The Impact of Cross-Border Transactions on Your Hong Kong eTAX Filings

In an increasingly globalized economy, Hong Kong businesses frequently engage in cross-border transactions ranging from international sales and purchases to intellectual property licensing and intercompany financing. While Hong Kong’s territorial tax system provides significant advantages, the complexity of cross-border arrangements demands meticulous attention to compliance requirements when filing your profits tax returns through the Inland Revenue Department’s (IRD) eTAX system.

This comprehensive guide examines how cross-border transactions affect your Hong Kong tax obligations, explores the latest regulatory developments for 2024-2025, and provides practical strategies to ensure accurate eTAX filings while optimizing your tax position.

Understanding Hong Kong’s Territorial Source Principle

Hong Kong operates under a distinctive territorial source principle of taxation, fundamentally different from the worldwide income approach adopted by many other jurisdictions. Under this framework, only profits that have their source in Hong Kong are subject to Hong Kong profits tax, regardless of where the income is received or where the taxpayer is resident.

The Source Determination Test

Determining the geographical source of profits remains one of the most critical and complex aspects of Hong Kong tax compliance for businesses engaged in cross-border transactions. The IRD applies an operation test based on the principle that “profits are regarded as arising in or derived from the place where the operations are carried out from which the profits in substance arise.”

For trading transactions, the IRD examines the location where:

• Contracts are negotiated, concluded, and performed
• Purchase and sale orders are executed
• Goods are sourced and delivered
• Key commercial decisions are made
• Banking facilities are maintained

For service income, consideration includes where services are performed, where expertise is exercised, and where value is created. Manufacturing profits typically arise where the manufacturing activities take place, though this can be complicated by processing arrangements involving multiple jurisdictions.

Offshore Claim Considerations

Many Hong Kong companies claim that certain profits are offshore and therefore exempt from Hong Kong profits tax. However, it is a common misconception that offshore transactions are automatically exempt from scrutiny. The Hong Kong IRD is increasingly vigilant in assessing offshore claims, particularly those involving related-party transactions or arrangements lacking commercial substance.

When filing through eTAX, businesses claiming offshore profits must be prepared to substantiate their position with comprehensive documentation including contracts, correspondence, shipping documents, payment records, and evidence of where operations were conducted.

The Foreign-Sourced Income Exemption (FSIE) Regime: Phase 2 Changes

To align with international standards and maintain Hong Kong’s position on the EU’s “white list” of compliant tax jurisdictions, significant amendments to the FSIE regime came into effect on January 1, 2024. These changes have profound implications for multinational enterprises (MNEs) receiving foreign-sourced income in Hong Kong.

Expanded Scope of FSIE 2.0

The Inland Revenue (Amendment) (Taxation on Foreign-sourced Disposal Gains) Ordinance 2023, enacted on December 8, 2023, expanded the FSIE regime to cover foreign-sourced disposal gains on all types of property, not merely equity interests or financial instruments as previously covered. This expansion applies to both movable and immovable property, regardless of whether gains are capital or revenue in nature.

Economic Substance Requirements (ESR)

The enhanced economic substance requirements under FSIE 2.0 distinguish between pure equity-holding entities and non-pure equity-holding entities:

For Pure Equity-Holding Entities:

A reduced economic substance requirement applies. The entity must conduct the following specified economic activities in Hong Kong:

• Holding and managing its equity participations
• Complying with Hong Kong corporate law filing requirements

For Non-Pure Equity-Holding Entities:

Full economic substance requirements apply. The entity must, in Hong Kong:

• Make necessary strategic decisions in respect of assets acquired, held, or disposed of
• Manage and bear principal risks associated with such assets
• Employ an adequate number of qualified employees to carry out specified economic activities
• Incur adequate operating expenditure for conducting these activities

The determination of what constitutes “adequate” employees and expenditure is at the Commissioner’s discretion, considering the nature and scale of the entity’s activities. Taxpayers should maintain detailed documentation demonstrating the substantive nature of Hong Kong operations.

Advance Rulings for Tax Certainty

To provide taxpayers with certainty and reduce compliance burdens, the IRD offers advance rulings on compliance with economic substance requirements. MNE entities can apply for an Opinion on their ESR compliance concerning disposal gains on the extended scope of properties. Those who previously obtained favorable advance rulings under FSIE 1.0 can apply to expand the scope to include FSIE 2.0 covered income.

When preparing eTAX filings, businesses claiming FSIE exemptions should ensure proper disclosure and maintain supporting documentation for at least seven years to substantiate their position in case of IRD review.

