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Hiring Hong Kong Employees, Contractors & Interns: The ‘No Tears’ Approach

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To conserve cash and operate as cost-efficiently as possible, many startups and SMEs will try to grow their teams by engaging independent contractors, interns and other unpaid workers. 

Although these alternatives may seem appealing, employers do not have unlimited freedom to choose how they fill vacancies. Any individual who is essentially performing the work of an employee may be regarded legally by the Labour Tribunal and courts as an employee of that business, which could result in the business being liable for unpaid salaries and other employment entitlements.

This article breaks down the main legal requirements for hiring employees, independent contractors and interns and offers tips to ensure your business is entering into legal work arrangements.

Hiring employees

In Hong Kong, a person hired as an employee will typically be someone whose skills and experience will be needed on a continuous, long-term basis and is prepared to make herself available according to the needs of the business. The long-term nature of the role means that employers can rely on employees for the continuity that contractors and interns are unable to provide.  

Legally, employers need to be aware of the following:

  • employees have employment status under Hong Kong employment laws which entails very specific entitlements that must be met by the employer (e.g., minimum wage, MPF contributions, statutory holidays, leaves of absence, maternity protection, notice periods for termination, severance, etc).
  • any worker who has been employed continuously by the same employer for four weeks or more, with at least 18 hours worked in each week will generally be regarded as an employee.
  • regardless what your employment contract with the worker says regarding salary, vacation leave, notice and severance arrangements, as an employer you have to comply with statutory minimums for each of these as prescribed by various Hong Kong employment laws.
  • all employees covered by the Employment Ordinance, irrespective of their designated job titles or working hours, are entitled to the statutory rights and protections mentioned above. The Ordinance makes no distinction between “permanent”, “temporary”, “full-time”, “part-time” employees vs. “gig” workers.
  • as an employer, you will have statutory obligations with respect to reporting salary and reporting termination of employment to the IRD for the purpose of tax collection. 

Hiring independent contractors or consultants (“contractors”)

Typically, a contractor will be a person who can provide your business with short-term, niche expertise. They could be anything from a project-based programmer to an interim CFO or CTO. And he or she might work on your premises or off-site depending on your requirements and theirs. However, legally there are a number of features that set them apart from employees:

  • contractors have no employment status. Their relationship with your business will not be regulated by Hong Kong’s employment laws or the MPF scheme and they will not be entitled to receive benefits offered to your employees.
  • the relationship between your business and the contractor is dictated almost solely by the contract between the parties so your business may terminate the agreement with the contractor at any time (subject to the terms in the contract) and will have obligation to provide notice or compensation upon terminating the contractor’s service. 
  • unlike employees, there is no statutory requirement to pay contractors at least the minimum wage. You are free to agree whatever payment terms that make sense and are acceptable to the contractor.
  • contractors are responsible for the input they provide, including the success or failure of their deliverables. They usually retain control over when, how and where work is completed.
  • contractors are allowed to contract with other companies at the same time.
  • contractors generally use their own equipment (unless otherwise stipulated in the contract), which reduces your overhead costs.
  • contractors submit invoices to the company to receive payment for the work. 
  • your business is not responsible for reporting the contractor’s income to the Inland Revenue Department (IRD) much less withholding or collecting taxes on that income.

What happens if we get it wrong?

The unique flexibility that contractors have, in terms of legal requirements, makes them a convenient alternative to hiring an employee to perform the same role. Unfortunately, startups sometimes fall into the trap of thinking that they have an independent contractor relationship with a worker and nothing to worry about because they have an agreement that says as much. The same applies to founders, who often mistakenly believe that somehow they are either independent contractors or exempt from Hong Kong’s minimum wage and employment laws. However, if an employee-employer relationship is found to exist in substance, whatever title the worker has been given will be irrelevant. The IRD and the courts will ignore it and again, the business could be on the hook for unpaid salaries and employment benefits. 

