This year, more than 130 jurisdictions took the bold step to agree on a two-pillar solution promulgated by the Organization for Economic Cooperation and Development (OECD) to tackle risks of base erosion and profit shifting (BEPS) arising from digitalization of economy. BEPS 2.0 aims to reform international taxation rules to ensure multinational enterprises (MNEs) pay a “fair share of tax” regardless of where they operate and how they structure their operations.
BEPS 2.0 is a two-pillar solution. Pillar One would re-allocate taxing rights over MNEs to market jurisdictions where the MNEs have businesses and earn profits, regardless of whether they have a physical presence in the market jurisdiction. Pillar Two seeks to put a floor on competition over corporate income tax by introducing a global minimum tax rate that jurisdictions can use to protect their tax bases.
Speakers: (from left) Michael Olesnicky, Senior Consultant, Tax, Baker McKenzie; Jo-An Yee FCPA, International Corporate Tax Advisory – Hong Kong Leader, EY and a member of the Institute’s Taxation Faculty Executive Committee (TFEC); Eugene Yeung CPA, Partner, Corporate Tax Advisory, KPMG China, and a TFEC member; William Chan CPA, Partner, Grant Thornton Tax Services, and Chair of the TFEC; Sarah Chan FCPA, Partner, Tax and Business Advisory Services, Deloitte China, and Deputy Chair of the TFEC; Benjamin Chan CPA, Acting Deputy Commissioner (Technical), Inland Revenue Department; and Gwenda Ho CPA, Partner, Tax Services, PwC Hong Kong, and a TFEC member
Panellists at this year’s Annual Taxation Conference held by the Hong Kong Institute of CPAs in July agreed that the initiative was important for the stabilization of the international tax system. However, they argued that there were still many ambiguities surrounding how it will be rolled out, how it will achieve its purposes, and how the rules will affect Hong Kong and global businesses.
This was one of the three topics covered by the panel. With insightful views on the future, they hosted a lively discussion based on the theme of “Trends and challenges in the changing international tax landscape.”
New global tax rules
To kick start the event, Sarah Chan FCPA, Partner of Tax and Business Advisory Services at Deloitte China, and Deputy Chair of the Institute’s Taxation Faculty Executive Committee (TFEC), asked the panellists whether they thought there was more clarity around Pillar One than the proposal discussed a year ago.
According to Jo-An Yee FCPA, International Corporate Tax Advisory – Hong Kong Leader, Asia-Pacific Technology Tax Leader at EY, and a member of the TFEC, the criteria for determining whether an entity would be in-scope under Pillar One has been simplified since last year’s discussion and is now very much focused on turnover and profitability. However, she feels that it has also moved away from its original objective.
“Pillar One was purely trying to target digital businesses, which didn’t necessarily have a physical presence in jurisdictions where they operate, and it tried to introduce new nexus and revenue-sourcing rules so some taxes could be allocated to their consumer markets,” she said.
However, now Pillar One has been extended to all sectors with only a few exclusions, which moves away from the original purpose and could cause some confusion. There has been a change to the blueprint, Sarah Chan agreed, although some sectors, such as regulated financial services and extractives, have been carved out of the latest version.
Echoing these sentiments was Michael Olesnicky, Senior Consultant in Tax at Baker McKenzie, and Non-official Member on the Hong Kong government’s Advisory Panel on BEPS 2.0. He explained that under the initial proposals, the idea was that all MNEs in certain sectors, such as automated digital services with a global revenue of more than 750 million euros, would have been caught by Pillar One. This would have covered around 4,000 MNEs. But now, with the new threshold being raised to over 20 billion euros, less than 100 MNEs (78 on one estimate) will be affected, albeit in a wider range of industries. The aim is to reduce this threshold to 10 billion euros after seven years.
As jurisdictions continue to hash out the details, Olesnicky believes that there could still be a way to go before there will be much clarity on the rules and their application.
The discussion then quickly turned to Hong Kong and whether the adoption of these pillars is actually worthwhile. Olesnicky argued that, under Pillar One, affected MNEs won’t be paying more taxes but there will be a reallocation of the jurisdictions in which they will be paying taxes. More taxes will be paid in overseas jurisdictions, but these taxes should be creditable in their home jurisdictions. So, given the relatively small size of Hong Kong’s market, he asked, “Is it really worth enacting legislation to apply Pillar One as there would be a lot of additional work and compliance? And, given Hong Kong’s small size, I wonder if the revenue gain for us makes it worthwhile.”
Benjamin Chan CPA, currently Acting Deputy Commissioner (Technical) of the Inland Revenue Department (IRD), said that the government has been actively participating in the discussion of the rules under the OECD platform. While Pillar One might enable Hong Kong, as a market jurisdiction, to derive additional revenue from MNEs without physical presence in Hong Kong, for those with physical presence that have already been subject to tax here, the tax increase could be marginal. “There are many types of businesses and the nature of their operations are very different. How to determine the source of their revenue is a great challenge. This uncertainty poses challenges for the government to assess the impact of Pillar One on Hong Kong.”