Transfer Pricing Compliance and Documentation

Hong Kong’s transfer pricing rules, introduced in 2018 and aligned with OECD standards, significantly impact businesses engaged in cross-border transactions with related parties. Failure to comply with arm’s length pricing principles can result in substantial tax adjustments and penalties.

The Arm’s Length Principle

Hong Kong’s transfer pricing regime comprises two fundamental rules:

Rule 1 (Section 50AAF): Requires that transactions between associated enterprises are calculated on an arm’s length basis. The IRD has the authority to make transfer pricing adjustments on income or expenses arising from domestic or cross-border related-party transactions that deviate from arm’s length pricing and result in a potential Hong Kong tax advantage.

Rule 2 (Section 50AAK): Requires the attribution of profits to a permanent establishment of a non-Hong Kong resident as if the PE were a distinct and separate enterprise under the OECD’s separate enterprise principle.

Three-Tiered Documentation Requirements

Hong Kong’s transfer pricing regime mandates a three-tiered standardized documentation approach for certain entities:

Documentation Exemptions

A Hong Kong entity that satisfies any two of the following conditions is exempt from preparing Master File and Local File for an accounting period:

• Total revenue does not exceed HKD 400 million
• Total asset value does not exceed HKD 300 million
• Average number of employees does not exceed 100

Additionally, transaction-based exemptions apply when controlled transactions do not exceed these thresholds:

• Transfer of goods: HKD 220 million
• Provision of services: HKD 110 million
• Transfer or use of intangibles: HKD 110 million

2025 Enforcement Trends

The IRD is intensifying transfer pricing reviews and audits. Taxpayers should anticipate more frequent requests for Form IR1475, which summarizes key transfer pricing information from Master File and Local File. This form must be submitted within one month of the IRD’s request.

To mitigate compliance risks, many taxpayers are increasingly utilizing Advance Pricing Arrangements (APAs), which provide prospective certainty on transfer pricing methodologies. APAs can be unilateral, bilateral, or multilateral, depending on the jurisdictions involved.

Country-by-Country Reporting Requirements

Country-by-Country (CbC) Reporting represents a critical component of international tax transparency, providing tax authorities with comprehensive information about the global operations of multinational enterprise groups.

Applicability and Filing Obligations

CbC Reporting applies to MNE groups with consolidated group revenue of at least EUR 750 million (approximately HKD 6.8 billion) for the immediately preceding accounting period, where the group has constituent entities or operations in two or more jurisdictions.

Primary Filing Obligation:

The primary obligation to file a CbC Return rests with the ultimate parent entity (UPE) if it is resident in Hong Kong. The filing must be submitted within 12 months after the end of the fiscal year through the IRD’s CbCR e-filing portal in XML format, following OECD prescribed standards.

Secondary Filing Obligation:

A Hong Kong constituent entity of a Reportable Group whose UPE is not resident in Hong Kong may be subject to secondary filing obligations if:

• The UPE’s jurisdiction does not require CbC reporting
• Hong Kong has an international agreement with the UPE’s jurisdiction but no exchange arrangement is in place
• There has been a systemic failure by the UPE’s jurisdiction to exchange CbC Reports

Information Required in CbC Reports

The CbC Report must include:

• Aggregate tax jurisdiction-wide information on income allocation
• Taxes paid in each jurisdiction
• Indicators of economic activity location (employees, tangible assets, revenues)
• Listing of all constituent entities with jurisdiction of incorporation and main business activities

Penalties and Information Exchange

Non-compliance with CbCR requirements can result in substantial penalties:

• Fines up to HKD 50,000 for failure to file or inaccurate reporting
• Additional penalties up to HKD 100,000 for persistent non-compliance
• Increased IRD scrutiny leading to potential tax audits

Hong Kong exchanges CbC Reports with numerous jurisdictions pursuant to the Convention on Mutual Administrative Assistance in Tax Matters (MAC) for accounting periods beginning on or after January 1, 2019.

Double Taxation Agreements and Tax Treaty Benefits

Hong Kong’s expanding network of Comprehensive Double Taxation Agreements (CDTAs) provides significant benefits for businesses engaged in cross-border transactions, offering relief from double taxation and certainty regarding tax treatment.

Current Treaty Network

As of 2025, Hong Kong has signed CDTAs with 53 jurisdictions and is negotiating with an additional 19 jurisdictions. Recent additions include Bangladesh and Croatia, with agreements coming into force on December 20, 2024, and applicable for Hong Kong tax for years of assessment beginning on or after April 1, 2025.

