the potential challenges from the tax authorities than to take remedy actions when dispute arises. Although there is no specific transfer pricing documentation requirement in Hong Kong currently, companies will clearly be in a better position to defend themselves when transfer pricing or profit reallocation adjustments are made by tax administration if they have proper transfer pricing documentation in place. And, as we discussed above, such documentation may shortly be required in any event.
On the other hand, the mechanism set out in DIPN 45 remains untested and there are still uncertainties as to some of the practical application of the principles stated in the DIPN 45. As such, investing in doing the transfer pricing right at the outset proactively is again definitely commercially better than spending resources in dealing with transfer pricing or profit reallocation investigation, disputes and adjustments made by tax administration or seeking double taxation relief when they arise.
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Read more by downloading our Hong Kong Tax News Flash (May 2009, Issue 4) (pdf file, 139KB) for your reference.
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