Opportunities remain for supporting tax policies
Turning to Pillar Two, Sarah Chan said that there are concerns that Hong Kong will lose out in terms of taxing rights and revenue if the city does nothing, particularly given Hong Kong’s territorial tax system and its concessionary tax rates for areas specified sectors. So, she asked the panellists what their views were regarding the implementation of the global anti-base erosion (GloBE) rules under Pillar Two.
Eugene Yeung CPA, Partner of Corporate Tax Advisory at KPMG China, Convenor of the Taxation Faculty Budget Proposals 2022/2023 Sub-committee, and a member of the TFEC, doubted whether there will be a loss of revenue. He said that Pillar Two could essentially result in a top-up tax on revenue that Hong Kong has not previously received before. In this regard, if MNEs would otherwise have to pay additional taxes to their headquarters’ jurisdiction, “why shouldn’t Hong Kong take a part of that!”
Again, reiterating the fact that these BEPS 2.0 measures are really targeting large MNEs, he said that tax incentives under Hong Kong’s preferential tax regimes would still benefit smaller businesses even under any new rules.
Sharing Yeung’s views was Gwenda Ho CPA, Partner of Tax Services at PwC Hong Kong, and a member of the TFEC. She suggested if Hong Kong didn’t take actions in response to Pillar Two, it would be losing its taxing rights to other jurisdictions. A key consideration should be on how Hong Kong can implement the new rules in a way that would minimize the compliance burden on the affected taxpayers, as well as any impact on small- and medium-sized businesses. “The challenging task is for the government to carefully balance the different considerations, such as keeping Hong Kong’s simple tax system; and secondly, using non-tax measures to maintain and enhance the competitiveness of Hong Kong. That will be critical,” she said.
Hong Kong’s preparedness
Even though the panellists were sceptical about BEPS 2.0’s timetable for implementation, they agreed that Hong Kong needs to be prepared. Benjamin Chan said: “The OECD has set a very ambitious timeline for all jurisdictions to bring Pillar Two into law by 2022, and to make it effective by 2023. But the IRD understands from its discussions that this timetable may be adapted according to developments.”
Regardless, the Hong Kong government is catering for all eventualities by planning and preparing ahead. The government is already engaging with a wide range of stakeholders on the response measures that may have to be adopted, and gauging their views on the potential impact. It has also been conveying views to the OECD. Once the government gets a clearer picture, it can then convey the right messages to practitioners and taxpayers on how Hong Kong will respond, Benjamin Chan said.
Sarah Chan suggested that some people may be confused by the many recent changes in the international tax landscape, and their interrelationships and impact on Hong Kong. She asked panellists’ view on this.
Olesnicky responded by saying that the changes are all part of a continuum aimed at ensuring consistency in how jurisdictions treat certain kinds of income and trying to tackle what is seen as harmful tax competition between jurisdictions, as well as preventing abuses. He added that it would be a mistake to see BEPS 2.0 as the end of the process. In future, the OECD may look at other proposals for tax reform, such as the gig economy and about tax authorities assisting one another with enforcement and tax collection.
The speakers agreed that these developments are not necessarily a bad thing for Hong Kong. In fact, Yee said that Pillar Two, for example, really gives “Hong Kong a bit of a kick because it’s time for us to up our game.”
“We have been so reliant on the fact that we have a simple and low tax system… but now this is the opportune time for Hong Kong to say that we are a key digital hub, we are a financial centre, a logistics hub. It gives an opportunity for Hong Kong to focus more on the non-tax factors,” she said.
“There are many types of businesses and the nature of their operations are very different. How to determine the source of their revenue is a great challenge.”
Moving on, the panellists then turned their discussion to the digitization of tax governance and its relevant transformation. Sarah Chan asked the panellists to share their observations about the latest developments in the automation of tax compliance processes.
Yeung started by explaining that the tax compliance environment has transformed, and automation has become part of the process. However, he contends that some jobs can never be replaced by robots. “We, as professional accountants, bring value to the table by making judgement calls,” he said. “We need human brains to do that and leave the routine functions to technology.”
Ho agreed and said that when it comes to the younger generation of accountants, they want their jobs to be fun and don’t want to sit around just doing mundane work such as filling out tax returns. “So, the use of robotics to help with the more boring tasks is a good development,” she said.
Ho also said that companies with global operations need to be able to access and compile information quickly. They can use technology to get a better picture of what’s happening everywhere. “Having a dashboard so that a tax director sitting here in Hong Kong knows real-time what’s happening all over the world. I think that’s very important,” she said.
On that note, Sarah Chan took the opportunity to ask Benjamin Chan about Hong Kong’s proposed e-filing system of tax returns, and the objective of recently-introduced legislative provisions imposing penalties on service providers.
Benjamin Chan explained that, under the new provisions, taxpayers will be allowed to engage service providers to furnish tax returns on their behalf. This will be entirely optional. In the past, taxpayers had to furnish tax returns on their own, so this added option will bring convenience to taxpayers. However, the option also means that a service provider will be allowed to carry out taxpayers’ obligations under the Inland Revenue Ordinance, and it is thus necessary for sanctions to be put in place to ensure compliance of the statutory requirements and to protect the interests of taxpayers. This is ultimately why the penalty provisions were added.