Key Benefits of DTAs

Hong Kong’s CDTAs provide multiple advantages for cross-border transactions:

• Elimination of Double Taxation: Prevention of the same income being taxed in both Hong Kong and the treaty partner jurisdiction
• Reduced Withholding Tax Rates: Lower rates on dividends, interest, and royalties paid across borders
• Certainty on Residence: Tie-breaker rules for determining tax residence in cases of dual residence
• Permanent Establishment Clarity: Definitions of when a foreign enterprise creates taxable presence
• Mutual Agreement Procedures: Mechanisms for resolving disputes between tax authorities
• Information Exchange: Cooperation between tax administrations to prevent tax evasion

Claiming Treaty Benefits in eTAX Filings

When claiming treaty benefits in your Hong Kong profits tax return through eTAX, you must:

• Identify the relevant DTA and specific provision being relied upon
• Demonstrate residence status in the treaty partner jurisdiction (typically through a certificate of residence from foreign tax authorities)
• Show beneficial ownership of income where required
• Maintain documentation evidencing compliance with treaty conditions
• Complete any specific forms required by the IRD for treaty benefit claims

Note that Hong Kong has adopted the Multilateral Convention to Implement Tax Treaty Related Measures (MLI), which modifies the application of certain DTAs to incorporate BEPS recommendations, including principal purpose test provisions to prevent treaty abuse.

BEPS 2.0 Pillar Two: Global Minimum Tax Implementation

The most significant recent development in Hong Kong’s international tax framework is the implementation of BEPS 2.0 Pillar Two, representing a fundamental shift in the global tax landscape for large multinational enterprises.

Legislative Framework

On June 6, 2025, Hong Kong gazetted legislation implementing Pillar Two measures effective from January 1, 2025, comprising:

• Income Inclusion Rule (IIR): Requires Hong Kong ultimate parent entities to pay top-up tax for low-taxed income of group members in other jurisdictions
• Hong Kong Minimum Top-up Tax (HKMTT): A domestic top-up tax ensuring Hong Kong constituent entities pay at least 15% effective tax rate, with revenues retained in Hong Kong rather than allocated to foreign jurisdictions under the IIR
• Undertaxed Profits Rule (UTPR): Postponed for further study, would allocate top-up tax among jurisdictions where an MNE operates if the UPE jurisdiction has not implemented the IIR

Scope and Application

Pillar Two applies to MNE groups with annual consolidated revenue of at least EUR 750 million in at least two of the four immediately preceding fiscal years. The HKMTT applies to all Hong Kong constituent entities of in-scope MNE groups, regardless of the ownership interest percentage.

Importantly, the government has emphasized that Hong Kong’s territorial source principle of taxation continues to apply outside the Pillar Two context. The introduction of Pillar Two does not affect the tax liabilities or other obligations of entities under Hong Kong’s existing tax system for entities not within scope.

Calculating the Effective Tax Rate

The effective tax rate (ETR) calculation under Pillar Two differs significantly from traditional Hong Kong profits tax computations. The ETR is calculated as covered taxes divided by GloBE income (Global Anti-Base Erosion income) for each jurisdiction where the MNE group operates.

Where the jurisdictional ETR falls below 15%, a top-up tax is calculated to bring the effective rate to the 15% minimum threshold. This calculation involves complex adjustments and may require significant system changes for affected taxpayers.

eTAX Filing Implications

MNE groups subject to Pillar Two will need to:

• Determine whether they meet the EUR 750 million threshold
• Calculate jurisdictional ETRs for all locations where they operate
• Compute any applicable top-up taxes under IIR or HKMTT
• File additional returns and disclosures with the IRD
• Maintain detailed documentation supporting calculations
• Consider restructuring to optimize after-Pillar Two tax positions

Practical Considerations for eTAX Filings

Documentation and Record-Keeping

Robust documentation is essential for defending positions taken in your eTAX filings regarding cross-border transactions. Hong Kong law requires businesses to maintain records for a minimum of seven years from the completion of the transactions to which they relate.

For cross-border transactions, comprehensive documentation should include:

• Contracts and agreements with foreign parties
• Invoices, receipts, and payment records
• Shipping and logistics documentation
• Correspondence demonstrating where negotiations and decisions occurred
• Board minutes and management reports
• Banking records showing payment flows
• Transfer pricing documentation (Master File, Local File)
• Economic substance documentation for FSIE claims
• Tax residency certificates for treaty benefit claims
• CbC Reports and notifications

Common Pitfalls to Avoid

1. Automatic Offshore Assumptions:

Many taxpayers incorrectly assume that transactions with foreign parties are automatically offshore. The IRD examines the substance of operations, not just the location of counterparties or where payments are received.

