Hong Kong Launches Public Consultation on Implementation of Global Minimum Tax and Hong Kong Domestic Minimum Top-up Tax

On 21 December 2023, the Hong Kong Financial Services and Treasury Bureau (FSTB) and Inland Revenue Department (IRD) jointly released a consultation paper (Consultation Paper) on the implementation of the Global Anti-base Erosion Model Rules (Pillar Two) (GloBE Rules) and the Hong Kong minimum top-up tax (HKMTT). This Consultation Paper is a formal response to the international tax reform proposals drawn up by the Organization for Economic Co-operation and Development (OECD) to address base erosion and profit shifting. It introduces in good details the legal and administrative framework of implementing the GloBE Rules and complementary HKMTT, and comments from the relevant stakeholders on matters left for consideration by Hong Kong (as the implementing jurisdiction) are invited until 20 March 2024. Following the public consultation, the Hong Kong Government will work towards formulating and submitting the proposed legislative amendments to the Legislative Council in the second half of 2024, and subject to the Legislative Council’s review and approval, these legislative amendments are expected to take effect for a fiscal year beginning on or after 1 January 2025 as announced in the 2023/24 Budget Speech.

This alert is to provide an overview and summary of the key legal and administrative framework for implementing the GloBE Rules and HKMTT.

Alignment with the GloBE Rules

The GloBE Rules target multinational enterprise (MNE) groups with annual consolidated revenue of or above EUR750 million, and seek to ensure these MNEs pay a minimum tax of 15% in respect of the profits derived from every jurisdiction they operate. To avoid rebasing the revenue threshold each year, it is proposed that the EUR currency will be adopted. The top-up tax should be collected either by the low-tax jurisdiction itself, if it implements a Qualified Domestic Minimum Top-up Tax (QDMTT), or by another implementing jurisdiction based on the imposition of Income Inclusion Rule (IIR) or Undertaxed Profits Rule (UTPR).

With a view to secure a qualified status of the GloBE Rules implemented in Hong Kong under the OECD’s peer review, it is confirmed that Hong Kong will implement and administer the GloBE Rules, including both IIR and UTPR, in a way that is consistent with the outcomes provided for under the GloBE Rules, including the relevant commentary and administrative guidance published by the OCED (OCED Guidance) starting from 2025 onwards. There are different approaches to incorporate the GloBE Rules into domestic legislations and the Hong Kong Government has proposed using a hybrid approach, which means that the GloBE Rules will be directly incorporated into the Inland Revenue Ordinance (Cap. 112) (IRO) with limited adaptations and the enacted GloBE rules will have to be read and applied in a way that best secures consistency with the requirements in the OCED Guidance in force immediately before the enactment. Taxpayers should therefore review and consider the various publications by the OECD to fully understand the requirements of the GloBE Rules. One question that remains to be clarified is how the Hong Kong Government intends to address any updated GloBE Rules and further guidance materials published by the OCED after the enactment of the relevant legislations.

It is also mentioned in the Consultation Paper that specific provisions may be added to deal with the interaction between the enacted GloBE Rules and the existing provisions under the IRO. As Hong Kong adopts the territorial source principle of taxation, another area that may require further clarification is whether a Hong Kong constituent entity may be subject to top-up tax if it is currently claiming offshore profits under section 14 of the IRO.

Also, as clearly provided in the Consultation Paper, Hong Kong intends to implement a domestic minimum top-up tax, i.e. HKMTT, to preserve its own taxing right. By means of implementing a HKMTT that is consistent with the outcomes of the GloBE Rules and not providing any benefits that are related to the rules, such HKMTT will be accepted as a QDMTT and can be deducted from the top-up tax liability under the GloBE rules in respect of that jurisdiction.

Further, the Consultation Paper confirms the following general principles:

• Hong Kong will strictly follow the revenue threshold of EUR750 million; In-scope MNE groups, whether headquartered in or outside Hong Kong, will be covered by the HKMTT;
• Hong Kong will maintain the territorial source principle of taxation;
• Hong Kong will seek to minimize the compliance burden of in-scope MNE groups and safeguard Hong Kong’s taxing rights; and
• Hong Kong will uphold its simple, certain and low tax regime.

