EY tax and transfer pricing specialists Wilson Cheng, Martin Richter, Kenny Wei and Flora Chan précis the recent regulations on transfer pricing in Hong Kong, explain the required documentation and related exemption criteria, and suggest good practices to ensure compliance and to mitigate administrative penalties.

Transfer pricing – which refers to the rules and methodologies for pricing transactions between related parties – has been one of the most-discussed topics in the tax world globally over the last decade. The core foundation of transfer pricing is the arm’s length principle, which means that the amount charged by one related party to another for a transaction must be the same as if the parties were not related.

The United States led the development of detailed, comprehensive transfer pricing rules in the 1980s. To date, over 120 jurisdictions have included transfer pricing rules in their tax legislations.

On 13 July 2018, the HKSAR Government gazetted Inland Revenue (Amendment) (No 6) Ordinance 2018 (the Amendment Bill). The main objectives of the Amendment Bill were to codify certain transfer pricing principles into the Inland Revenue Ordinance (Cap 112) (the IRO) and to implement the minimum standards outlined by the Organisation for Economic Co-operation and Development (OECD).

The Hong Kong transfer pricing framework is largely based on the ‘OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations’ (OECD Guidelines). The main transfer pricing matters covered in the Amendment Bill are:

  • the transfer pricing regulatory regime, and
  • transfer pricing documentation.

In additional to the Amendment Bill, in July 2019 the Inland Revenue Department of the HKSAR Government (IRD) issued the following Departmental Interpretation and Practice Notes (DIPN) to provide detailed guidance on the newly enacted transfer pricing rules:

  • DIPN No 58 – Transfer Pricing Documentation and Country-by-Country Reports
  • DIPN No 59 – Transfer Pricing between Associated Persons, and
  • DIPN No 60 – Attribution of Profits to Permanent Establishments in Hong Kong

Transfer pricing regulatory regime

The Amendment Bill codifies the arm’s length principle into the IRO by introducing the fundamental transfer pricing rule, which allows for an adjustment of the profits or losses of an enterprise where the actual transaction made between two associated persons departs from the provision that would have been made between independent persons and which has created a tax advantage.

Associated parties are defined based on tests of participation in the management, control and capital of an enterprise, or of common participation by a third party.

The fundamental rule applies to the years of assessment beginning on or after 1 April 2018 and to both cross-border and domestic transactions. In practice, the IRD will consider the overall Hong Kong tax position of the transactions involved in the application of the transfer pricing rules. Specifically, insofar as domestic transactions between associated persons do not give rise to actual tax differences in Hong Kong, the relevant persons will not be obliged to compute the income or loss arising from these transactions on the arm’s length principle.

Transfer pricing documentation

The Amendment Bill adopts the OECD’s recommended three-tiered documentation structure, comprising a master file, local file and country-by-country reporting (CbCR).

Master and local files

From the fiscal year starting on or after 1 April 2018, Hong Kong taxpayers are required to prepare master file and local file documentation. The master file provides a high-level overview of the group’s global operations and policies, while the local file provides detailed transactional transfer pricing information specific to a constituent entity in each jurisdiction. The information in the local file supplements the master file and helps to meet the objective of assuring that the entity has complied with the arm’s length principle in the relevant jurisdiction.

To balance the need of meeting international tax standards with that of reducing the compliance burden on the business sector as far as practicable, the IRD provides exemptions from preparing master and local files based on the size of business and the amount of transactions.

Specifically, enterprises engaging in transactions with associated enterprises will not be required to prepare a master file and/or a local file if they meet one of the following exemption criteria:

1. Exemption based on size of business. Taxpayers meeting any two of the following three conditions are not required to prepare either the  master file or the local file:

i. total amount of revenue is not more than HK$400 million

ii. total value of assets are not more than HK$300 million, and

iii. average number of employees is not more than 100.

2. Exemption based on amount of transaction. If the amount of a category of related party transactions (excluding domestic transactions) for the relevant accounting period is below the prescribed threshold, the taxpayer will not be required to prepare a local file for that particular category of transactions:

i. transfer of properties (other than financial assets and intangibles) does not exceed HK$220 million

ii. transactions in respect of financial assets are not over HK$110 million

iii. transfer of intangibles is not more than HK$110 million, and

iv. any other transaction (for example, service income and royalty income) does not exceed HK$44 million.

3. Exemption in respect of domestic transactions. Neither master nor local files are required to be prepared for domestic transactions between associated persons.

If a taxpayer is fully exempted from preparing a local file, it will also not be required to prepare a master file.

Frequency of update and retention period

The international standard is to review and update the master file and local file annually. However, the IRD recognises that some business descriptions, functional analyses and descriptions of comparables may not change significantly from year to year. In order not to impose an undue compliance burden on a Hong Kong entity, the IRD will allow certain information (for example, benchmarking studies and the descriptions of comparables of the relevant transactions) in the local file to be rolled forward for a maximum of three years if the relevant conditions of the controlled transactions or operations of the entity remain consistent across the years.

Where arrangements continue in force for more than one accounting period (such as a distribution agreement lasting for several years), there is no need to prepare new documentation for a subsequent accounting period, provided that the original documentation is sufficient to demonstrate that the Hong Kong entity has made a complete and correct return for the later period. Nevertheless, any significant change in the nature or terms of the transaction or transactions in question should be recorded.

In line with the prevailing retention requirement for business records under Section 51C of the IRO, a Hong Kong entity must retain the master and local files for a period of not less than seven years after the end of the accounting period concerned.


CbCR is designed to provide tax authorities with a high-level snapshot of the global position of profit and tax for a multinational group operating in various jurisdictions. This will enable tax authorities to make a more informed assessment of where risks lie.

