Transfer Pricing in Hong Kong vs. Mainland China: Key Compliance Differences

Regulatory Framework Foundations

Understanding the foundational regulatory landscapes governing transfer pricing in Hong Kong and Mainland China is essential for multinational enterprises operating across both jurisdictions. While both have aligned their frameworks with OECD BEPS (Base Erosion and Profit Shifting) Action 13 guidelines, significant differences exist in implementation, enforcement, and compliance requirements.

Hong Kong Transfer Pricing Legal Framework

Hong Kong’s transfer pricing regime was established through the Inland Revenue (Amendment) (No.6) Ordinance 2018, enacted on July 13, 2018. This represented the most significant reform to Hong Kong’s tax code since 1986. The legislation introduced Part 8AA to the Inland Revenue Ordinance (IRO), implementing two primary rules:

• Section 50AAF (Transfer Pricing Rule 1): Requires arm’s length pricing for transactions between associated persons, applicable for years of assessment 2018/19 onwards
• Section 50AAK (Transfer Pricing Rule 2): Governs profit attribution to permanent establishments in Hong Kong, applicable for years of assessment 2019/20 onwards

The Hong Kong Inland Revenue Department (IRD) published three critical Departmental Interpretation and Practice Notes (DIPNs) on July 19, 2019:

• DIPN 58: Transfer Pricing Documentation requirements
• DIPN 59: Transfer Pricing between Associated Persons
• DIPN 60: Attribution of Profits to Permanent Establishments

China Transfer Pricing Legal Framework

China’s transfer pricing legislation is more mature and complex, with regulations evolving over nearly two decades. The framework includes:

• Corporate Income Tax Law (2007) Part 6: Establishes fundamental transfer pricing principles
• SAT Bulletin [2009] No. 02: Implementation Measures of Special Tax Adjustments (Guoshuifa)
• SAT Bulletin [2016] No. 42: Enhancement of Related Party Transaction Declaration and Contemporaneous Documentation Administration
• SAT Bulletin [2016] No. 64: Country-by-Country reporting requirements
• Various Notices: Notice 6, Notice 46, and ongoing guidance from the State Taxation Administration

In 2025, China continues to strengthen enforcement through AI-powered digital audits and data-driven compliance monitoring, particularly for cross-border supply chains and intellectual property-intensive structures.

Arm’s Length Principle Application

Hong Kong’s Approach

Section 50AAF(1) of the IRO requires that when determining profits for tax purposes, transactions between associated persons must be conducted at arm’s length. The IRD has the authority to substitute the actual price with an arm’s length price, thereby nullifying any tax advantage arising from non-arm’s length pricing.

Key characteristics of Hong Kong’s implementation:

• Applies to both domestic and cross-border related-party transactions that result in a potential Hong Kong tax advantage
• Domestic transactions may be exempt under Section 50AAJ if specific conditions are met (detailed below)
• Follows OECD Transfer Pricing Guidelines for applying transfer pricing methods
• Even entities exempt from documentation requirements must still comply with the arm’s length principle

China’s Approach

China’s transfer pricing legislation is based on the arm’s length principle throughout, with descriptions highly similar to the OECD Guidelines. However, the framework is principles-based rather than heavily formulaic, giving tax authorities considerable discretion in applying adjustments.

Key characteristics of China’s implementation:

• Comprehensive coverage of all related-party transactions, both domestic and cross-border
• Strong emphasis on “substance over form” analysis
• Special focus on entities engaged in single-function operations (toll manufacturing, contract R&D, distribution) – loss-making entities must prepare Local File regardless of transaction thresholds
• Increasing use of AI and digital audit tools in 2025 to identify pricing inconsistencies
• 10-year statute of limitations for special tax adjustments (significantly longer than general tax assessments)

Documentation Requirements Comparison

Hong Kong Entity-Level Exemption Thresholds

A Hong Kong entity is exempt from preparing Master File and Local File if it satisfies any two of the following three conditions:

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

Hong Kong Transaction-Based Exemptions

If entity-level thresholds are not met, further exemption may apply based on controlled transaction volumes not exceeding:

• HKD 220 million: Transfers of tangible properties (excluding financial assets and intangibles)
• HKD 110 million: Transactions involving financial assets
• HKD 110 million: Transfers of intangible assets
• HKD 44 million: Other transactions (e.g., services, royalties)

China Local File Preparation Thresholds

Chinese entities must prepare a Local File if related-party transactions exceed the following annual thresholds:

• RMB 200 million (USD 27.6 million): Transfer of ownership of tangible assets
• RMB 100 million (USD 13.8 million): Transfer of financial assets
• RMB 100 million (USD 13.8 million): Transfer of ownership of intangible assets
• RMB 40 million (USD 5.5 million): Other related-party transactions

Critical Exception: Entities engaged in single-function operations (toll manufacturing, contract R&D, distribution) that report losses must prepare a Local File regardless of transaction volumes.

Domestic Transaction Exemptions

Hong Kong’s Section 50AAJ Domestic Exemption

Hong Kong provides a specific exemption for certain domestic transactions under Section 50AAJ(2) of the IRO. Domestic transactions are excluded from transfer pricing requirements if all three conditions are met:

1. Domestic Nature: The actual provision relates to a trade, profession, or business carried out in Hong Kong by both related persons
2. No Actual Tax Difference or Non-Business Loan: Either:
   • The income generated from the transaction is taxed in Hong Kong for both parties, OR
   • The transaction relates to interest-free loans not in the ordinary course of money lending or intra-group financing business
3. No Tax Avoidance Purpose: The key purpose of the provision is NOT to use losses of any related person to reduce Hong Kong tax liability

Important Note: Even for exempt domestic transactions, the arm’s length principle under Rule 1 must still be observed. The exemption applies only to documentation requirements and IRD adjustment authority, not to the fundamental pricing requirement.

China’s Domestic Transaction Treatment

China does not provide a comprehensive exemption for domestic transactions. All related-party transactions, whether domestic or cross-border, are subject to transfer pricing scrutiny if they meet documentation thresholds or raise tax authority concerns.

However, practical enforcement focuses primarily on:

• Cross-border transactions with related parties in different tax jurisdictions
• Transactions involving tax haven jurisdictions
• Intercompany arrangements resulting in profit shifting to lower-tax jurisdictions
• Single-function entities showing losses or abnormally low profit margins

Country-by-Country Reporting

China CbC Secondary Filing Requirements

A Chinese subsidiary may be required to submit CbC reports if:

• The MNE group submitted CbCR forms, but the collecting jurisdiction does not have an information exchange mechanism with China, OR
• The jurisdiction has an exchange mechanism with China, but the CbCR has not been successfully exchanged with China

Advance Pricing Arrangement (APA) Programs

Hong Kong APA Program

Hong Kong introduced its APA program in 2012, providing taxpayers with a transparent mechanism to achieve tax certainty on related-party transactions.

Types of APAs Available

• Unilateral APA: Agreement solely between Hong Kong taxpayer and the IRD Commissioner. Previously not accepted due to resource constraints, but the IRD concluded its first unilateral APA in January 2019, marking a landmark development. Unilateral APAs are now accepted for transactions with jurisdictions where Hong Kong has no Double Taxation Agreement (DTA).
• Bilateral APA: Arrangement involving the IRD and relevant tax authorities in foreign jurisdictions with DTAs with Hong Kong
• Multilateral APA: Involving three or more tax jurisdictions

Key Milestones

• September 2014: First bilateral APA concluded with the Netherlands
• January 2015: Second APA concluded with Japan (completed in just 4 months)
• January 2019: First unilateral APA concluded
• 2020: Streamlined APA procedures introduced to reduce processing time

Application Process

Applicants should submit a request for APA early engagement at least 6 months prior to the proposed commencement date. The request must include a draft case plan outlining:

• Business operations and related-party transactions
• Proposed transfer pricing methodology
• Critical assumptions and functional analysis
• Proposed APA coverage period (typically 3 to 5 years)

DTA Requirement

For bilateral and multilateral APAs, Hong Kong must have a DTA with the concerned jurisdiction. As of June 2025, Hong Kong has concluded comprehensive DTAs with 52 countries and regions.