Hiring interns

As mentioned above, Hong Kong employment laws generally don’t differentiate between different categories of employment per se. Contrary to popular belief, interns are not a ‘magical’ category of worker that exists outside of the law. Subject to certain exceptions below, interns are employees who are also entitled to rights and protections in Hong Kong employment laws. First, let’s distinguish between paid and unpaid interns. Unpaid interns are essentially a special category of workers that are exempt from the minimum wage. There are essentially two sub-categories:

  • Student interns
  • Work experience interns (“WEI”)

The main differences between them are that whereas a student internship has to be endorsed by or part of the intern’s programme of study and forms a component of the programme, a WEI internship need not be endorsed or related to the intern’s programme of study. If a student internship meets the legal criteria, the intern can be any age when starting the internship. However, with WEI internships, the WEI must be 26 years or younger when the internship commences.

Startups may agree with a WEI to treat the first 59 days of the internship, calculated on a calendar basis from the start date, as exempt student employment and if so, during that period, the employer will be exempted from paying the statutory minimum wage. However, for any period of employment beyond the first 59 days, a WEI is entitled to be paid at least the minimum wage. It is important to note that a WEI cannot have more than one exempt student employment period within the same calendar year whether with the same employer or not. 

Internships that meet the student internship requirements allow the intern to work in the business lawfully without being paid at all. Unlike WEI internships, there are no time limits exempting minimum wage requirements. 

This brings us to paid interns. Describing anyone in Hong Kong as a “paid intern” is a bit of a misnomer since a paid intern could be someone who actually meets the above legal definition of unpaid intern (but who your business has generously decided to pay) as well as an employee who doesn’t meet those criteria and who you must pay at least minimum wage to. 

The important thing to remember is that unless you have been shown proof that a candidate meets all of the relevant criteria for unpaid intern, it is safest to assume that this person will be joining your team as a paid employee. 

Please note that as an employer, you will be required to contribute to the paid intern’s MPF if she has reached age 18 and has been continuously employed for 60 calendar days or more. When in doubt, seek clarification from an experienced lawyer before hiring such candidates because if it turns out that any don’t meet all of the criteria, you could be liable for back-pay, unpaid MPF contributions as well as some serious legal penalties if they have already started working. 

Remember your workplace health and safety obligations

As a business, your startup or SME not only owes health and safety obligations to your employees, but also to any unpaid workers on the premises. Always remember that you have an ongoing duty to ensure their health and safety.

What agreements do we need?

Regardless of which position you are looking to fill on your team, you will need a properly drafted agreement that defines the position, responsibilities, remuneration and any benefits during the engagement. If you’re a startup, you will probably need legal advice on how to include equity (in the form of shares or share options) within the remuneration package for your employees. 

Don’t forget to include confidentiality provisions and IP protections in these agreements

Startups more often than not forget to put suitable confidentiality and IP protections in their internship agreements and the confidentiality provisions in their independent contractor agreements are also often useless. It’s best to take a risk management approach to these provisions and tailor them to the specific risks that each business faces. Speak with your lawyer and she will help put what you need in place. 

Generally speaking, unless otherwise provided for in your contract, any person that works for your business will own the intellectual property rights for whatever they develop, whether it be software code, graphics, logos, marketing materials, or simply ideas. Accordingly, it is vitally important that as an emerging business, you ensure that employment contracts, internship agreements and certain independent contractor agreements contain assignments of legal and moral (attribution) rights to your business.

July 2021

Hong Kong has Granted First-ever Standard Patent by Original Grant

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The Intellectual Property Department granted the first ever original grant patent (OGP) on 4th June 2021, within 14 months after the date of filing of the original patent application by the applicant. 

The OGP was introduced as part of the patent system reform in 2019 to provide inventors an additional route to obtain standard patent protection saving the need to file the patent application first in the designated jurisdictions outside Hong Kong and then having it re-registered in Hong Kong.

For details on the OGP and the rest of the patent reform, please refer to our earlier article “New patent system in Hong Kong.”

If you have any questions in relation to patent protection of your invention in Hong Kong or other intellectual property protection, please feel free to contact our IP team at info@oln-ip.com.

July 2021

Wearing Red Soles has a Price

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Distinction, that was the key. The day Louboutin took his assistant’s nail polish in 1993 and painted the sole of the shoe he was making, he was telling the entire world, or at least the European Union, that shoes with red soles must be Louboutin’s. 

In 2021, the French shoe designer is suing Amazon for trademark infringement… again. 

The worldwide well-known online marketplace is offering High Heeled shoes with red soles, similar to those protected by Louboutin’s trade mark.

The case has been referred by the Luxembourg Court to the Court of Justice of the European Union.

