Hong Kong Issues Draft Law for IIR and Domestic Top-Up Tax From January 1, 2025

Legislation

On December 27, 2024, the Inland Revenue (Amendment) (Minimum Tax for Multinational Enterprise Groups) Bill 2024 (‘the Bill’) was published in the Official Gazette.

The Bill includes an Income Inclusion Rule (IIR) and a domestic minimum tax (intended to be a Qualified Domestic Minimum Top-Up Tax) from January 1, 2025.

Whilst the Bill includes detailed provisions for the application of the Under-Taxed Profits Rule (UTPR), Section 26AE(7) provides that the UTPR is to be applicable for a fiscal year beginning on or after a date specified by the Secretary for Financial Services and the Treasury by notice published in the Gazette.

General

The Bill comprehensively implements the OECD Model GloBE rules (and accompanying guidance).

The new Schedule 60 in the Inland Revenue Ordinance (IRO) effectively reproduces the OECD Model Rules, with some minor amendments.

Schedule 61 includes the provisions for the design and application of the DMTT (referred to as Hong Kong minimum top-up tax or ‘HKMTT’).

Schedule 62 contains the provisions on the administration of the IIR top-up tax and HKMTT including requirements for the filing of returns and payment of top-up tax.

Therefore, unlike some other jurisdictions (eg Switzerland) that directly transpose the OECD Model Rules and guidance by a static reference to the OECD Model Rules, Hong Kong reproduces the OECD Model Rules in domestic law. It also provides that the OECD Commentary and Administrative Guidance is to be given effect to supplement and clarify the interpretation and operation of the GloBE Model Rules.

The explanatory notes to the Bill also provides that future changes to the OECD Commentary and Administrative Guidance will be incorporated into the IRO through subsidiary legislation so as to allow swift adoption.

Given that Hong Kong adopts a territorial source principle of taxation and does not impose tax based on an entity’s residence, the IRO does not contain a definition of “resident” for general purposes. Given the residence of an entity is of key importance under the GloBE rules to determine whether an entity is located in Hong Kong for top-up tax purposes, the Bill includes a definition of “Hong Kong resident entity”.

It proposes to provide that an entity is a tax resident in Hong Kong if:

(a) where an entity is a company: the entity is incorporated in Hong Kong or, if incorporated outside Hong Kong, normally managed or controlled in Hong Kong; or

(b) in any other case: the entity is constituted under the laws of Hong Kong or, if otherwise constituted, normally managed or controlled in Hong Kong.

This definition will take retrospective effect from January 1, 2024.

Administrative Guidance

Section 26AF of the Bill provides that the application of the GloBE rules in Hong Kong (including Schedule 60, which reproduces the GloBE model rules) is to be construed in accordance with the ‘OECD GloBE rules guidance’ in a way that best serves the purpose of making provision for the following, within the meaning of the OECD GloBE model rules:

-a qualified HR;

-a qualified UTPR;

-a qualified domestic minimum top-up tax;

-safe harbours.

The OECD GloBE rules guidance is defined in Part 1 of Schedule 63 to the Bill as including the:

–April 2024 Consolidated Commentary to the GloBE Rules

–February 2023 OECD Administrative Guidance (AG1)

–July 2023 OECD Administrative Guidance (AG2)

–December 2023 OECD Administrative Guidance (AG3)

–June 2024 OECD Administrative Guidance (AG4)

–April 2024 Examples to the Model Rules

Each of these is to be taken into account for GloBE purposes in Hong Kong from January 1, 2025.

Therefore, all aspects of the OECD Administrative Guidance to date should be applied in Hong Kong.

Nevertheless, the Bill includes various notes that covers the application of the OECD Administrative Guidance (up to and including AG3). Whilst these notes are provided for information only and have no legislative effect, they do support the application of the OECD Administrative Guidance for specific aspects of the Model GloBE Rules.

