Transfer Pricing

What is Transfer Pricing?


Transfer Pricing is the pricing of goods, services and intangible assets between related parties.


The related parties are parties that control each other or are directly or indirectly under the joint control of the other party.  They include subsidiaries, representative offices, branches and headquarters.


Related parties must be treated fairly.  In recent years, transfer pricing has become one of the most important international tax issues facing MNCs, regardless of their size.  The failure of the organization to meet the required standard risks resulted in high financial costs as a result of additional taxes, interest and fines imposed by the tax authorities.


Development of Transfer Pricing in Hong Kong:

Inland Revenue (Amendment) (No. 6) Ordinance 2018 was gazetted on 13 July 2018 with the major objectives of:


  • Codify transfer pricing principles into law;

  • Implementation of a number of measures in Erosion Tax Base and Profit Shifting (BEPS) program; and

  • Consistency of relevant provisions of the Inland Revenue Ordinance (chapter 112th) with international tax provisions


What is Transfer Pricing Documentation?


The Transfer Pricing Documentation needs to demonstrate that efforts have been made to ensure that related party transactions are conducted in a fair and equitable context.  The preparation and preservation of appropriate documentation would facilitate the review by tax authorities and would therefore help to address any transfer pricing that might arise.


There are not enough documents to prove that the transfer price is fair, and taxpayers may not be able to raise valid objections to prevent tax authorities from adjusting transfer pricing. The Inland Revenue Department does not require the submission of transfer pricing documents when submitting tax returns.  However, the Inland Revenue Department may require selected taxpayers to prove that their associated transactions are fair and reasonable.


What are included inside Transfer Pricing Documentation?



  • Master File;

  • Local File;and

  • Country-by-Country Report (“CbCR”)


What enterprises need to prepare Transfer Pricing Documentation? 


If the Hong Kong entities meet the conditions of A) and B) below, the Group needs to prepare the Master File and the Local File:


A) Scale of Group meets either 2 of the following 3 points:


  • Total annual revenue exceeds HK$4 billion

  • Total assets exceed HK$3 billion

  • Average number of employees exceeds 100


B) Further, transactions involving Hong Kong affiliates between the Group companies meet any of the following four points:


  • Transfer of tangible assets (including current assets and real estate) exceeding HK$220m

  • Financial asset transactions exceed HK$110m

  • Transfer of intangible assets (including trademarks) over HK$110m

  • Exceed HK$44m for other transactions (such as service income)

What enterprises need to prepare Country-by-Country Report (“CbCR”)?

Group's revenue exceed HK$6.8 billion


What information is required for Master File?


  • organizational structure

  • Structure of legal ownership 法律上及擁有權上的架構

  • Geographical location of member entities

  • Description of the Group's business (including important sources of revenue)

  • Important service arrangement between related entities

    • Ability to provide services

    • How to allocate service costs

    • Transfer Pricing policies

  • Functional Analysis (key functions, risks and assets used by companies within the Group)

What information is required for Local File?

  • Description of the management structure

  • Detailed description of the business and implementation strategies

  • List our of major competitors

  • Description of key transactions

  • Detailed comparability and functional analysis

  • Transfer pricing methodology and reasons for choosing method


What are the principles of Arm's Length Principle?   


The Arm's Length Principle is an internationally recognized transfer pricing standard for related parties.  When the transfer price of the related party adheres to this principle, they reflect the comparability of the pricing of the transaction to be carried out by an independent commercial entity in similar circumstances, and therefore there will be no distortion in the profit and tax liabilities.  The Inland Revenue Department abides by this principle of fairness and considers it to be the most appropriate criterion for determining the transfer price of the related party.


What are the pricing criteria for transfer pricing?

According to the transfer pricing criteria of the Organisation for Economic Co-Organization and Development (OECD), it is divided into two major parts and five classification methods:


A: Traditional transaction methods

  1. comparable uncontrolled price method - CUPM

  2. resale price method – RPM

  3. cost plus method – CPLM


B. Transactional profit methods

  1. profit-split method – PSM

  2. transactional net margin method – TNMM


A-1. Comparable uncontrolled price method - CUPM

Compare the transaction prices between related party transactions and third party transactions, if there is a significant gap in the transaction price between the two, the price representing the transaction of the affiliated enterprise is not in accordance with the Arm' s Length Principle


A-2. Resale price method – RPM

Comparison of gross margin earned between related party transactions and third party transaction [gross margin / net sales], The gross margin earned by a non-affiliated enterprise is the normal price between the affiliated enterprises.


A3. Cost plus method – CPLM

At the cost purchased by the third party transactions, the transfer price of the affiliated enterprise becomes after the appropriate profit is added.


B-1. Profit-split method – PSM

The trading of third party transactions are guided by the average annual profit, which is used to calculate the transfer price of the affiliated enterprise.


B-2. Transactional net margin method – TNMM

The transactional net profit method may also be referred to as the comparable net profit margin Method–CNMM, which compares the net profits of related and non-related transactions of the same enterprise to calculate compliance with ARM's Length Transfer price of principle.


What is "Safe Harbor" rule?


The "Safe harbour" in the transfer pricing system is a provision applicable to the defined taxpayer or category of transactions and exempts eligible taxpayers from certain obligations imposed by a State under the general transfer pricing rules.  In Hong Kong, the Inland Revenue Department is prepared to accept certain fare increases for certain daily support activities as a reasonable fair fee for these services, provided that the daily support activities provided by the service provider to its affiliates are not provided to the unrelated party.

The following flowchart outlines the processing of related party services for transfer pricing purposes.



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