The Red Sole Monopoly recognised in 2018 

Louboutin’s red is well protected: on 12th June 2018, the Court of Justice of the European Union ruled in Case C-163/16 Christian Louboutin and Christian Louboutin SAS v Van Haren Schoenen BV that a trade mark consisting of a colour applied to the sole of a shoe may be registered in the EU. 

The Court held that a sign, such as that at issue, cannot, in any event, be regarded as consisting ‘exclusively’ of a shape, where the main element of that sign is a specific colour designated by an internationally recognised identification code. 

Previously, the Paris Court of Appeal had also considered that the application of a colour to a specific location on a product constituted a distinct and protectable trademark. 

Therefore, in the European Union, only Louboutin is allowed to paint the sole of its shoes with the bright red number 18.1663TP in the Pantone colour chart. 

Louboutin vs Amazon  – Chapter 1, Belgium

Marketplaces like Amazon are online sales platforms connecting buyers and sellers. 

Let’s say that a seller other than Louboutin wishes to offer Red Sole Shoes through Amazon. Should Amazon be liable for trademark infringement by a seller on the platform? 

Is the storage of counterfeit goods for sale considered an infringement of trade mark rights in the European Union? 

Amazon was sued by Louboutin in Belgium in order to engage its liability. 

In August 2019, Amazon was found directly liable for the counterfeiting of the red Louboutin sole by a Brussels Court even though Amazon was only in charge of the storage and shipping of the products. 

However, in April 2020, in Coty vs Amazon case, the Court of Justice of the European Union excluded any liability of Amazon judging that only the seller and not the platform has the purpose of offering those goods for sale.

National Courts within the European Union are bound by the Court of Justice of the European Union decisions. Based on the recent Coty Vs Amazon C 567/18 decision, the Brussels Court of Appeal partially overturned Louboutin’s decision in June 2020. Therefore, Louboutin lost its case. 

Louboutin vs Amazon – chapter 2, Luxembourg 

Amazon is evolving, mainly through new services launched during the pandemic. Nowadays, Amazon not only stores and ships the products, but also promotes and advertises counterfeit products through its “Fulfilment by Amazon” offer. This new era of online services could be considered as the platform’s active involvement in the sale of infringing products.

Louboutin has sued Amazon before the Court of Luxembourg. The novelty of the case compared to the 2020 Belgian lawsuit is the “Fulfilment by Amazon” offer.

Is the use of a sign identical with a trade mark in an advertisement displayed on a website attributable to its operator if, in the perception of a reasonably well informed and reasonably observant internet user, that operator has played an active part in the preparation of that advertisement or if that advertisement may be perceived by such an internet user as forming part of that operator’s own commercial communication?

Is the shipment, in the course of trade and without the consent of the proprietor of a trade mark, to the final consumer of goods bearing a sign identical with the mark constitutes a use attributable to the shipper only if the shipper has actual knowledge that that sign has been affixed to those goods?

Is such a shipper the user of the sign concerned if the shipper itself or an economically linked entity has previously made an active contribution to the display, in the course of trade, of an advertisement for the goods bearing that sign or has taken the final consumer’s order on the basis of that advertisement?

The Court of Justice of the European Union was seized on those terms by the Luxembourg Court on the 8th of March 2021. 

Given the reasoning of the previous ruling by the Court of Justice of the European Union, we foresee a different issue for Amazon this time. Since Amazon is now actively promoting the goods, the Court of Justice of the European Union might consider that the platform The expected judgement will be crucial for Amazon services in the entire European Union. 

Are you considering exporting your products to the European Union? OLN’s French Practice and IP Department can assist you to make sure you are not infringing EU trademark law. 

Written: June 2021

OLN IP Ranked Tier 1 in Copyright/Trademarks in ALB IP Rankings 2021

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Congratulations to Benjamin Choi and Vera Sung and the rest of the OLN IP team on being listed as a tier 1 firm for Trademarks/Copyright and as a tier 2 firm for Patents in the Asian Legal Business ‘Asia IP Rankings 2021’ for Hong Kong. For more details, please click here.

We are especially proud of this news given OLN IP is new venture. Established by OLN Oldham, Li & Nie on the 1st January 2021, OLN IP is a consultancy led by Benjamin Choi and Vera Sung. It offers tailored, commercially-driven advice to intellectual property owners, across the different IP asset classes, including IP portfolio management. For more details, please click here.