Hong Kong has adopted the OECD model for CbCR and the CbCR filing threshold is set in accordance with the OECD recommendation, such that if the multinational group’s aggregated turnover for a fiscal year exceeds EUR750 million (approximately HK$6.8 billion), the group will be considered a ‘reportable group’ and will have a CbCR filing obligation.

The primary obligation of filing a CbCR falls on the ultimate parent entity (UPE). If the UPE of a multinational group is a tax resident in Hong Kong, the UPE will be required to file a CbCR with the IRD. In addition to UPEs, the IRD also implements the ‘secondary’ and ‘surrogate’ filing mechanisms for Hong Kong entities of multinational groups with CbCR filing obligations. For example, if the UPE of a reportable group is a tax resident in the Mainland but is not required to file a CbCR in the Mainland, the Hong Kong entity of the reportable group will have a secondary filing obligation in Hong Kong.

A CbCR has to be prepared for each accounting period beginning on or after 1 January 2018. A Hong Kong filing entity will be required to file a notification to the IRD in relation to its CbCR obligation within three months after the end of the relevant accounting period. The actual country-by-country return is then required to be filed within 12 months after the end of the accounting period.

Permanent establishment

The new transfer pricing rules apply not only to transactions between associated parties but also to dealings between different parts of an enterprise. As a result, dealings between a foreign head office of an enterprise and its permanent establishment (PE) in Hong Kong need to adhere to the separate enterprises principle when attributing profits to the PE.

DIPN No 60 provides the IRD’s view on the application of the new rules defining PE creation and the attribution of profits to PEs under the IRO and, in particular, the application of the Authorised OECD Approach (AOA) in the context of the IRO.

The AOA is a working hypothesis and consists of a two-step approach to attributing profits, which consists of:

  1. using functional and factual analysis to hypothesise the PE as a distinct and separate enterprise, and
  2. applying the arm’s length principle to the hypothetical enterprise.

While DIPN No 60 indicates that the accounts and books of the PE in Hong Kong are a practical starting point for the attribution of profits to the PE, in the end a functional and factual analysis of the PE (cross-checked with transfer pricing documentation) should be the basis for determining the attribution.


The Amendment Bill introduces an administrative penalty relating to transfer pricing. However, given that transfer pricing is not an exact science, the penalties have been set at a level lower than those for other incidents of non-compliance under Section 82A of the IRO.

Specifically, penalties will be imposed where a tax return was made with incorrect information on transfer pricing without a reasonable rationale or with the intent to evade tax. Taxpayers will be liable to an administrative penalty by way of additional tax not exceeding the amount of tax undercharged (vis-à-vis an amount trebling the tax undercharged, as currently imposed for incorrect return and other matters under Section 82A of the IRO).

That said, the IRD has not ruled out the possibility of imposing more stringent penalties or initiating criminal prosecutions on blatant cases in accordance with relevant provisions of the IRO. The availability of transfer pricing documentation alone will not qualify for an exemption from penalties, but will be considered in determining whether individual taxpayers have a ‘reasonable excuse’ to be exempt from the penalties.

With the burden of proof on taxpayers and more stringent penalties anticipated, it is crucial for taxpayers to put proper transfer pricing documentation in place within the set timeframe of nine months after the financial year-end to demonstrate that the arm’s length principle has been applied in all related party dealings. Proper transfer pricing documentation includes a local fact-finding and robust functional analysis detailing the functions performed, assets used and risks assumed by Hong Kong entities.

In respect of the transfer pricing documentation requirements, taxpayers who fail to prepare master file and local file documentation without a reasonable excuse are liable to a level 5 fine (HK$50,000) and may be ordered by the court to prepare such documentation within a specified time. Failure to comply with that order carries a level 6 fine (HK$100,000) on conviction.

In relation to CbCR, penalties will apply if a taxpayer fails to file reports or notifications, provides misleading, false or inaccurate information, or omits information in the CbCR. Penalties are as outlined below:

  • on summary conviction: a fine at level 3 (HK$10,000) and imprisonment for six months, or
  • on conviction after indictment: a fine at level 5 (HK$50,000) and imprisonment for three years.

Penalty and offence provisions will also apply to the service providers engaged by the reporting entity.


The introduction of the transfer pricing rules demonstrates the IRD’s commitment to combating cross-border tax avoidance and is a significant development in preserving its reputation as an international financial and business centre. Adopting the OECD minimum standards will also enable Hong Kong to avoid being listed as a ‘non-cooperative’ tax jurisdiction.

Whilst the IRD has sought to limit the impact of the transfer pricing requirements on the regulatory burden and compliance costs for businesses, the new documentation and filing requirements represent a significant change in the tax environment in Hong Kong. They are highly complex and have wide-ranging consequences for taxpayers in Hong Kong.

Accordingly, taxpayers – in particular multinational corporations or any enterprise with cross-border activities – should review their existing operating and tax/transfer pricing structures to ensure their compliance with the new transfer pricing regulations and seek professional advice where necessary.

Even though an entity may be exempt from the preparation of the master and local files, the availability of robust transfer pricing documentation can be a mitigating factor in any tax review or tax audit situation that might result in a penalty.

Further, tax audit cases in Hong Kong cover at least six years of assessment and it is common to involve transfer pricing issues. Robust transfer pricing documentation can help ease the difficulties in justifying an entity’s related party transactions during a tax audit and can prevent loss of knowledge when there is a change of personnel in the entity.

Wilson Cheng, Partner, Tax Controversy Services; Martin Richter, Partner, International Tax and Transaction Services – Transfer Pricing; Kenny Wei, Partner, International Tax and Transaction Services – Transfer Pricing; Flora Chan, Senior Manager, Tax Controversy Services


This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgement. Member firms of the global EY organisation cannot accept responsibility for loss to any person relying on this article.