July 2021 / Hong Kong
The COVID-19 pandemic has caused significant disruptions to people’s lives, resulting in changes to the ways in which businesses operate and the locations where people work. Such changes also give rise to certain tax issues, including those relating to tax residence of companies and individuals, permanent establishment (PE), employment income of cross-border employees and transfer pricing. The Inland Revenue Department (IRD)’s general approach to these issues is set out below.
It will be noted that the IRD’s approach in relation to the tax issues is generally in line with the Updated Guidance on Tax Treaties and the Impact of the COVID-19 Pandemic (the COVID-19 Tax Treaty Guidance) and Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic (the COVID-19 Transfer Pricing Guidance) released by the Organisation for Economic Co-operation and Development (OECD) in January 2021 and December 2020 respectively, to which further references may be made. These Guidances should be read together with the Commentary on the Model Tax Convention on Income and on Capital (MTC) and OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations.
It has to be stressed that the views expressed below are for general information only. The treatment for each case will be determined on its own facts and circumstances.
- Tax Residence of Companies
- Tax Residence of Individuals
- Permanent Establishment
- Income from Employment
- Transfer Pricing
Tax Residence of Companies
Restrictions on international travel due to the pandemic may give rise to a change in the locations where senior management hold their meetings or conduct the business of an enterprise and concerns have been raised about the effect of such change on the tax residence of a company. The IRD does not consider that such a temporary change during extraordinary time would in itself alter the tax residence status of a company. In assessing the company’s residence status, the IRD will take into account all relevant facts and circumstances.
If a company is considered to be a resident of Hong Kong and another jurisdiction simultaneously, the tie-breaker rules under the relevant tax treaty would need to be considered to determine the jurisdiction where a company is regarded as a resident for the purposes of the treaty. As stated in the COVID-19 Tax Treaty Guidance, a company’s place of residence determined by the tie-breaker rules under a tax treaty is unlikely to be affected by the fact that the individuals participating in the management and decision-making of the company cannot travel as a result of a public health measure imposed or recommended by at least one of the governments of the jurisdictions involved.
Tax Residence of Individuals
An individual may have to temporarily remain in the host jurisdiction because he is prevented from returning to his home jurisdiction as a result of travel restrictions or other public health measures imposed under the pandemic. Generally, such an individual would unlikely become a resident of the host jurisdiction, and even if he did, he would normally remain a resident of the home jurisdiction under the tie-breaker rules in the relevant treaty. A different approach may, however, be appropriate if the change in circumstances continues after the public health restrictions are lifted.
Whether a non-Hong Kong resident person has a PE in Hong Kong within the meaning of a tax treaty or Part 3 of Schedule 17G to the Inland Revenue Ordinance (IRO) (as the case may be) is a question of fact and degree. In determining the issue, the IRD will examine all the relevant facts and circumstances, including the international travel disruption caused by public health measures imposed by governments in response to COVID-19. Given the extraordinary nature of the COVID-19 pandemic, the IRD is prepared to adopt a flexible approach when determining the issue, having regard to the relevant principles in the COVID-19 Tax Treaty Guidance.
As explained in the said Guidance, the exceptional and temporary change of the location where employees exercise their employment because of the COVID-19 pandemic, such as working from home, should not create new PEs for the employers. Similarly, the temporary conclusion of contracts in the home of employees or agents because of the pandemic should not create PEs for enterprises, though a different approach may be appropriate if the employees or agents were habitually concluding contracts on behalf of the enterprises in their home jurisdictions before the pandemic.
It is important to note that the above views are relevant only to circumstances arising during the COVID-19 pandemic when public health measures are in effect. Where an individual continues to work from home after the cessation of the public health measures, further examination of the facts and circumstances would be required to determine whether a PE exists.