May 2021

Proposed Changes to the Profit Requirement for Main Board IPO

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Introduction

2020 was a year of turmoil, with the outbreak of COVID-19 in late 2019 and early 2020, global economy experienced the biggest slowdown in recent decades. Despite the economic downturn and the poor market sentiment, the Hong Kong IPO market saw an increase in the total IPO funds raised in 2020 by more than 26% when compared with 2019 totalling HKD397 billion and if compared with 2018, total IPO funds raised rose by 38%, while the total number of new listings dropped by approximately 15% compared with 2019 and by approximately 29% compared with 2018. 

Consultation of the Stock Exchange

The Stock Exchange of Hong Kong Limited (“Stock Exchange”) published a number of consultation papers in 2020, out of which the consultation on Corporate WVR Beneficiaries and Main Board Profit Requirement are likely to have bigger impact on the IPO market performance in 2021.

In January 2020, the Stock Exchange published the Consultation Paper on Corporate WVR Beneficiaries (“WVR Beneficiaries Consultation Paper”) proposing to extend the WVR regime to permit corporates to benefit from WVR, subject to appropriate safeguards. 

In November 2020, the Stock Exchange published the Consultation Paper on the Main Board Profit Requirement (“Profit Requirement Consultation Paper”) proposing to increase the profit requirement for Main Board listing applicants. 

The current requirement for a Main Board listing applicant is that the minimum profit attributable to shareholders shall be HKD50 million for the 3 years preceding the application, with HKD20 million for the most recent financial year and an aggregate of HKD30 million for the 2 preceding financial years. In the Profit Requirement Consultation Paper, the Stock Exchange proposed 2 options for the increase:

Option 1: raises the overall profit requirement by 150%, with a minimum profit attributable to shareholders of HKD50 million for the most recent financial year and HKD75 million for the preceding 2 financial years

Option 2: raises the overall profit requirement by 200%, with a minimum profit attributable to shareholders of HKD60 million for the most recent financial year and HKD90 million for the 2 preceding financial years

Reasons for the change

The main reason for this proposed change is that since the increase in the market capitalisation requirement from HKD200 million to HKD500 million in 2018, the implied historical P/E ratio based on the market capitalisation requirement jumped from 10 times to 25 times. The new profit requirement will bring the implied historical P/E ratio of companies only marginally meeting the profit and market capitalisation requirements down to 8-10 times, a level similar to that prior to the market capitalisation increase in 2018. The Stock Exchange has indicated that the proposed increase in profit requirement is aimed at:

  • Deterring creation of shells for subsequent disposal at a profit. 
  • Further distinguishing Main Board from GEM, attracting only sizeable companies that can meet high market standards to list on Main Board.
  • Improving the overall quality of Main board issuers.

Who would be affected most by this proposed increase in profit requirement? Obviously, companies that originally planned to list on GEM, pre-revenue biotech companies and those companies that can meet the new profit requirement will not be affected by this proposal. This proposed increase will surely drive some of the intended applicants who just marginally met the current profit requirement out of the game, unless they turn to list on GEM instead, or wait a few more years until their profits meet the new requirement. The new profit requirement does not only apply to potential Main Board listing applicants, but it also applies to listed issuers who intend to transfer their listing from GEM to the Main Board.

Effect of the new Profit Requirement

With the increase in the profit requirement for new listing applicants, the Stock Exchange expects the number of eligible companies to drop drastically. Based on the number of applications received by the Stock Exchange between 2016 and 2019, about 60% of the applicants would have become ineligible for listing upon adoption of either Option 1 or Option 2 of the new profit requirement.

Companies in early stage of development or small to medium-sized companies which have lower profits will be affected by the new profit requirement. But this does not mean they will be refused access to the capital market at all. These companies can still apply to list on GEM and raise funds for their future development. They still can transfer their listing to Main Board once they are able to meet the new Main Board profit requirement.

Transitional arrangement

The Stock Exchange acknowledges that there are companies who may have already commenced their listing project on the basis of the current profit requirement. As the new profit requirement is expected to come into effect not earlier than 1 July 2021, the Stock Exchange believes that there should be sufficient time for these potential applicants to prepare and submit their listing applications prior to the new profit requirement coming into effect. 

