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Tax Q&A · Introduction to international tax

Navigating International Tax Without a Double Tax Treaty: FATCA, BEPS, and Transfer Pricing

FULL QUESTION

What happens if a country (eg Hong Kong) doesn’t have a double tax treaty with the US, but does have an exchange of information agreement (FATCA model 2 IGA) in place. The country has, however, committed to work towards transforming to be in line with the OECD BEPS initiative and TP guidelines. What does it mean in the context of the international tax interaction between any such country and the US?

ADDITIONAL WRITTEN ANSWER

In the context of international tax interaction between Hong Kong (or any country without a double tax treaty with the US) and the US, but with an exchange of information agreement (like the FATCA Model 2 IGA) and a commitment to the OECD BEPS initiative and Transfer Pricing (TP) guidelines, several implications arise. Here’s a breakdown of what this means:

1. Absence of Double Tax Treaty

  • No relief for double taxation: Without a double tax treaty, Hong Kong and US residents or companies do not benefit from treaty-based relief such as reduced withholding tax rates, exemptions, or credits for taxes paid in one jurisdiction against the tax liability in the other. This can lead to potential double taxation.
  • Tax jurisdiction conflicts: If both Hong Kong and the US claim taxing rights over the same income (for example, due to residency or source rules), there is no treaty mechanism like a Mutual Agreement Procedure (MAP) to resolve these disputes.

2. Exchange of Information Agreement (FATCA Model 2 IGA)

  • Information sharing: Although there is no double tax treaty, the existence of a FATCA Model 2 Intergovernmental Agreement (IGA) facilitates the exchange of financial information between Hong Kong and the US. This is aimed at combating tax evasion by US persons and corporations, ensuring transparency and compliance with US tax laws.
  • Focus on US persons: The FATCA Model 2 IGA means that Hong Kong-based financial institutions report information about US persons (e.g., individuals or companies with US tax obligations) to Hong Kong’s tax authorities, who then transmit the data to the IRS. This primarily serves the US tax authorities but contributes to overall transparency and compliance.

3. Commitment to OECD BEPS Initiative and Transfer Pricing Guidelines

  • Alignment with international standards: Hong Kong’s commitment to the OECD Base Erosion and Profit Shifting (BEPS) initiative and Transfer Pricing guidelines signifies that it is working to adopt measures that prevent tax avoidance, including ensuring that profits are taxed where economic activities are conducted and value is created.
  • Transfer pricing: Even though there’s no treaty, the adoption of OECD TP guidelines means Hong Kong is expected to follow the arm’s length principle in transactions between related parties, ensuring that pricing reflects what would have been agreed upon by unrelated parties in a competitive market. The US is also aligned with these guidelines, making transfer pricing a common framework for both countries.
  • Increased compliance expectations: For multinational enterprises (MNEs) operating between Hong Kong and the US, this means that cross-border transactions will be scrutinized based on transfer pricing documentation requirements, and adjustments could be made by either country if transfer pricing principles are violated.
  • Global anti-avoidance measures: Through the BEPS project, the US and Hong Kong are committed to combat tax avoidance strategies like profit shifting, which can lead to alignment in their international tax enforcement, despite the absence of a bilateral tax treaty.

4. Potential Tax Conflicts

  • Risk of double taxation without resolution mechanisms: Without a double tax treaty, companies and individuals might face double taxation, and there’s no access to a Mutual Agreement Procedure (MAP) for resolving disputes. This can be problematic if both Hong Kong and the US try to tax the same income.
  • Importance of tax planning: Businesses will need to be more cautious with tax planning, focusing on unilateral relief mechanisms (e.g., tax credits or deductions under domestic laws) to avoid double taxation. Additionally, they must ensure their tax positions align with both countries’ tax systems.

5. Future Tax Treaty Possibility

  • Potential for negotiation: Given Hong Kong’s commitment to the BEPS project and its alignment with international tax standards, there might be a greater likelihood of future negotiations towards a double tax treaty with the US. A treaty would help eliminate double taxation issues and provide certainty and relief for both countries’ taxpayers.