Update: transfer pricing for an intra-group arrangement

Transfer pricing for an intra-group arrangement sits at the point where the Inland Revenue Department's scrutiny is sharpest and the documentation gap is most exposed. For groups with a Hong Kong holding or operating entity transacting with related parties in the Mainland, the BVI, the Cayman Islands or elsewhere, the question is not whether the arm's-length standard applies – it does – but whether the file is ready to demonstrate it.

Under Hong Kong's territorial tax system, the arm's-length principle (the requirement that transactions between connected parties be priced as if conducted between independent parties at market terms) applies to intra-group arrangements that affect the source and quantum of Hong Kong-assessable profits. The governing instrument is the Inland Revenue Ordinance, as supplemented by the transfer-pricing provisions and the applicable OECD guidance that the Inland Revenue Department has adopted as interpretive reference. For fiscal years beginning on or after 1 January 2025, in-scope multinational enterprise groups face the additional layer of the Hong Kong minimum top-up tax under the Pillar Two regime.

This briefing covers what the current enforcement environment means in practice, who it affects across the Greater China corridor, and the immediate documentation step.

What is the enforcement environment now calling for?

The Inland Revenue Department has, in recent cycles, increased the frequency and depth of transfer-pricing queries in profits tax inquiries. The focus is not the headline rate – Hong Kong's two-tier profits tax of 8.25% on the first HK$2,000,000 of assessable profits and 16.5% above that remains unchanged – but the source and substance question: where was value genuinely created, and does the intra-group pricing reflect that?

For a group that books service fees, royalties, interest payments or management charges through a Hong Kong entity, the department's review will go to the substance behind the price. A Hong Kong entity receiving a reduced fee for services rendered to an offshore affiliate, or paying above-market charges to a related party in a lower-tax jurisdiction, creates exposure on both sides of the arrangement. The territorial system does not provide shelter. It simply changes which profits are in scope; the pricing of the arrangement still has to hold.

The foreign-sourced income exemption (FSIE) regime – the set of economic-substance conditions that must be satisfied for certain offshore income to remain outside Hong Kong assessable profits, in force from 1 January 2023 – adds a second layer. A group that relies on FSIE treatment for dividends, interest or disposal gains received through a Hong Kong holding entity must demonstrate that the substance is real. A thin or circular intra-group arrangement that migrates value away from the entity asserting substance directly undermines that position.

In our cross-border tax practice, we see the same pattern recur: the arrangement was designed at the point of incorporation, the pricing was set once, and the contemporaneous documentation was never maintained. By the time an inquiry arrives, the file does not support the price.

Who is affected across the corridor?

The groups most exposed are those with a Hong Kong entity in the middle of a cross-border chain – typically a holding company above a Mainland operating entity, or a service or IP hub sitting between offshore principals and Mainland or Southeast Asian operations. The Mainland–Hong Kong corridor is the highest-frequency context. But the same analysis applies to groups routing through Hong Kong from the UAE, Cyprus or the United Kingdom.

For Pillar Two purposes, groups with consolidated revenue at or above EUR 750 million in fiscal years beginning on or after 1 January 2025 must also consider how the minimum top-up tax interacts with their intra-group pricing. An arrangement that shifts profits to a low-tax jurisdiction within the group may trigger a top-up charge in Hong Kong. The transfer-pricing file and the Pillar Two position are not separate exercises.

Smaller groups below the Pillar Two threshold are not insulated. The transfer-pricing rules under the Inland Revenue Ordinance apply regardless of group size where the arrangement materially affects Hong Kong-source profits. The exemptions available to smaller enterprises relate to documentation thresholds, not to the arm's-length requirement itself.

What is the immediate action?

The immediate step is a documentation review. That means: confirming that a contemporaneous transfer-pricing study exists and covers each material intra-group arrangement; verifying that the benchmarking analysis uses comparables that reflect current market conditions; and checking that the functional analysis correctly maps the functions performed, assets used and risks assumed by the Hong Kong entity.

Where the arrangement involves a cost-sharing arrangement (a structure under which related parties contribute to the development of intangibles or services in proportion to anticipated benefit), the documentation burden is higher. The Inland Revenue Department applies the OECD guidance on cost contributions closely in practice.

Groups that have not reviewed their transfer-pricing file within the past two years should treat that as a gap. The file must be in place before an inquiry arrives; it cannot be reconstructed after the fact. If the existing arrangement no longer reflects the actual operations of the group – because functions have moved, personnel have changed or the commercial terms between the entities have drifted from the documented position – the arrangement should be corrected and the documentation updated before the next return is filed.

The sequence above describes the standard position. Your matter turns on the specific arrangement, the jurisdictions engaged, and the state of the existing file – which is where the risk is located or resolved.

For a structured read on your intra-group pricing position across the Hong Kong and cross-border corridors you use, write to us at info@lockhartyip.com.

For the broader Tax Positions practice, including our approach to source-and-substance analysis and FSIE positioning, see the practice page. On the interaction between holding company tax residence and management and control, see our guide on tax residence, management and control for holding companies. For the Pillar Two layer, the analysis in our Hong Kong minimum top-up tax matter note sets out the key thresholds and their interaction with existing structures.

Speak with Lockhart & Yip

For a scoped view of your matter, contact info@lockhartyip.com. Discuss your matter →

Related

• Tax Positions
• Tax Residence Management Control Holding Company Guide 3
• Pillar Two Hong Kong Minimum Top Up Tax

This publication is general information and does not constitute legal advice. For advice on your situation, contact info@lockhartyip.com.