BVI economic substance rules

After the implementation of the British Virgin Islands (“BVI”) economic substance rules (“ES Rules”) in 2019, BVI legal entities carrying on relevant activities have to choose to either move their management and operations to the BVI or report tax in their tax resident jurisdiction.

While pure equity holding BVI entities (which only derive dividend income and/or capital gains) generally find it easier to comply with the ES Rules, entities carrying on other relevant activities would more likely opt for reporting tax in their tax resident jurisdiction. In this regard, Hong Kong is one of the preferred jurisdictions given its low tax rate and convenience of setting up economic substance.

For BVI entities engaged in IP business, particular attention should be paid as they could be subject to heavier penalties in case of non-compliance. Before the ES Rules came into force, it was common for multinational corporations to set up IP-holding entities in low or no tax jurisdictions including the BVI, to lower the overall effective tax rate of the group. However, as their IP businesses are rarely established or developed in the BVI, it might be difficult for them to justify their BVI tax residence under the ES Rules.

Transfer pricing documentation

Hong Kong entities are required to prepare transfer pricing documentation, namely master file, local file and country-by-country report, if two thresholds are met. The first threshold is based on the size of business:

1.       a total annual revenue over HK$400 million;

2.       total assets over HK$300 million; or

3.       an average number of employees over 100.

The second threshold is based on the amount of related party transactions. Entities meeting any one of the four criteria below are required to prepare transfer pricing documentation:

1.       transfers of properties (excludes financial assets / intangibles) over HK$220 million;

2.       transactions in financial assets over HK$110 million;

3.       transfers of intangibles over HK$110 million; or

4.       any other transactions (e.g. royalty income / expenses, service income) over HK$44 million.

Hong Kong entities should review whether they meet the above thresholds when preparing their financial statements and indicate in Supplementary Form S2 of the Profits Tax Return whether they are required to prepare the master file, local file and country-by-country report.

Management should also bear in mind that the Hong Kong Inland Revenue Department is empowered to impose not only an administrative penalty, but also penalties on transfer pricing adjustments up to the amount of tax underpaid if the corporation fails to present proper transfer pricing documentation upon request.

Conclusion

As global tax landscape changes constantly, professional accountants in business are strongly advised to keep abreast of the latest Hong Kong and international tax regulations, which could have significant tax implications on multinational corporations, and review their group tax planning schemes regularly. Should you have any enquiries on tax planning, please contact us to schedule a confidential preliminary consultation with our team of tax experts.