|
Most tax jurisdictions, including Hong Kong, require taxpayers to maintain adequate documentation to support the
income and profits they report to the relevant Revenue Authorities. In recent years, this burden of proof has become more onerous. Nowhere is this more prevalent internationally than in the area of transfer
pricing.
What is transfer pricing?
Transfer pricing describes the process through which companies
in the same group set the prices at which they trade with each
other.
Companies within the same group have the ability to establish special conditions in their intra-group transactions. Revenue
Authorities will therefore seek to ensure (and hence companies will need to prove) that transfer prices have not been set to manipulate profits in order to avoid taxes or to reduce the group's
tax burden e.g. by shifting profits from a higher tax jurisdiction to a lower tax jurisdiction. Basically, the prices charged for intra-group transactions should be comparable to those set for unrelated parties. That is, they should be
"arm's length" prices.
Setting your transfer price
The theory is simple, but in practice deciding how to set transfer prices and keep sufficient documentation can be
difficult.
Although by no means a definitive guide, the following steps should be taken as a minimum checklist in this
area:
| • |
Identify and document the transactions carried out between group companies, including determining how transfer prices have been set in the past, obtaining copies of existing agreements and considering the accounting
treatment.
|
| • |
Identify comparable transactions with independent third parties. Such transactions may be within your group or may involve considering comparable data obtained from other sources, such as industry
data.
|
| • |
Perform a functional and risk analysis of related party transactions. This will include determining how related and unrelated party transactions actually take place and analysing differences, such as who bears the risk of default, who performs the critical functions, for example, quality control and shipping
etc.
|
| • |
Document and review your transfer pricing policies on a regular
basis. |
Although historically there have been very few transfer pricing cases in Hong Kong, partly because most groups have sought to book profits in Hong Kong with its lower tax regime, there is an increasing trend by the Inland Revenue Department to use the anti-avoidance provisions in the Inland Revenue Ordinance (IRO) to investigate the shifting of profits between Hong Kong and other jurisdictions. This encompasses a review of the prices charged between companies in a group. Thus, although there are no transfer pricing provisions in the IRO, the Inland Revenue Department does have the power to undertake a transfer pricing review based on the anti-avoidance provisions in the IRO. Taxpayers in Hong Kong should therefore ensure that they have sufficient records to justify their prices to group members compared with third
parties.
In addition, there are at least two jurisdictions involved in these transactions; so not only do you have to consider the tax exposure in Hong Kong, but you also need to consider the transfer pricing legislation in the second country.
|