As indicated in the Profit Requirement Consultation Paper, applications submitted prior to the new profit requirement becoming effective will be assessed under the current profit requirement, provided that such applications have not lapsed for more than 3 months, been withdrawn, rejected or returned by the Stock Exchange. All applications submitted prior to the new profit requirement effective date will be allowed to be renewed ONCE after the new profit requirement effective date if the renewal is submitted within 3 calendar months after the original application is lapsed such that the application will continue to be assessed under the current profit requirement. But any further renewal of applications after the first renewal will be subject to assessment under the new profit requirement.

It should be noted that any applicant who has submitted their listing application prior to the new profit requirement coming into effect will not be permitted to withdraw their application and re-submit again just shortly before the new rules’ effective date such that the application will have a longer period of assessment and vetting under the current profit requirement.

Temporary relief

This may even apply to companies which might otherwise have fulfilled the new profit requirement but for the economic downturn in 2020 which caused its final year of profit attributable to shareholders to drop below the proposed new threshold. In the Profit Requirement Consultation Paper, Stock Exchange raised a point on whether temporary relief shall be granted to good quality companies with strong historical financial performance whose financial results were adversely affected by COVID-19 if certain conditions were met. If such temporary relief is adopted by the Stock Exchange, any potential company seeking such relief shall submit an application to the Stock Exchange for consideration on a case-by-case basis. As it is unclear whether this temporary relief will eventually be adopted after the consultation, it would seem unwise for companies to wait for the consultation conclusion rather than submitting their listing application prior to the effective date of the new profit requirement. If it turns out the temporary relief is not adopted, these companies may lose the chance of submitting their application before the new rule comes into effect, and will have to wait until they meet the new profit requirement.  

Conditions for granting temporary relief:

1. Aggregate profit during Track Record Period (TRP) meets the aggregate proposed profit requirement;
2. Positive cash flow from operating activities from ordinary course of business;
3. Circumstances affecting the financial performance is only temporary;
4. At least 6 months of TRP falls in 2020;
5. Sufficient disclosure on the likelihood of recurrence of circumstances affecting its financial performance plus mitigation measures undertaken plus profit forecast covering 1 full financial year after listing

GEM transfer of listing

Since the publication of the Profit Requirement Consultation Paper, sponsors have been actively pursuing potential cases trying to persuade and convince interested companies considering listing on the Main Board or a transfer to the Main Board from GEM to kick start the process in order to meet the last day for submission prior to the new rules becoming effective such that their applications will still be considered and assessed under the current profit requirement. 

Outlook for 2021

Since the proposed change in the profit requirement, if eventually adopted, will only come into effect not earlier than 1 July 2021 together with the proposed transitional arrangements which apply to applications filed before the effective date of the new rules, we can most certainly expect a surge in the number of new listing applications and transfer of listing applications to be submitted prior to the effective date of the new profit requirement. Applicants who have commenced their IPO or transfer of listing projects will definitely speed up their process with a view to submit the application before the new rule comes into effect. Even the Stock Exchange indicated in the Profit Requirement Consultation Paper that it is expected the number of applications will increase before the new rules come into effect. In fact, the Stock Exchange has accepted 102 Main Board listing applications since 1 January 2021 which is more than the combined applications for July to December 2020. Just in April 2021 the Stock Exchange has accepted 33 Main Board listing applications. It is very likely that the expected increase in number of both Main Board listing applications and GEM transfer applications will inevitably delay the process and vetting time of applications, whether these applications can proceed to listing within the original 6 months plus the additional 6 months of a renewed application under these circumstances in order to rely on the current profit requirement remain to be seen.

Holding Foreign Companies Accountable Act

In addition to the proposed new profit requirement, the passing of the Holding Foreign Companies Accountable Act (HFCAA) by the US government in December 2020 will also be a driving force for more US-listed Chinese companies to apply for secondary listing on the Stock Exchange pursuant to Chapter 19C of the Listing Rules. The Act requires auditors of US listed foreign companies to allow the Public Company Accounting Oversight Board (PCAOB) to inspect their audit work papers as a means to protect investors and further public interests in the preparation of informative, accurate and independent audit report. If a company fails to comply with this for 3 consecutive years, the Act requires that the SEC prohibit the securities of such company from being traded on a national securities exchange, including OTC trading.  will render the company liable to be delisted from the US stock exchange. 