Income from Employment
Where an employee resident in another jurisdiction and exercising an employment in Hong Kong is stranded in Hong Kong because of the COVID-19 pandemic; and would otherwise have left Hong Kong and qualified for exemption from salaries tax in Hong Kong under Article 15 of the MTC, the additional days spent by the employee in Hong Kong under such circumstances would be disregarded for the purposes of the 183-day test in Article 15(2)(a). This approach covers situations where the employee is prevented from travelling due to quarantine requirements, certified sickness caused by COVID-19, travel ban imposed by government and cancellation of flights necessitated by government public health measures. It does not, however, cover the situation where the employee, like members of the public, is simply urged to avoid non-essential travel.
It should be mentioned that at the domestic level, the IRD has no discretion to exclude the days of physical presence in Hong Kong for the purposes of counting days under section 8(1B) of the IRO.
The IRD will generally follow the COVID-19 Transfer Pricing Guidance which maintains that the arm’s length principle remains the applicable standard for the purpose of evaluating the transfer pricing of controlled transactions in the face of the pandemic, though due regard must be given as to how the outcomes of the economically significant risks controlled by the parties to the transactions have been affected by the pandemic.
In view of the effect of the COVID-19 pandemic on the economic conditions, it may be appropriate to have separate testing periods for the duration of the pandemic or to include loss-making comparables when performing a comparability analysis. A limited-risk entity could be accepted to have incurred losses if the losses are found to be incurred at arm’s length. The receipt of government assistance may also affect the price of a controlled transaction.
The IRD will uphold existing advance pricing arrangements (APAs), unless a condition leading to the revocation, cancellation or revision of the APA has occurred. Where material changes in economic conditions lead to the breach of the critical assumptions, taxpayers should notify the IRD not later than one month after the breach occurs.
Source: Inland Revenue Department
The global minimum corporate tax – agreed upon by Group of 20 finance ministers this month – is set to re-chart the course of international investment flows, creating new uncertainties for Southeast Asian nations that have been striving to lure foreign capital and financial expertise.
Final agreement on the 15 per cent minimum-tax plan, originally agreed to by Group of 7 (G7) developed economies in early June, is not expected until October. It could also be years before it takes effect.
But its adoption may force nations in the fast-developing Southeast Asian region, still struggling to overcome the impact of coronavirus pandemic lockdowns, to rely more on their domestic consumer markets and their supply of cheap labour for future economic growth, according to analysts.
Additionally, some say the plan may push certain members to forge closer economic ties with China to consolidate their positions in the global economic landscape.
The minimum tax has been hailed as a way to improve the fiscal positions of countries ravaged by the pandemic. But it will also hit tax havens in Asia and throughout the world, as well as big multinational companies that have shifted profits to low-tax countries still operating in many high-tax jurisdictions.
When the G7 proposed the minimum global corporate tax, the 15 per cent rate was a compromise between the United States’ pitch for a 21 per cent rate and the 12.5 per cent plan put forth by a working group of the Organisation for Economic Cooperation and Development (OECD).
The efforts to end multinational companies’ “race to the bottom” have been endorsed by international agencies such as the International Monetary Fund and some developing countries hit hard by the pandemic.
“Developing and emerging economies are particularly exposed, as tax measures are an important part of the industrial policy and investment promotion toolkit,” the United Nations Conference on Trade and Development said in its recent annual report.
The organisation’s world investment report painted a bleak picture for the Southeast Asian region, as the former investment hotspot reported a 25 per cent fall in net capital inflows, to US$136 billion, last year. However, this performance was better than the average 35 per cent decline worldwide.
The largest destinations for foreign capital inflows – such as Singapore, Indonesia and Vietnam – all recorded declines last year, given supply-chain disruptions and delayed investment plans caused by the pandemic.
The foreign investment in Singapore fell 21 per cent to US$91 billion, led by a more than 80 per cent drop in manufacturing investment, according to the UN report. Malaysia’s FDI fell by 55 per cent to US$3 billion, while that of Myanmar dropped 34 per cent to US$1.8 billion.
Most of the Southeast Asian countries are on the safe side of the Western push for a minimum corporate tax. For instance, the Philippines levies the region’s highest corporate tax rate of 30 per cent, followed by 25 per cent in Myanmar, 24 per cent in Malaysia, 22 per cent in Indonesia and 20 per cent in Laos and Vietnam.