This includes:

-Deemed consolidation test (Article 1.2);

-Consolidated deferred tax amounts (Article 1.3);

-Sovereign wealth funds and the definition of Ultimate Parent Entity (Article 1.4);

-Clarifying the definition of ‘Excluded Entity’ (Article 1.5);

-Meaning of “ancillary” for Non-Profit Organisations (Article 1.6);

-Forex hedge election (Article 2.2);

-Debt release election (Article 2.4);

-Accrued Pension Expenses (Article 2.5);

-Covered Taxes on deemed distributions (Article 2.6);

-Excess negative tax carry-forward guidance (Article 2.7);

-Substitute Loss carry forwards (Article 2.8);

-Equity gain or loss inclusion election (Article 2.9);

-Allocation of taxes arising under a Blended CFC Tax Regimes (Article 2.10), as well as the AG3 amendments;

-Application of Article 7.6 to Insurance Investment Entities (Article 3.1); 

-Exclusion of Insurance Investment Entities from the definition of Intermediate Parent Entity and Partially-Owned Parent Entity (Article 3.2);

-The extension of Additional Capital to include Restricted Tier One Capital (Article 3.3);

-Liabilities related to Excluded Dividends and Excluded Equity Gain or Loss from securities held on behalf of policyholders (Article 3.4);

-Simplification for Short-term Portfolio Shareholdings (Article 3.5);

-Application of Tax transparency election to Mutual insurance companies (Article 3.6);

-Deferred Tax Transition Rules (Article 4);

-Currency conversion rules (Article 1 Second Set of OECD Administrative Guidance);

-Tax Credits Guidance (MTTCs) (Article 2 Second Set of OECD Administrative Guidance);

-SBIE Rules;

-Foreign rules (Article 3 Second Set of OECD Administrative Guidance);

-Stock-based compensation election (Article 3 Second Set of OECD Administrative Guidance);

-Leases (Article 3 Second Set of OECD Administrative Guidance).

Safe Harbour and Penalty Relief Guidance

Part 3 of Schedule 61 of the Bill provides for the transitional Country-by-Country Reporting (“CbCR”) Safe Harbour, the transitional UTPR Safe Harbour, the QDMTT Safe Harbour and the Simplified Calculations Safe Harbour for non-material constituent entities (“NMCEs”) so as to reduce compliance burden for in-scope MNE groups.

The Transitional CbCR Safe Harbour in the Bill includes specified adjustments for the December 2023 OECD Administrative Guidance, including provisions for:

• Purchase Accounting Adjustments (consistent reporting condition, goodwill impairment adjustment);

• Same Financial Statements/Local Financial Statements for Statutory Reporting
• MNEs not required to file CbC Reports;

• Qualified Financial Statements for PEs;

• Treatment of hybrid arbitrage arrangements;

Section 14 of Part 3 of Schedule 61 of the Bill provides that a jurisdiction qualifies for the QDMTT safe harbour if meets the QDMTT safe harbour standards under an OECD peer review process for that fiscal year.

The Bill also outlines a number of cases where the Switch-Off Rule applies (as provided in the OECD Administrative Guidance), including:

-The QDMTT safe harbour does not apply for constituent entities of the group located in the UPE jurisdiction, if:

         -the UPE of the group is a flow-through entity; and

         -the QDMTT of the jurisdiction does not impose a charge in any circumstances on a UPE that is a flow-through entity.

-The QDMTT safe harbour does not apply for constituent entities of the group located in a jurisdiction in which an IIR applying entity of the group is located, if:

         -the IIR applying entity is a flow-through entity; and

         -the QDMTT of the jurisdiction does not impose a charge in any circumstances on an IIR applying entity that is a flow-through entity.

-The QDMTT safe harbour does not apply for constituent entities of the group located in a jurisdiction, if:

          -a QDMTT of the jurisdiction adopts the international activity exclusion that is consistent with Article 9.3 of the GloBE rules; and

          -that exclusion is not limited to the case where a qualified IIR does not apply in respect of the constituent entities located in the jurisdiction.

Domestic Minimum Tax

Schedule 61 of the Bill provides for a qualified domestic minimum top-up tax that has qualified domestic minimum top-up tax safe harbour status (including transitional qualified status). This is referred to as the Hong Kong minimum top- up tax (HKMTT).

The intention is for the design of HKMTT to meet the requirements of a QDMTT so that the top-up tax paid under HKMTT is creditable against the top-up tax imposed under the GloBE rules. This will enable in-scope MNE groups to benefit from the QDMTT Safe Harbour.

Schedule 61, Section 4 of the Bill provides that the top-up tax chargeable for the fiscal year on the HK constituent entity under the HKMTT is based on the general GloBE provisions, subject to a number of modifications. The main modifications are:

Local Accounting Standard

Schedule 61, Section 5 of the Bill provides that the accounting standard used for determining the HKMTT will be a local accounting standard if:

-each HK constituent entity of the MNE group has financial accounts prepared in accordance with the local accounting standard;

-the accounting period of each entity’s accounts is the same as the fiscal year of the consolidated financial statements of the UPE of the MNE group; and

-for the fiscal year:

                  -each HK constituent entity of the MNE group is required to prepare or use the entity’s accounts for determining its liability to tax in Hong Kong or to comply with any other law of Hong Kong; or

                   -each entity’s accounts are subject to external financial audit.