With the HFCAA becoming law in the US, and the successful homecoming listings of US-listed Chinese companies in Hong Kong in 2020, we can expect the number of homecoming listings of US-listed Chinese companies to continue to grow in 2021. Amongst the top 10 largest IPOs in terms of funds raised in 2020, three of which are secondary listing of NASDAQ primary listed Chinese companies, ranking first, third and sixth. All three of these secondary listing companies are in the TMT sector, their total funds raised comprised 18.5% of the total IPO funds raised in 2020. TMT continues to be the hottest sector ranking first in terms of total funds raised in the Hong Kong IPO market in 2019 and 2020.

Consultation Conclusion on Corporate WVR Beneficiaries

The Consultation Conclusion on Corporate WVR Beneficiaries published in October 2020 further opened the gate for Greater China Issuers (having centre of gravity in Greater China) that are:

1.    controlled by one corporate WVR beneficiary (or a group of corporate beneficiaries acting in concert) which is the largest shareholder in terms of shareholders’ votes and such votes controlled by the WVR beneficiary is not less than 30% of the total shareholders’ votes (at or before 30 Oct 2020); and 
2.    primary listed on a Qualifying Exchange (being NYSE, NASDAQ and London Stock Exchange Main Market and belonging to the Premium Listing segment) on or before 30 October 2020,

to apply for secondary listing in Hong Kong.

These issuers, known as Qualifying Corporate WVR Issuers, will be treated in the same way as the Grandfathered Greater China Issuers under Chapter 19C of the Listing Rules. Qualifying Corporate WVR Issuers seeking to secondary list on the Stock Exchange shall be an innovative company and shall satisfy the qualifications for listing set out in Chapter 19C of the Listing Rules.

The total number of new listings in 2020 under the new listing regime, i.e. biotech companies, innovative companies with weighted voting rights structures and concessionary secondary listings, was 27, compared with 11 in 2019 and 7 in 2018, showing an increase by 145% and 286% respectively. 

Conclusion

The consultation period for the change in Main Board profit requirement ended on 1 February, the consultation conclusion is not yet available when this article is published. We will find out when the consultation conclusion is published which option the Stock Exchange will adopt.

In the 3 months since the Stock Exchange published the Profit Requirement Consultation Paper, the Stock Exchange has accepted a total of 44 new listing applications (including transfer of listing applications and Reverse Takeover) in November, December 2020 and January 2021. As rightly predicted by the Stock Exchange, the number of new listing applications (including transfer of listing applications and Reverse Takeover) accepted by the Stock Exchange in the three months between February and April 2021 almost doubled, totalling 85 applications. We shall see whether the number of applications accepted in the coming months prior to the new profit requirement coming into effect will continue to increase.

If you wish to learn more about listing in Hong Kong, please feel free to speak to our Simon Wong.

Simon Wong
+852 2186 1848 / +852 9460 9816
simon.wong@oln-law.com
Partner, Corporate & Commercial
Oldham, Li & Nie

May 2021

Are you ready for the global tax reform?

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A brief discussion on how MNCs should respond to the OECD’s new measures relating to Automatic Exchange of Information and Transfer Pricing issues

AEOI and the CRS – Enhanced tax controls on tax evasion  

We are living in a globalised world, and cross-border activities have become the norm in the last few decades. In the past, multinational corporations (MNCs) often adopt aggressive tax strategies by booking most profits in tax heavens where information sharing with foreign tax authorities is often minimal. The result is that tax authorities across the world often face difficulties in gathering sufficient offshore asset and transactional information of the tax payers to conduct tax assessments in their home jurisdiction. To unplug loopholes, the OECD has led the international effort in the implementation of Automatic Exchange of Information (AEOI) and adoption of the Common Reporting Standard (CRS).

In order for participating countries to enjoy the mutual benefits of information exchange, financial institutions (FIs) of a participating country are required to report financial information regularly to local tax authorities which is then transmitted to their overseas counterparts in exchange of similar information from other participating jurisdictions. It is noteworthy that more than 100 jurisdictions are already committed to AEOI implementation as at June 2020.

Why is this relevant to me?