Singapore, however, may lose some of the tax advantages that helped its economy prosper in recent years.
With a nominal 17 per cent corporate income tax, but a much lower effective rate after including incentives and tax breaks, Singapore was ranked as the 9th largest tax haven in the world in the Corporate Tax Haven Index 2021 compiled by Tax Justice Network, an advocacy group based in the United Kingdom. In Asia, only Hong Kong was considered a bigger tax haven, ranking 7th on the list.
Singapore, as a financial and shipping centre in Southeast Asia, is home to the regional headquarters of several multinationals, including American giants such as Microsoft, Apple, Actavis, Pfizer, Google, General Electric, Proctor & Gamble and General Motors. It is also increasingly a destination for Chinese companies, such as ByteDance.
Around 1,800 multinational enterprises in Singapore would meet the revenue criteria, while most of them will have effective tax rates below 15 per cent, according to Singapore’s finance minister, Lawrence Wong.
“All of these factors will, therefore, become more salient in our ability to attract and retain investments,” he was quoted by The Straits Times as saying at a July 5 parliamentary meeting.
Jonathan Culver, a tax partner at accountancy Deloitte in Hong Kong, said: “These global tax changes may weaken [Singapore’s] competitive position, but it is likely to remain one of the most attractive hub locations globally.”
Singapore could also create non-tax incentives to further enhance its attractiveness to foreign investment, and these could be funded by the taxes collected under a domestic minimum tax.
Many analysts differentiated the country from other tax havens such as the Cayman Islands, Bermuda and the British Virgin Islands, given Singapore’s thriving financing and shipping businesses and its role in bridging businesses between the East and the West.
Simon Poh, an associate professor (practice track) with the National University of Singapore’s business school, said the downside of a global minimum tax is so far limited for Singapore, because only a few large companies will be targeted, and the government can offset higher taxes with non-tax incentives.
“Many global companies have, over the years, chosen to base their operations in Singapore not entirely due to tax reasons,” he said, citing the city state’s strategic geographical location, global connectivity, political stability, pro-business environment and diverse talent pool.
Meanwhile, the G20 meeting may encounter some resistance within the European Union, where some countries have tax rates below the G7 minimum, including Ireland at 12.5 per cent and Hungary at 9 per cent, Poh said.
Singapore was ranked fifth in the 2021 world competitiveness ranking released by the Institute for Management Development. Other Asean countries also performed well: Malaysia placed 25th, Thailand placed 28th, and Indonesia placed 37th.
Meanwhile, the Doing Business project at the World Bank, which ranks the business environment of 190 economies, put Singapore in second place last year, followed by Malaysia at No 12, Thailand at No 21 and China at No 31.
G20 member Indonesia is among those having expressed support for the G7 proposal, with finance minister Sri Mulyani Indrawati joining US Treasury Secretary Janet Yellen in hailing the “historic opportunity to end the race to the bottom in corporate taxation”.
Indonesia saw foreign investment fall 22 per cent to US$19 billion last year. Investment from Japan plunged 75 per cent to US$2.1 billion, while that from Singapore shrank nearly 30 per cent to US$4.6 billion.
Suan Teck Kin, head of research at United Overseas Bank in Singapore, said Asean countries actually have many non-tax advantages, including political stability, cheap labour forces, huge markets and supply-chain resilience.
“For example, as they are part of RCEP [the Regional Comprehensive Economic Partnership], there will be huge supply chains for the entire region,” he said. “So, companies want to participate … for other considerations such as access to suppliers in this particular location between China and Asean, and access to labour and land.
“Also, it is a huge consumer market. They are young and have a high tendency to spend.”
The region, which is already China’s top trading partner, is set to benefit by attracting global value chain-related investments due to the China-US trade tensions and the associated global supply-chain restructuring, according to a report released in May by the Asean+3 Macroeconomic Research Office, a regional macroeconomic surveillance unit.
Chinese investment in Asean countries rose 52.1 per cent, year on year, to US$143.6 billion in 2020, with the top destinations being Singapore, Indonesia and Vietnam, government data showed.Source: South China Morning Post