China APA Program

China has a well-established APA program with significant activity. According to the State Taxation Administration’s 2023 Annual Report released in December 2024:

Program Statistics (2005-2023)

• Total APAs signed: 296 (153 unilateral, 143 bilateral)
• 2023 APAs signed: 36 (9 unilateral, 27 bilateral)
• 15 consecutive years of publishing annual APA reports (demonstrating transparency)

Types of APAs

• Unilateral APA: Agreement between enterprise and Chinese tax authority only. Provides certainty within China but cannot ensure avoidance of international transfer pricing disputes or double taxation. Typically completed within 2 years.
• Bilateral APA: Involving Chinese tax authority and one foreign tax authority. More effective for avoiding double taxation. Typically requires at least 2 years due to treaty negotiations and mutual agreement procedures.
• Multilateral APA: Involving Chinese tax authority and multiple foreign tax authorities

Simplified Unilateral APA Procedures (2021 Onwards)

In 2021, China introduced simplified unilateral APA procedures with delegated signing authority to provincial and local-level tax authorities. Key features:

• Eligibility: Companies with annual related-party transactions exceeding RMB 40 million (approximately USD 6 million) in the three tax years prior to application
• Time limits introduced to improve timeliness and reduce compliance costs
• Not applicable to bilateral and multilateral APAs

2025 Strategic Context

The State Taxation Administration continues to position APAs as an important measure to optimize the tax business environment, providing tax certainty for cross-border taxpayers and working to avoid and eliminate international double taxation.

Penalties and Enforcement

Hong Kong’s Reasonable Effort Principle

Under Section 82A of the IRO, proper transfer pricing documentation serves as evidence that an enterprise made reasonable efforts to determine the arm’s length amount. If the IRD makes adjustments despite these reasonable efforts, the enterprise will not be liable for additional tax of up to 100% of the tax undercharged.

This creates a strong incentive for documentation compliance, even for entities meeting exemption thresholds.

China’s 2025 Enforcement Trends

The State Taxation Administration is significantly enhancing enforcement in 2025 through:

• AI-powered digital audits: Advanced algorithms identify inconsistencies in related-party transactions, particularly in cross-border supply chains and IP-heavy structures
• Data-driven compliance monitoring: Integration of customs data, foreign exchange records, and tax filings to detect anomalies
• Stricter scrutiny of loss-making entities: Single-function entities reporting losses face mandatory Local File preparation and heightened audit risk
• Focus on substance over form: Increased emphasis on economic substance and value creation alignment

China’s Special Tax Adjustment Procedures

Under Article 44 of the Corporate Income Tax Law, if a company fails to provide complete and accurate related-party transaction documentation, tax authorities may:

• Apply their own methods to assess taxable income based on reasonable estimates
• Impose transfer pricing adjustments with 10-year lookback period
• Calculate interest at People’s Bank of China benchmark rate plus 5%
• Apply 5% penalty (waived only if proper documentation prepared)

Shenzhen 2025 Innovation: Transfer Pricing Adjustment Mechanism

On June 23, 2025, the Shenzhen Tax Service issued guidance introducing tax-related services for domestic enterprises implementing transfer pricing method-based profit compensation via inbound remittance of foreign exchange. This innovative mechanism allows:

• Taxpayers to voluntarily perform upward tax adjustments via inbound transfer pricing adjustments
• Application for formal notice from Shenzhen municipal tax authority (fourth branch)
• Remittance of partial adjustment amounts to reduce interest and potential penalties during negotiation processes
• Standardized procedures for inbound TPA settlement in Shenzhen

Recent Regulatory Updates and 2025 Developments

Hong Kong – Minimum Tax for Multinational Enterprises

The Inland Revenue (Amendment) (Minimum Tax for Multinational Enterprise Groups) Ordinance 2025 was enacted on June 6, 2025. Key provisions:

• Implements OECD’s global minimum tax of 15% on MNE groups with annual consolidated revenue of EUR 750 million or above
• Updates Hong Kong’s transfer pricing rules to align with the 2022 OECD Transfer Pricing Guidelines
• Enhances international tax compliance framework
• Demonstrates Hong Kong’s commitment to BEPS 2.0 implementation

China – Enhanced Digital Enforcement

2025 marks a new era of stricter enforcement in China, characterized by:

• Digitization: Integration of AI and machine learning in audit selection and risk assessment
• Data-driven audits: Cross-referencing of multiple data sources (tax filings, customs declarations, foreign exchange records, CbC reports)
• Real-time monitoring: Advanced systems for identifying transfer pricing anomalies as transactions occur
• Focus areas: Cross-border supply chains, intellectual property structures, cost-sharing arrangements, intra-group financing

State Taxation Administration 2023 APA Report Insights

Released in December 2024, the 15th consecutive annual report demonstrates:

• Continued commitment to transparency and predictability
• Increasing bilateral APA activity (27 bilateral vs. 9 unilateral in 2023)
• Cumulative total of 296 APAs since program inception in 2005
• Growing acceptance of APAs as tax planning tool for multinational compliance

Strategic Compliance Considerations

For Multinational Enterprises Operating in Both Jurisdictions

1. Harmonize Documentation Approaches: While both jurisdictions follow OECD three-tiered documentation, timing and content requirements differ. Prepare comprehensive global documentation that satisfies both jurisdictions’ specific requirements.
2. Leverage Hong Kong’s Domestic Exemption (Section 50AAJ): Carefully structure Hong Kong-only operations to potentially qualify for documentation exemptions while ensuring arm’s length compliance is maintained.
3. Monitor China’s Loss-Making Entity Rules: Single-function entities in China (toll manufacturing, contract R&D, distribution) must prepare Local Files if showing losses, regardless of transaction thresholds. Ensure pricing policies support reasonable profit outcomes.
4. Plan for Different Deadlines: Hong Kong’s 9-month deadline vs. China’s June 30 deadline for Local Files requires coordinated documentation preparation processes.
5. Consider APA Programs Strategically:
   • Hong Kong: Leverage bilateral APAs with DTA partners; explore unilateral APAs for non-DTA jurisdictions
   • China: Utilize simplified unilateral APA procedures for qualifying transactions; pursue bilateral APAs for significant cross-border arrangements
6. Prioritize Documentation Quality Over Mere Compliance:
   • Hong Kong: Documentation provides protection from additional tax under Section 82A
   • China: Proper documentation waives 5% penalty and reduces audit scrutiny
7. Prepare for Enhanced China Enforcement: 2025 digital audit capabilities require robust substantiation of commercial rationale, functional analysis accuracy, and value chain alignment.
8. Language and Format Compliance:
   • Hong Kong: English or Chinese acceptable
   • China: Chinese mandatory; budget for translation and cultural adaptation of documentation
9. Retention and Accessibility:
   • Hong Kong: 7 years minimum retention
   • China: 10 years mandatory retention; must produce within 30 days of request
10. Stay Updated on 2025 Minimum Tax Impacts: Hong Kong’s implementation of OECD Pillar Two affects MNE groups with EUR 750 million+ revenue. Coordinate transfer pricing and minimum tax compliance strategies.

Risk Mitigation Best Practices

• Annual Documentation Review: While roll-forward provisions exist, annual review ensures accuracy and current relevance
• Benchmarking Studies: Regularly update comparability analyses using current financial data
• Functional Analysis Updates: Document changes in business models, value chains, or intangible asset ownership
• Intercompany Agreement Alignment: Ensure written agreements reflect actual conduct and economic substance
• Pre-filing Consultations: Engage with tax authorities proactively to address uncertainties
• Coordination with Finance Teams: Integrate transfer pricing into financial planning, forecasting, and reporting processes

Comparative Summary Table

Disclaimer: This article provides general information only and should not be construed as legal or tax advice. Transfer pricing regulations are complex and subject to ongoing change. Multinational enterprises should consult with qualified tax professionals and legal advisors to address specific circumstances and ensure compliance with current regulations in Hong Kong and Mainland China.

Last Updated: December 2025
Document ID: 19110