The Launch of Advanced Pricing Arrangement in Hong Kong

Upon the release of the Departmental Interpretation and Practice Notes no.48 ("DIPN 48") on 29th of March 2012, the Hong Kong Inland Revenue Department ("IRD") has finally launched the Advance Pricing Arrangement ("APA") programme in Hong Kong.

Purpose of the APA
The APA programme gives enterprises the opportunity to reach a binding agreement with the IRD on the method of applying the arm's length principle to related party transactions so that transfer pricing issues can be dealt with more efficiently, generally on a prospective basis.

DIPN 48 provides the detailed guidance for the process, terms and conditions of the APA.

Constraints on the application of the APA.
DIPN 48 explicitly states that the APA programme only applies to the following situations:

Only resident companies or non-resident companies with a permanent establishment ("PE") in Hong Kong that are chargeable to Hong Kong profits tax may apply for an APA. Companies or PE's in Hong Kong with no Hong Kong source of profits are therefore very likely to be excluded from the APA programme.

APA applications would generally only be accepted for cross-border related party transactions involving countries that are double taxation agreement ("DTA") partners with Hong Kong.

The IRD only allows for applications of bilateral and multilateral APA.

The thresholds for the APA application set out in DIPN48 are as follows:

- HKD 80 million per year for related-party transactions involve sale and purchase of good;
- HKD 40 million per year if the APA application relates to services; and
- HKD 20 million per year if the APA application relates to the use of intangible assets.

Stages of the APA process
The APA process includes five stages: (1) Pre-filing, (2) Formal application, (3) Analysis and evaluation, (4) Negotiation and agreement, and (5) Drafting, execution and monitoring.

DIPN48 indicates that the tentative timeframe for concluding an APA is 18 months from the acceptance of the formal application, with an additional 6 months depending on the progress of negotiation with the relevant Competent Authority. Generally, a longer timeframe is required in more complex cases.

Collateral issues
During the initial stage of the APA process, the IRD will identify the collateral issues pertaining to an APA application such as tax avoidance issue and try to work out the resolution in order to conclude the APA. However, if the IRD finally finds that section 20, 61 or 61A of the Inland Revenue Ordinance applies to these collateral issues, it will withdraw from the APA process as no APA will be agreed.

The APA programme provides a mechanism for taxpayers and tax authorities to reach an agreement on the transfer pricing arrangement. This minimizes potential legal and compliance costs associated with transfer pricing issues. Multinational companies are encouraged to review their current transfer pricing policies, and consider if they can benefit from the APA programme introduced. Whenever necessary, taxpayers should seek the advice from the tax professionals in the application of the APA.