Let’s assume that you are a tax resident of your home Country A and have offshore assets or income in Country B. If both countries are committed to AEOI, Country B will become duty-bound to share your financial information automatically with the tax authorities of Country A, such that the latter may track your offshore investments beyond national borders, carry out a tax avoidance investigation and enforce any non-compliance. The most typical types of information covered include tax return and financial statements, company directors/shareholders, company registration, interests, dividends, account balance or value, sales proceeds from financial assets, etc. Such new disclosure regimes have made tax evasion through non-disclosure extremely difficult, if not practically impossible, because offshore undeclared financial assets can now be targeted by a taxpayers’ country of residence.

In Hong Kong, legislative amendments were introduced into the Inland Revenue Ordinance in 2016 to enhance tax transparency and combat cross-border tax evasion. Information exchange is permitted where a bilateral agreement is concluded between the Hong Kong government and a partner jurisdiction. By the start of 2020, the number of reporting jurisdictions in Hong Kong has increased extensively to 126. FIs in Hong Kong are required by law to collect information of identified individual/corporate account holders and their financial account information for onward exchange with other jurisdictions. Furthermore, FIs in Hong Kong must require account holders to complete a self-certification form to declare their tax residence status, and any intentional or reckless false statement on residence status will constitute a criminal offence.

The AEOI regime is relatively new, which might explain why reports about defects in the CRS are not uncommon. For example, there are still many offshore jurisdictions without a public company register and the ultimate beneficial owners might remain unidentifiable. However, with increasing perfection over the CRS, the past practice of utilising offshore entities for secrecy or confidentiality purposes is deemed to be phasing out gradually.

Take-home message

Given the global enhanced tax transparency, in-house legal professionals should plan ahead with their tax advisers before implementing any cross-border transactions, especially where certain offshore financial information may be exposed and reported back to the tax authorities of the home jurisdiction. Quite often, they are no longer protected on the grounds of secrecy or client confidentiality. In addition, since the AEOI regime may take retrospective effect in some jurisdiction, companies with foreign operations are also expected to review past transactions to ensure that tax disclosure has been adequately made to avoid penalties imposed upon future investigations.

Transfer Pricing – how does it work?

As mentioned above, tax authorities often pay close attention to MNCs to ensure that their modus operandi is not structured in a way that diverts domestic profits to overseas entities. A typical tax strategy which is often subject to challenge and scrutiny is called ‘transfer pricing’ – a practice adopted by MNCs to determine pricing, often artificially, between related entities and reduce tax liability for the group as a whole. This is most common where one entity is located in high-tax rate regime and another overseas company is in a low-tax rate jurisdiction. Imagine Company A is a PRC semiconductor manufacturer and Company B is a trading company in Hong Kong set up to facilitate onward global sales. The group may manipulate intercompany pricing by suppressing product price of Company A such that part of the manufacturing profits could be shifted from the PRC to Hong Kong when they are sold to third-party end customers. The group’s profits are thus subject to a more favourable tax rate in Hong Kong. This example can be illustrated in the following diagram.

Against this background, tax authorities around the world have taken active steps to prevent artificial pricing manipulation through anti-avoidance legislation to combat erosion of their tax revenue. Although details in the legislation may vary from jurisdiction to jurisdiction, the common objective is to enforce an ‘arm’s length transaction’ rule that requires pricing to be based on similar transactions done between unrelated parties. We shall briefly discuss below relevant Transfer Pricing law and practice and latest update in Hong Kong.

Transfer Pricing (TP) in Hong Kong

Prior to the legislative amendment in 2018, s.20 of the Inland Revenue Ordinance (IRO) (now repealed) had long been the general provision used to deal with TP issues. Under this section, if a non-Hong Kong resident carried on business with a resident with whom he was closely connected and the operations were arranged in such a way that they resulted in the Hong Kong resident producing no Hong Kong profits or less than ordinary profits, the non-Hong Kong resident’s business would be deemed as carrying on a business in Hong Kong, and thus chargeable to Hong Kong tax. Currently, TP issues in Hong Kong are mainly curbed by s.50AAF (alongside with other anti-avoidance provisions) by empowering the Hong Kong Inland Revenue Department (HKIRD) to impose TP adjustments on income or expenses in accordance with the arm’s length principle if a transaction has been made between two associated persons which (i) differs from the one which would have been made between two independent persons and (ii) confers a potential Hong Kong tax benefits. This principle corresponds to the OECD TP Guidelines for Multinational Enterprises and Administrators (issued in July 2017) (Guidelines) and became effective from 1 April 2018 (i.e. the 2018/19 Year of Assessment). It is worth noting that the burden in proving an arm’s length transaction falls upon the taxpayer and should they fail to satisfy the HKIRD, it may make adjustment accordingly.

