Executive summary

On 27 December 2024, Hong Kong published the draft bill¹ to implement domestic minimum top-up tax in Hong Kong (HKMTT) and the Income Inclusion Rule (IIR) under Pillar Two of the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) 2.0 initiative.

Upon passage of the bill, the IIR and the HKMTT will be effective retroactively from 1 January 2025, while implementation of the Undertaxed Profits Rule is postponed, subject to further studies.

Detailed discussion

The bill closely follows OECD model rules with limited local modifications. It also includes provisions to ensure consistency with OECD commentaries and guidance, while future additional administrative guidance issued by the OECD will be incorporated through subsidiary legislation by way of publishing a notice in the Gazette. The key features of the bill are highlighted as follows:

• With retrospective effect from 1 January 2024, an entity would be considered to be a Hong Kong-resident entity if it is incorporated or constituted in Hong Kong or if it is normally managed or controlled in Hong Kong. This definition is not expected to affect the tax liabilities or other obligations of entities under the existing Hong Kong tax system, as Hong Kong does not impose tax based on an entity's residence. The government also reiterates that the territorial-source principle of taxation will continually apply outside the context of Pillar Two.
• HKMTT will only be applied to in-scope multinational enterprise (MNE) groups with revenue in the consolidated financial statements of the ultimate parent entity equivalent to or more than €750m for at least two of the four years preceding the fiscal year, except for certain regulated exclusions.
• All Hong Kong constituent entities of the MNE group, including those held under joint venture structures, will be subject to the whole amount of the HKMTT, irrespective of their ownership interest. Relief will be provided to avoid double taxation.
• Investment entities and insurance investment entities are excluded from the scope of the HKMTT to preserve tax neutrality for these entities. HKMTT will apply to a stateless constituent entity similarly to how HKMTT applies to a Hong Kong constituent entity.
• HKMTT is intended to be a Qualified Domestic Minimum Top-up Tax. The local financial accounting standard will be adopted to determine the financial accounting net income or loss for HKMTT purposes when conditions are met.
• All safe harbors available under the Pillar Two Rules are provided to reduce the compliance burden, if conditions are met.
• The main-purpose test will be introduced as a general anti-avoidance provision for Pillar Two Rules with no grandfathering provisions. If the rule applies, the arrangement in question will be disregarded as if it had never been entered into.

The Hong Kong government also proposes the following tax compliance and administration approaches for the Pillar Two Rules:

• An annual top-up tax notification should be filed within six months after the end of the fiscal year.
• An annual top-up tax return should be filed within 15 months (extended to 18 months for a transition year) after the end of the fiscal year. Hong Kong constituent entities will be relieved of the obligation to file the information provided on the Global Anti-Base Erosion (GloBE) Information Return if the same information will be exchanged with Hong Kong under a qualifying competent authority agreement.
• A notice of assessment and demand for top-up tax will be issued based on the top-up tax return. No provisional top-up tax will be charged. The top-up tax will generally be due one month after the date of the notice of assessment.
• An MNE group is permitted to appoint one Hong Kong constituent entity to file the top-up tax notification and tax return, and to designate one or more top-up tax-paying entity.
• The existing tax administration mechanisms will apply to the Pillar Two Rules and mutual agreement procedure mechanisms will be available to resolve cross-border disputes on the top-up taxes.
• Penalties will apply in the event of noncompliance, including filing the required notifications and returns late or incorrectly.

Implications

Considering the Hong Kong general profits tax rate is 16.5%, MNE Groups with a presence in Hong Kong should evaluate the impact of the proposed Pillar Two Rules for tax provisioning and compliance. Affected MNE Groups should assess applicability of safe harbors, especially the transitional country-by-country safe harbor, as these could reduce the complexity of the full calculation and compliance burden.