The top-up tax under the GloBE Rules and HKMTT regime is to be regarded as profits tax under the IRO.

At this stage, note that the Subject to Tax Rule under the GloBE Rules, a treaty-based rule applicable when certain intra-group cross-border payments are subject to taxation below the minimum rate of 9%, is not covered by the Consultation Paper as this is subject to bilateral discussion with the treaty partners concerned.

In-scope Threshold

The Hong Kong Government confirms that the GloBE Rules and HKMTT will only apply to MNE groups with annual consolidated revenue of or above EUR750 million. Small MNE groups and purely local groups are excluded. In-scope MNE groups, whether headquartered in or outside Hong Kong, will be covered by the HKMTT. This is to ensure that Hong Kong can collect top-up tax of low-taxed constituent entities in Hong Kong, which would otherwise be collected by other jurisdictions under the GloBE Rules. This will also provide a level playing field for all in-scope MNE groups operating in Hong Kong and relieve them from paying top-up tax in other jurisdictions.

Charging and Calculation of Top-up Tax

A top-up tax will be charged on an MNE group when its effective tax rate (ETR) in a jurisdiction is below the 15% minimum rate, and the rate of top-up tax will be the difference between the minimum rate and the ETR in the jurisdiction. The top-up tax percentage is applied to the net GloBE income in the jurisdiction, after applying the substance-based income exclusion (SBIE). Tax payable pursuant to a QDMTT can offset the top-up tax that would have been computed.

As presented in the Consultation Paper, the Hong Kong Government prefers the approach of charging the UTPR top-up tax by way of an equivalent adjustment in the form of an additional tax, instead of denial of a deduction, which is considered to be a simpler approach. This is to ensure a Hong Kong constituent entity which is liable to pay top-up tax under the UTPR for a fiscal year will have to incur a cash tax expense. As such, any carry-froward of UTPR top-up tax (where loss is sustained) will not be necessary. As regards the allocation of UTPR top-up tax among Hong Kong constituent entities of an in-scope MNE group, it is proposed that the UTPR top-up tax will, by default, be allocated among Hong Kong constituent entities based on their respective number of employees and value of tangible assets, unless the group designates one or more than one Hong Kong constituent entities to pay the top-up tax.

Definition of Hong Kong Resident Entity

For purposes of the GloBE Rules and HKMTT, it is crucial to determine whether an entity is located in Hong Kong for the purpose of collecting top-up tax. Currently the IRO does not contain a general definition of “resident”, and it is therefore proposed that the following new definition be introduced:

• In the case where an entity is a company, it is considered a Hong Kong resident entity if it is incorporated in Hong Kong, or if it is incorporated outside Hong Kong, it is normally managed or controlled in Hong Kong; or
• In any other case, an entity is considered a Hong Kong resident entity if it is constituted under the laws of Hong Kong, or if otherwise constituted, it is normally managed or controlled in Hong Kong.

Given some jurisdictions may have started implementing the GloBE rules starting from 1 January 2024, it is proposed that the meaning of Hong Kong resident entity be applied retrospectively from 1 January 2024.

Hong Kong Minimum Top-up Tax

The HKMTT will be so designed that enables itself to qualify as a QDMTT. To this end, the HKMTT will mirror all the requirements of the GloBE rules subject to the permitted and optional variations within the OECD’s framework. In addition, the HKMTT will be designed to produce a liability for top-up tax that is equivalent to the top-up tax liability that would have arisen under the GloBE Rules. The key design features of the HKMTT include:

• Only applicable to MNE groups with annual consolidated revenue of or above EUR750 million.
• In-scope MNE groups, whether headquartered in or outside Hong Kong, will be covered by the HKMTT.
• All Hong Kong constituent entities of the in-scope MNE groups, as well as JVs and JV subsidiaries held by the groups, will be subject to the HKMTT. The HKMTT attributable to such JVs or their JV subsidiaries will be directly imposed on the JVs or their JV subsidiaries concerned (instead of being allocated to other Hong Kong constituent entities of the group).
• The proposed definition of Hong Kong resident entity above will apply.
• The HKMTT payable will, by default, be allocated among Hong Kong constituent entities of an in-scope MNE group based on the ratio of the GloBE income of the Hong Kong constituent entity to the aggregate GloBE income of all Hong Kong constituent entities of the group, unless the group designates one or more than one Hong Kong constituent entity to pay the HKMTT.
• All constituent entities of an in-scope MNE group must have financial accounts based on the local financial standard.
• The minimum tax rate will be set at 15%.
• SBIE will be included.
• De minimis exclusion will be included.
• Exclusion for initial phase of international activity will be included for in-scope MNE groups where no parent entity is required to apply qualified IIR with respect to Hong Kong constituent entities of the group.

