For Hong Kong-based businesses with operations or related-party transactions in Mainland China, navigating cross-border tax rules is a critical exercise in risk management. While Hong Kong offers a simple, low-tax regime, Mainland China’s “special tax adjustments” (STAs) present a complex layer of compliance. How can you ensure your intercompany pricing withstands scrutiny from both jurisdictions without eroding your competitive edge?

The Cross-Border Compliance Tightrope: Hong Kong vs. Mainland Rules

Hong Kong’s tax system is famously straightforward and territorial. A company incorporated here is taxed only on profits arising from trade, profession, or business carried on in Hong Kong. This principle, enshrined in the Inland Revenue Ordinance, is the bedrock of its appeal. In contrast, Mainland China employs a worldwide taxation system for resident enterprises and has a sophisticated transfer pricing regime designed to prevent profit shifting.

The challenge arises when a Hong Kong entity engages in transactions with its Mainland sister company. The pricing of goods, services, royalties, or loans between them must satisfy the “arm’s length principle” in both jurisdictions. A structure that is perfectly compliant in Hong Kong could be challenged by China’s State Administration of Taxation (SAT), leading to double taxation if not carefully managed.

Hong Kong’s FSIE Regime: The New Frontier for Holding Companies

A key development for Hong Kong entities receiving income from Mainland China is the Foreign-Sourced Income Exemption (FSIE) Regime. Since January 2024, foreign-sourced dividends, interest, disposal gains, and IP income received in Hong Kong by multinational enterprise (MNE) entities are only exempt from Profits Tax if they meet specific economic substance requirements.

Decoding Mainland China’s Special Tax Adjustments (STAs)

Mainland China’s STA framework empowers tax authorities to adjust transactions not conducted at arm’s length. The 2024 landscape integrates OECD BEPS principles with local doctrines like “location-specific advantages” (LSA), where China’s market, labour, or infrastructure is argued to contribute unique value that should be reflected in local taxable profits.

“The SAT isn’t just auditing numbers; it’s auditing business models. Firms that treat STAs as a checkbox exercise will face significant risks.”

— Dr. Wei Zhang, Partner at Zhong Lun Law Firm (Shanghai)

For a Hong Kong company, this means traditional transfer pricing benchmarks might be rejected if they don’t account for the specific value created in Mainland China. The focus is on substance over form.

Strategic Framework for Hong Kong-Based Groups

To navigate both systems successfully, adopt a holistic, two-jurisdiction strategy.

The Bigger Picture: Global Minimum Tax and Strategic Positioning

The introduction of the 15% Global Minimum Tax (Pillar Two) in Hong Kong, effective January 2025, adds another layer. Large multinational groups with operations in both Hong Kong and Mainland China will need to calculate their effective tax rate in each jurisdiction. While Hong Kong’s headline Profits Tax rate is low, the new Hong Kong Minimum Top-up Tax (HKMTT) ensures in-scope groups pay a minimum 15% rate here, which may affect how profits are allocated across the group.

Successfully operating across the Hong Kong-Mainland border is no longer just about enjoying a low tax rate. It’s about building a defensible, substance-based operational structure that aligns value creation with profit allocation under two distinct but increasingly interconnected tax systems. Proactive planning and documentation are your best defence against adjustments and double taxation.