Is your Hong Kong business prepared for the intensified transfer pricing scrutiny coming in 2025? With the Inland Revenue Department (IRD) ramping up enforcement and new global minimum tax rules taking effect, understanding how tax authorities identify red flags has never been more critical. This comprehensive guide reveals exactly what triggers IRD audits and how to stay compliant in Hong Kong’s evolving transfer pricing landscape.

Hong Kong’s Transfer Pricing Framework: What’s Changed?

Hong Kong’s transfer pricing journey began with legislation in 2018, but the real enforcement shift is happening now. The Inland Revenue (Amendment) (Minimum Tax for Multinational Enterprise Groups) Ordinance 2025, enacted on June 6, 2025, represents a watershed moment. This legislation not only updates Hong Kong’s transfer pricing rules to align with the 2022 OECD guidelines but also implements the global minimum tax framework known as Pillar Two.

The Arm’s Length Principle: Your Compliance Foundation

Codified in the Inland Revenue Ordinance (IRO), the arm’s length principle requires that transactions between associated enterprises be priced as if they were conducted between independent parties under comparable circumstances. As outlined in Departmental Interpretation and Practice Notes No. 59 (DIPN 59), the IRD has authority to adjust profits or losses where related-party transactions deviate from arm’s length conditions.

Three-Tiered Documentation: What You Must Prepare

Hong Kong mandates a standardized three-tiered documentation approach detailed in DIPN 58. This system provides the IRD with comprehensive information for risk assessment and ensures alignment with international standards.

Who Must Comply? Exemption Thresholds Explained

A Hong Kong entity is exempt from preparing Master and Local Files if it satisfies any two of these conditions for the relevant accounting period:

• Total revenue does not exceed HKD 400 million
• Total value of assets at period end does not exceed HKD 300 million
• Average number of employees does not exceed 100

Red Flags That Trigger IRD Scrutiny

The IRD uses Form IR1475 as its primary screening tool. When requested, taxpayers must submit this form within one month. The information collected enables more effective audit targeting and risk assessment.

Specific Transaction Patterns Under Scrutiny

• Related-Party Loans: The IRD scrutinizes interest rates, particularly for loans to/from low-tax jurisdictions
• Royalty and IP Payments: Detailed analysis to ensure payments reflect IP value and functions performed
• Service Arrangements: Examination of shared service arrangements and intercompany service fees
• Trading Arrangements: Review of buy-sell or commission arrangements, particularly for limited-risk distributors

Penalties and Consequences of Non-Compliance

The consequences of transfer pricing non-compliance in Hong Kong are severe and multi-layered. Understanding these penalties is crucial for risk management.

Documentation-Related Penalties

Under sections 80(2Q), (2R), and (2S) of the IRO:

• Failure to prepare or retain documentation: Fine up to HKD 100,000
• False or misleading information on Form IR1475: Heavy penalties on both entity and signing individual
• Failure to submit documentation when requested: Prosecution, fines, plus potential full audit

Transfer Pricing Adjustments and Additional Charges

• Standard cases: Additional tax charge of 100% to 300% of underpaid taxes
• Deliberate wrongdoing: Fine up to HKD 50,000, additional charge of 100% to 300% of underpaid taxes, and potential imprisonment for up to three years

Best Practices for Transfer Pricing Compliance

1. Annual Reassessment: Review your transfer pricing position annually as business changes may affect compliance obligations
2. Proactive Documentation: Maintain comprehensive documentation even when exemption thresholds are met—it’s your best defense during audits
3. Contemporary Documentation: Prepare documentation contemporaneously, not retroactively, to accurately reflect current operations
4. Robust Benchmarking Studies: Regularly update studies comparing related-party transactions with comparable uncontrolled transactions
5. Clear Transfer Pricing Policies: Establish documented policies early, even before thresholds are met, for future readiness
6. Substance Over Form: Ensure documentation reflects economic substance, not just legal form, of transactions

2025 Developments: Global Minimum Tax and Beyond

The 2025 amendments represent Hong Kong’s commitment to international tax standards. Key provisions include:

• Global minimum tax of 15% effective from January 1, 2025 for qualifying MNE groups
• Hong Kong Minimum Top-up Tax (HKMTT) to ensure Hong Kong collects tax where other jurisdictions don’t apply sufficient top-up tax
• Updated transfer pricing rules aligned with the 2022 OECD Transfer Pricing Guidelines
• Targeted anti-avoidance rule based on the OECD’s main purpose test

As Hong Kong’s transfer pricing regime matures and global minimum tax rules take effect, proactive compliance is no longer optional—it’s essential for business survival. The IRD’s enhanced enforcement capabilities, combined with international information exchange, mean that transfer pricing risks are higher than ever. By understanding the red flags, maintaining robust documentation, and staying ahead of regulatory changes, Hong Kong businesses can navigate this complex landscape with confidence and avoid costly penalties.