2. Inadequate Transfer Pricing Documentation:

Waiting until the IRD requests documentation is a critical error. Transfer pricing documentation must be prepared contemporaneously within nine months of year-end to demonstrate compliance.

3. Misunderstanding Domestic Transaction Exemptions:

Not all domestic related-party transactions are exempt from transfer pricing rules. Only “specified domestic transactions” meeting specific criteria (particularly the “no actual tax difference” condition) qualify for exemption.

4. Insufficient Economic Substance for FSIE:

Claiming FSIE exemptions without demonstrating adequate employees, operating expenditure, and decision-making in Hong Kong exposes taxpayers to challenge and potential denial of exemptions.

5. Late or Incomplete CbC Notifications:

MNE groups must notify the IRD within three months after year-end regarding CbC reporting obligations. Late notification can result in penalties even if the report itself is filed timely.

Navigating the eTAX System

The IRD’s eTAX portal provides the primary platform for filing profits tax returns and related disclosures. When dealing with cross-border transactions:

• Ensure you complete all relevant sections regarding offshore claims, foreign-sourced income, and related-party transactions
• Attach required supplementary forms such as those relating to transfer pricing or FSIE claims
• Maintain copies of filed returns and all supporting documentation
• Monitor your eTAX account for IRD queries or requests for additional information
• Respond promptly to IRD communications, typically within one month unless otherwise specified

When to Seek Professional Advice

Given the complexity of cross-border tax issues, professional advice is strongly recommended when:

• Your business structure involves multiple jurisdictions or related-party transactions
• You are claiming that profits are offshore or exempt under FSIE
• Your group exceeds transfer pricing documentation thresholds
• You qualify for CbC reporting requirements
• You are subject to BEPS 2.0 Pillar Two
• You have received an IRD inquiry or audit notice
• You are considering restructuring with cross-border tax implications
• You want to apply for advance rulings or APAs

Strategic Planning for Cross-Border Tax Efficiency

While compliance is paramount, strategic planning within Hong Kong’s legal framework can optimize your tax position for cross-border transactions.

Structuring Operations for Source Optimization

Careful structuring of operations can legitimately position profits as offshore while maintaining sufficient Hong Kong presence to capture genuine Hong Kong-sourced profits. This requires:

• Clearly delineating Hong Kong and offshore activities
• Ensuring substance matches form (actual operations align with claimed structure)
• Maintaining contemporaneous documentation of where activities occur
• Avoiding artificial arrangements lacking commercial rationale

Leveraging Double Taxation Agreements

Strategic use of Hong Kong’s DTA network can reduce withholding taxes on cross-border payments and provide certainty. Consider:

• Structuring investments through Hong Kong to access favorable treaty rates
• Ensuring compliance with beneficial ownership requirements
• Obtaining tax residency certificates proactively
• Monitoring MLI impacts on existing treaty benefits

Transfer Pricing Policy Optimization

Well-designed transfer pricing policies align tax outcomes with value creation while withstanding scrutiny:

• Select appropriate transfer pricing methods based on functional analysis
• Benchmark intercompany pricing against comparable uncontrolled transactions
• Document economic rationale for pricing determinations
• Consider advance pricing arrangements for certainty on significant transactions
• Review and update policies regularly to reflect changing business circumstances

Managing BEPS 2.0 Impact

For MNE groups subject to Pillar Two, proactive management can minimize adverse impacts:

• Model jurisdictional ETRs to identify low-tax exposures
• Evaluate whether HKMTT or foreign IIR application is more favorable
• Consider operational or structural changes to optimize under the new regime
• Implement systems and processes for ongoing GloBE income and ETR calculations
• Monitor developments as jurisdictions implement varying Pillar Two approaches

Conclusion

Cross-border transactions present both opportunities and complexities for Hong Kong businesses. While Hong Kong’s territorial tax system and extensive treaty network offer significant advantages, the compliance landscape has grown increasingly sophisticated with the introduction of the enhanced FSIE regime, strengthened transfer pricing enforcement, and implementation of BEPS 2.0 Pillar Two measures.

Accurate eTAX filings require thorough understanding of source principles, meticulous documentation, and proactive compliance with transfer pricing and international reporting requirements. The IRD’s enhanced scrutiny of cross-border arrangements means that positions taken in tax returns must be defensible with robust evidence and sound analysis.

By maintaining comprehensive documentation, staying current with regulatory developments, seeking professional advice when appropriate, and implementing strategic tax planning within legal boundaries, Hong Kong businesses can navigate the complexities of cross-border taxation while optimizing their tax positions and ensuring compliance with all filing obligations.