Safe Harbors

It is proposed that the following transitional safe harbor for accounting periods commencing on or before 31 December 2026 and ending on or before 30 June 2028 (Transition Period). For a fiscal year that falls within this Transition Period, top-up tax of an in-scope MNE groups in Hong Kong will be deemed to be zero if the group can satisfy any one of the following tests:

1. De minimis test: The group reports a total revenue of less than EUR10 million and profit (loss) before income tax of less than EUR1 million in Hong Kong on its qualified CbC report for the fiscal year; or
2. Simplified ETR test: The group has a simplified ETR that is equal to or greater than the relevant transition rates for that fiscal year, i.e. (i) 15% for fiscal years beginning in 2023 and 2024, (ii) 16% for fiscal year beginning in 2025, and (iii) 17% for fiscal years beginning in 2026; or
3. Routine profit test: The group’s profit (loss) before income tax in Hong Kong is equal to or less than the SBIE amount, for constituent entities resident in Hong Kong under the CbCR, as calculated under the GloBE rule.

The Hong Kong Government also proposes to include a permanent QDMTT safe harbor in the legislation to reduce the compliance burden of in-scope MNE groups. Where an in-scope MNE group is eligible for the QDMTT safe harbor in respect of Hong Kong by meeting certain accounting standard, consistency standard and administration standard, the group only needs to undertake one QDMTT calculation and will be relieved from applying the GloBE Rules to Hong Kong since the top-up tax payable in respect of Hong Kong under the GloBE rules will be deemed to be zero.

The UTPR safe harbor will not be applicable to Hong Kong.

Filing Obligations

Each Hong Kong constituent entity of an in-scope MNE group will be required to furnish electronically on a dedicated electronic platform:

• a top-up tax return – the filing deadline is 15 months after the last day of the reporting fiscal year and may be extended to 18 months during a transition period; and
• an annual notification relating to its obligation of filing top-up tax return – the filing deadline is within 6 months after the end of the reporting fiscal year.

In-scope MNE groups (Hong Kong or foreign headquartered) will be allowed to designate one Hong Kong constituent entity to file the top-up tax return / notification.

In addition, to keep pace with the global trend of digital transformation of tax administration, the Hong Kong Government has been enhancing the statutory framework for electronic filing of profits tax returns. With the implementation of the GloBE Rules and HKMTT, Hong Kong constituent entities of in-scope MNE groups will be required to file their profits tax returns electronically for a year beginning on or after 1 April 2025 (as the first phase of mandatory electronic filing).

Our Observations

BEPS 2.0 has undoubtedly brought groundbreaking changes to the international tax landscape. In formulating the Consultation Paper, the Hong Kong Government has strived to align the design of HKMTT with the requirements under the GloBE Rules, and at the same time seeking to maintain the simple existing tax regime in Hong Kong to maintain its tax competitiveness.

Nonetheless, given that Hong Kong has for a very long time been serving as a financing, corporate and trading center in Asia, the changes and introduction of the GloBE Rules and HKMTT will have a substantial impact on a large number of MNE enterprises headquartered both in and outside Hong Kong. With Hong Kong aiming to implement the GloBE Rules and HKMTT in 2025, in-scope MNE groups should take immediate actions to assess the potential impact on their business models and worldwide tax liabilities. We will provide further updates when there are more developments.

Apart from the above, so far the State Administration of Taxation has not issued any formal regulation or consultation on Pillar two implementation for mainland China but we anticipate such rules will be rolled out shortly. We will keep a close watch and provide further updates when there are more developments.