Updates on implementation of global minimum tax and domestic minimum top-up tax in Hong Kong

In response to the stakeholders' feedback from the public consultation exercise reported in our previous client alert, the Hong Kong Financial Services and the Treasury Bureau (FSTB) and Inland Revenue Department (IRD) jointly issued a Legislative Council Paper in October 2024 with more clarifications on the implementation of Global Anti-base Erosion Model Rules (Pillar Two) (GloBE Rules) and the Hong Kong Minimum Top-up Tax (HKMTT), which is intended to qualify as a Qualified Domestic Minimum Top-up Tax (QDMTT). The Government is planning to introduce the relevant amendments to the Inland Revenue Ordinance (IRO) by January 2025. This alert aims at providing an overview of the Government's stance on the key public feedback received in anticipation of the amendment bill.

 

Timeline for implementation

The Income Inclusion Rule (IIR) and HKMTT will be implemented from 2025, while the Undertaxed Profits Rule (UTPR) will be implemented on a later date subject to further studies. This will likely lower the compliance burden of in-scope MNE groups at the initial stage of the Pillar Two implementation in Hong Kong. The Government emphasized that it would take into account all relevant factors before deciding on the UTPR implementation timeline, including the position of in-scope MNE groups operating in Hong Kong after the implementation of IIR and HKMTT and the practice of other jurisdictions.

Despite the Government's initial position in the Consultation Paper that the UTPR safe harbour is inapplicable to Hong Kong as the statutory corporate profits tax rate in Hong Kong is below 20%, the Government has confirmed in the Legislative Council Paper that a transitional UTPR safe harbour would be provided in the legislation as a transitional relief to the ultimate parent entity (UPE) jurisdiction of foreign-headquartered MNE groups with corporate income tax rates of at least 20%.

 

IRO amendments rather than standalone legislation

Instead of setting out the GloBE Rules and HKMTT rules in a separate legislation, the Government has maintained that amending the IRO to incorporate these rules is the most appropriate course of action, given that the top-up tax payable is, by its nature, an income tax imposed on earning and profits (among others).

Nonetheless, recognizing that the top-up tax is distinct from the “normal” profits tax under Part 4 of the IRO, the Government has indicated its intention to add the relevant GloBE Rules and HKMTT rules under a new, separate part of the IRO and review all existing references to profits tax under the IRO to ensure that these new rules would not be applicable to the “normal” profits tax.

The Government has also decided to incorporate the future administrative guidance issued by the Organization for Economic Co-operation and Development (OECD) into the IRO through subsidiary legislation. In addition, the IRD will publish its own implementation guidance on issues that are of common interest to in-scope MNE groups on its website.

 

Definition for “Hong Kong resident entity”

Aligning the approach adopted by many other jurisdictions which define “tax resident” in their tax laws, the Government intends to introduce a definition for “Hong Kong resident entity” for the IRO's general purposes (rather than the initial proposal in the Consultation Paper that the definition would only be applicable for the purposes of the GloBE Rules and HKMTT rules) after consulting the OECD.

Nonetheless, the definition is expected to take retrospective effect from 1 January 2024 (consistent with the proposal in the Consultation Paper), so that entities falling within the definition will be regarded as located in Hong Kong throughout the 2024 fiscal year.

 

Exclusion of investment and insurance investment entities

Similarly, in line with the practice adopted by other jurisdictions, the Government has also agreed to exclude investment entities and insurance investment entities from the HKMTT's scope to preserve the tax neutrality for investment funds and their asset holding vehicles.

 

Qualified refundable tax credit (QRTC) regime under consideration

Under the GloBE Rules, a QRTC is a tax credit designed to be refundable in cash or cash equivalents within 4 years from the year in which the constituent entity satisfies the conditions for receiving the credit.

On the basis that the existing tax incentives (which have the effect of reducing the effective tax rate to under 15%) may no longer benefit the in-scope MNE groups after the GloBE Rules and HKMTT are implemented, respondents have suggested that a QRTC regime should be introduced, either as an independent measure or as a replacement of the existing tax incentives.

Owing to the QRTC regime's effect of reducing the tax payable and creating a cash outflow, the Government is wary of its significant policy and financial implications, and is prudently considering its feasibility with regard to a multitude of factors including the policy objective of introducing a QRTC regime for specific activities or industries, the scope of qualifying activities for QRTC purposes, administration costs, and the risk of abuse.

 

Propositions regarding tax compliance and administration

In addition to the above, the Government has also commented on some other key feedback received as follows:

• Annual election for adopting the default allocation mechanism or designating consistent entity/entities to pay the top-up tax will be enabled, providing in-scope MNE groups with greater flexibility for managing its tax efficiency.
• Where the in-scope MNE group has disapplied the default allocation mechanism and designated constituent entity/entities to pay the top-up tax, administrative arrangements are being explored for allowing a “clean exit” (subject to the satisfaction of certain conditions) of constituent entities that intend to leave the group (e.g. in mergers and acquisitions).
• The top-up tax payment due date is to be extended to 1 month after the expiry of the deadline for filing the return or the date of the notice of assessment, whichever is the later.
• The objection period for top-up tax assessments is to be extended to 2 months after the date of the notice of assessment.
• As the IRD may not be timely informed of the tax adjustments initiated by the other jurisdictions (which might affect the top-up tax payable), the limitation period for issuing top-up tax assessments is to be set as 6 years from the end of the fiscal year, or the time when the non-assessment or under-assessment has come to the assessor's knowledge, whichever is the later.
• The general anti-avoidance provisions targeting the current taxation framework would be disapplied to the GloBE Rules and HKMTT top-up taxes. Avoidance arrangements would be more appropriately addressed by way of the OECD-promulgated specific provisions or guidance. To maintain the integrity of the regimes under GloBE Rules and HKMTT, the Government would introduce the “main purpose test” as a general anti-avoidance rule.
• The IRD will continue its existing approach in formulating the penalty provisions for the GloBE Rules and HKMTT rules, meaning that all relevant circumstances surrounding the taxpayer's wrongdoing will be evaluated to determine whether the requisite mental element of the offence concerned (e.g. without reasonable excuse) can be established. It will also refer to the factors mentioned in the OECD's guidance on transitional penalty relief when considering whether penal action is to be taken against a wrongdoing in relation to the GloBE Rules or HKMTT rules. Similarly, the existing approach regarding penalty on service providers will be adopted in relation to the filing of top up tax return or notification.

 

Our observations

The stakeholders' responses in the Legislative Council Paper reflected a generally positive attitude towards the Government's implementation of the GloBE Rules and HKMTT to preserve Hong Kong's taxing rights and minimize the in-scope MNE groups' tax compliance burden, while also upholding the region's competitive tax system.

With the Hong Kong Government's draft bill amending the IRO on the horizon for implementation in 2025, in-scope MNE groups are recommended to take immediate actions to review its potential impact on their current business models and worldwide tax liabilities. We will continue to monitor the developments and provide further updates as appropriate.