Mandatory Documentation – a ‘3-tiered’ approach

Master File and Local File

Despite the introduction of the new legislation, we understand that some enterprises in Hong Kong are not aware that they could be subject to the three levels of TP reporting requirements. In fact, with effect from April 2018, any Hong Kong entities engaging in related party’s transactions (RPTs) are required by the HKIRD to prepare a Master File and a Local File. They are required to disclose whether they are required to prepare any TP documentation when filing their Tax Returns. Nevertheless, an entity may be exempted from documentation requirements if at least two of the following exemption criteria are satisfied for a given accounting period:

  • Total revenue of the MNC group does not exceed $400 million;
  • Total value of assets does not exceed $300 million; and/or
  • Average number of employees does not exceed 100.

In addition, Hong Kong entities are not required to prepare the Local File if the relevant RPTs do not exceed the following amounts:

  • Transfers of properties (whether movable or immovable but excluding financial assets and intangibles) – HK$220 million;
  • Transactions in respect of financial assets – HK$110 million;
  • Transfers of intangibles – HK$110 million; and
  • Other transactions – HK$44 million.

The HKIRD has issued Departmental Interpretation and Practice Notes No.58 setting out the detailed contents required in the Master File and Local Files. For instance, the Master File must contain a high-level overview of the company group (including global business operations and TP policies) in order for the HKIRD to evaluate any significant TP risks. As for the Local File, detailed transactional TP information specific to the enterprise in each jurisdiction, including details of transactions, amounts involved and TP benchmarking analysis with respect to those transactions must be documented.

Country-by-Country Report (“CbC Report”)

MNC groups are also required to file a CbC Report where the consolidated group revenue for the preceding accounting period is at least HK$6.8 billion and the group has constituent entities or operations in two or more jurisdictions. Such report should include (among other data) aggregate tax jurisdiction-wide information relating to the global income allocation, taxes paid, and certain indicators of the location of economic activity among tax jurisdictions in which the MNE Group operates.

Guidelines on TP Benchmarking Analysis

The Guidelines have set out five TP methods to establish whether an RPT is consistent with the arm’s length principle when preparing a benchmarking study. Identification of a suitable method for TP analysis is a very technical exercise and is beyond the scope of this article. However, it is important for in-house lawyers to note that depending on the industry or business activities which taxpayers engage in, tax advisers often make use of external databases to conduct searches of financial data and to identify domestic data comparable to the RPTs and if such comparables are unavailable, then comparables from similar markets in Asia or other parts of the world will be used. In many cases, statistical concepts, such as the interquartile range, may be helpful tools in determining whether an RPT is consistent with the arm’s length principle.

Penalties

The HKIRD recognises the imprecise nature of TP and therefore caps the potential penalties at a level lower than for other tax offences. The penalty for non-compliance with the Rule is limited to 100 percent (as opposed to three times) of the tax undercharged. No additional tax will be imposed when the taxpayer has exercised a reasonable effort to determine the arm’s length amount. The HKIRD also takes the view that preparation of a Local File with a comparability analysis would be considered a reasonable effort in this regard, although more stringent penalties are imposed for omission or understatement of income.

Take-home message

It is not difficult for the HKIRD to identify entities who might have obligations to do TP documentation. Quite often, enterprises do not apprehend the immediate impacts of the new legislation on them simply because the HKIRD has not raised requisitions with the taxpayers yet. Many MNCs could therefore potentially be charged with non-compliance unless they fall within the statutory exemptions. It is therefore advisable to make preparations sooner rather than later because the evidential value is higher if a comparability analysis supporting TP calculation is done before (instead of after) an RPT is carried out. Given the technicality involved, it is always important to obtain proper advice from accounting and legal experts to reduce exposure to potential TP risks.

If you would like to discuss any points raised above in more detail, please do contact Anna Chan on the details below.

E: anna.chan@oln-law.com

April 2021