A local accounting standard is defined as International Financial Reporting Standards or the Hong Kong Financial Reporting Standards.

Taxes Pushed Down

As required in the OECD Administrative Guidance, Section 6 of Schedule 61 excludes taxes pushed down to PEs, CFCs, Hybrids and taxes on distibutions (aside from domestic withholding tax).

Specific provisions disregarded

Section 6 of Schedule 61 excludes certain provisions of the OECD Model Rules for HKMTT purposes. This includes:

Articles 4.2.1(b) (Taxes on distributed profits, deemed profit distributions, and non-business expenses imposed under an Eligible Distribution Tax System for HKMTT purposes);

Article 7.3 (Eligible Distribution Tax Systems);

Article 6.4.1(b) (application of IIR and UTPR in connection with Joint Ventures and JV Subsidiaries);

Article 6.5.1(e), (f) and (g) (application of IIR and UTPR in connection with Multi-Parented MNE Groups);

Initial Activity Exemption

The UTPR exclusion for MNEs in their initial phase of international activity does not need to be included in a QDMTT, however, it can be included. The Second Set of OECD Administrative Guidance provides jurisdictions with three options regarding the temporary UTPR exclusion in their QDMTT legislation.

Option one allows the jurisdiction not to adopt it.

Option two allows the jurisdiction to adopt it but limits it to cases where no Parent Entity is required to apply a Qualified Income Inclusion Rule with respect to Constituent Entities of an MNE Group located in the QDMTT jurisdiction.

Option three allows the jurisdiction to adopt it without any limitations. (Note, if a jurisdiction opts for Option three, for the purposes of the QDMTT Safe Harbour the Switch-Over Rule would apply).

Hong Kong applies two one in Section 7 of Schedule 61.

Transitional Year Reset

Section 8 of Schedule 61 provides for the transitional year refreshing rule.

A new transition year, arises in an accounting period in which the entities of an MNE/domestic fall within the scope of a qualified IIR or UTPR if this accounting period begins after the beginning of the transition year for QDMTT purposes.

In the new transition year the following attributes of the relevant Constituent Entities are refreshed:

-Any Excess Negative Tax Expense Carry-forward under Article 4.1.5 or Article 5.2.1 is eliminated at the beginning of the new Transition Year.

-The DTL recapture rule in Article 4.4.4 does not apply to any deferred tax liability that was taken into account in computing the ETR under the QDMTT and that was not recaptured prior to the new Transition Year.

-Any GloBE Loss Deferred Tax Asset that arose in a year preceding the new Transition Year must be eliminated. The Filing Constituent Entity may make a new GloBE Loss election in the new Transition Year.

-The deferred tax items previously determined are eliminated and Article 9.1.1 is applied at the beginning of the new Transition Year.

-Article 9.1.2 applies to transactions occurring after November 30, 2021 and before the beginning of the new Transition Year. However, if QDMTT was payable due to the application of Article 4.1.5 in respect of a deferred tax asset attributable to a tax loss, the deferred tax asset is not treated as arising from items excluded from the computation of GloBE Income or Loss under Chapter 3 of the OECD Model Rules.

Elections

As required in the OECD Administrative Guidance, Section 9 of Schedule 61 of the Bill also requires that any GloBE election made (or revoked) is taken into account for QDMTT purposes, if the election is included in a GloBE Information Return that would affect the top-up tax calculation.

Currency

The Second set of OECD Administrative Guidance also provides that where all the constituent entities use the domestic accounting standard and use the Hong Kong currency as their functional currency in preparing those financial statements, the calculations for the purposes of the HKMTT are to be carried out in the Hong Kong currency.

Where not all Constituent Entities in the jurisdiction use the Hong Kong currency as their functional currency, Section 10 of Schedule 61 of the Bill provides that the Filing Constituent Entity may make a Five-Year Election to undertake the HKMTT computations for all Constituent Entities in the jurisdiction either:

-in the presentation currency of the Consolidated Financial Statements; or

-in Hong Kong currency.

Investment Entities

Schedule 60, Section 3 of the Bill provides for an exclusion for investment entities and insurance investment entities for HKMTT purposes.