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Hong Kong: Practice Note on Transfer Pricing Methodologies Issued

(Dec. 9, 2009) The Hong Kong Inland Revenue Department issued Departmental Interpretation Practice Note No. 46, Transfer Pricing Guidelines – Methodologies and Related Issues, on December 4, 2009. According to HKIRD, the purpose of the Note “is to illustrate how the HKIRD would apply transfer pricing principles,” including in regard to resolution of disputes involving transfer pricing. (DIPN 46, HKIRD website, Dec. 4, 2009, available at http://www.ird.gov.hk/eng/new/index.htm.) One definition of transfer pricing is the system of determining “the price that is assumed to have been charged by one part of a company for products and services it provides to another part of the same company, in order to calculate each division's profit and loss separately.” (What Is Transfer Pricing, Tax Information Institute website, http://www.itinet.org/transferpricing/about.htm (last visited Dec. 9, 2009).)

The Note explains the Transfer Pricing Guidelines of the Organisation for Economic Co-operation and Development in the Hong Kong context, most notably the application of OECD transfer pricing methodologies under Hong Kong's Inland Revenue Ordinance (IRO) (Cap. 112, LAWS OF HONG KONG, http://www.hklii.org/hk/legis/en/ord/112/ (last visited Dec. 8, 2009)). It also clearly states that the HKIRD will generally apply the principles in those Guidelines, except where incompatible with express provisions of the Ordinance. (DIPN 46, supra.) In its conclusion, the Note states:

Broadly, the provisions in the IRO and the relevant articles in the DTAs [Double Taxation Agreements] should allow the Commissioner to reallocate profits or adjust deductions by substituting an arm's length consideration for the consideration, if any, stipulated by the resident and non-resident enterprises. These apply where the Commissioner considers that the resident and non-resident enterprises are not dealing at arm's length and the consideration is not an arm's length consideration. The practice generally followed by the Department would not differ from transfer pricing methodologies recommended in the OECD Transfer Pricing Guidelines. (HKIRD, Departmental Interpretation Practice Note No. 46, Transfer Pricing Guidelines – Methodologies and Related Issues [hereinafter Note No. 46] (Dec. 2009), at 35, available at http://www.ird.gov.hk/eng/pdf/e_dipn46.pdf.)

An appendix to the Note sets forth five types of transfer pricing methodologies, with examples of each. (Id.)

It may also be noted that in April 2009, the HKIRD issued Departmental Interpretation and Practice Notes No. 45, Relief from Double Taxation Due to Transfer Pricing or Profit Reallocation Adjustments. DIPN 45 provides an overview of Hong Kong's double taxation system and sections on economic double taxation, juridical double taxation, and taxation not in accordance with the DTA, with examples. (HKIRD, Departmental Interpretation and Practice Notes No. 45, Relief from Double Taxation Due to Transfer Pricing or Profit Reallocation Adjustments (Apr. 2009), available at http://www.ird.gov.hk/eng/pdf/e_dipn45.pdf.)

Hong Kong has five DTAs, with Belgium, mainland China, Luxembourg, Thailand, and Vietnam. Each has provisions requiring application of the arm's length principle in pricing transactions between associated enterprises, and “[i]t is expected that future DTAs will contain similar provisions.” (Note No. 46, supra, at 1.)