He went on to clarify that only certain kinds of wrongdoings would be caught under the new penal provisions. For example, a service provider fails to furnish a tax return in accordance with the information provided by the taxpayer and the return is materially incorrect, or a service provider fails to file a tax return though it is engaged to do so by the taxpayer. However, “such wrongdoings should not be common,” he said. At the same time, the service provider will not be required to verify the correctness of the information provided by the taxpayer.
Sarah Chan then asked the panellists to share their views on what they thought tax governance and tax compliance would look like in the next five years.
For Yee, she predicts that the future is not about automation making tax easier, but about identifying tax risk. “With everything that is happening, that is quite important.” She believes that there will be a greater move towards the taxpayer and tax authorities having a more cohesive and transparent relationship. Other jurisdictions were looking at cooperative compliance, which could involve tax authorities having more access to data and controls.
Yeung pointed out the increasing importance of technical and ethical judgement calls on the part of tax representatives. Olesnicky added that, in the past, the role of representatives was more about minimizing effective tax rates and the technical application of rules; whereas, nowadays, the emphasis was on paying a fair amount of tax, ensuring proper compliance, avoiding penalties and protecting against reputational risk.
Yeung, Olesnicky and Benjamin Chan also touched on the issue of technology and big data as being part of the future. From robots and technology doing routine work, to how tax authorities are going to handle the vast amount of information currently being automatically exchanged between jurisdictions, one thing they could all agree on is that the future is going to be digital.
“The consideration for MNEs in particular using Hong Kong as an IP location is that we have all the right business factors.”
Hong Kong as an intellectual property hub
Considering these various developments, Sarah Chan asked the panellists what they thought it would take for Hong Kong to become a global intellectual property (IP) hub of the future.
Ho said that companies generally have no problem with paying reasonable taxation but they also need to be able to claim appropriate deductions for expenditure incurred in earning income. She advocated implementing a unilateral tax credit and said that such would be crucial for Hong Kong to deal with double taxation since the city still needs to work on expanding its treaty network. Olesnicky added that he would like to see tax concessions being expanded to exploitation income where research and development is done in Hong Kong and is then commercialized. “Hong Kong did a lot of work to give enhanced tax deductions for IP, but where we shot ourselves in the foot is that once you develop the IP, you have to exploit it. The problem is that it is an incomplete exemption,” he said.
Yee is enthusiastic about using Hong Kong as an IP location, and her experience supports this development. “I’ve done multiple very large migration projects and the consideration for MNEs in particular using Hong Kong as an IP location is that we have all the right business factors,” she said, citing Hong Kong’s strong IP protection laws, talented IP lawyers, and valuation companies that actually understand IP, as just a few factors. However, Hong Kong’s biggest shortcoming, according to her, is interpretation around IRD’s Departmental Interpretation and Practice Note 22 Taxation of Royalties and Other Income from Intellectual Properties. “Putting aside any geopolitical tensions, tax is the other question mark,” she said.
Another area that Hong Kong could benefit from is stronger talent attraction and development. Yeung said that he hopes that the government can do more to attract talent to station in Hong Kong. Recognizing that COVID-19 has now developed a work culture where certain roles can be performed from overseas, attracting talent to come and to stay in Hong Kong and recognizing their efforts in the process is important, he said.
Benjamin Chan said that the government has to consider a few things. Firstly, the city needs to assess what economic benefits can be brought by introducing either tax or non-tax measures in relation to IP. Secondly, it needs to consider whether any measures introduced can withstand a review of harmful tax practices by the OECD and the European Union (EU). Not to mention the potential impact of the BEPS 2.0 initiative should also be evaluated. He stressed that: “We should never introduce measures of which the benefits can be easily counteracted by the GloBE rules.”
However, he also said that there is always room for the city to improve its tax regime for the purposes of facilitating businesses and formulating tax policies in relation to IP.
A new tax regime?
Finally, the panellists were asked whether they thought Hong Kong, having a territorial tax system, ought to revamp the system given the new landscape. Olesnicky noted that Hong Kong would not be compelled to change its tax system due to Pillars One and Two. However, he was also concerned about the EU review of Hong Kong’s foreign source income exemption regime, the outcome of which could be negative. Also the OECD defined the tax base for Pillar Two purposes as including offshore income and capital gains.
Benjamin Chan noted that while Hong Kong is not mandated to change its tax system under BEPS 2.0, if other jurisdictions adopted the rules, Hong Kong could end up ceding its taxing rights if it did nothing.
Overall, the panellists agreed that adjustments and consultations would be par for the course, whether in response to BEPS 2.0, or the upcoming EU reviews, or simply responding to a new remote work culture. “We need to start thinking out of the box. We need to accept that the world is changing rapidly, and business models are very different from 20 to 30 years ago,” Ho said. “Whether the traditional way of viewing substance or viewing permanent establishment should still be applicable in the new economy, well, I think this is a question for tax authorities to think about. Maybe this could be a BEPS 3.0 question.”
A recording of the conference is available on the Institute’s website.