How to approach Pillar Two and the Hong Kong minimum top-up tax for a large group

For fiscal years beginning on or after 1 January 2025, large multinational enterprise groups with consolidated annual revenue at or above EUR 750 million face a coordinated global minimum tax regime. Hong Kong's response – the minimum top-up tax and the income inclusion rule – operates under the Inland Revenue Ordinance as amended and sits alongside the OECD-endorsed Pillar Two framework. The question is not whether the rules apply. The question is whether your group's existing structure, substance profile, and cross-border filing positions are calibrated to them.

This guide sets out the decision a general counsel or in-house tax director faces, the sequence of steps in the order they must be taken, the single most common mistake we see in cross-border groups operating through Hong Kong, and a short checklist before the next filing cycle closes.

What is the decision, and why does it matter for a Hong Kong-anchored group?

Pillar Two establishes a global effective tax rate floor of 15% at a jurisdictional level. Where a constituent entity – a group company in a given jurisdiction – sits below that floor, a top-up charge arises. The question for any large group is: where is the top-up collected, and by whom?

Hong Kong's minimum top-up tax addresses precisely this. It gives Hong Kong the primary right to collect the top-up on under-taxed Hong Kong constituent entities, rather than ceding collection to a parent jurisdiction abroad. The income inclusion rule operates above it: where a parent entity in an income-inclusion-rule jurisdiction holds a low-taxed subsidiary, the parent jurisdiction taxes the shortfall. Hong Kong has enacted both mechanisms.

For a group that runs its Asia-Pacific holding structure through Hong Kong – with operating subsidiaries across the Mainland, the BVI, the Cayman Islands, and Singapore – the decision tree has several branches. Which entities are constituent entities for Pillar Two purposes? Which of their jurisdictional effective tax rates fall below 15%? What substance does each entity have in its jurisdiction? The answers determine both the top-up liability and the administrative burden.

In our cross-border tax practice, we see groups that conflate this analysis with their ordinary profits tax position. That is the wrong frame. Hong Kong's headline profits tax rates – 8.25% on the first HK$2 million of assessable profits and 16.5% above that threshold – are not the relevant measure. Pillar Two computes a jurisdictional effective tax rate using adjusted covered taxes over qualified domestic income, a figure that can diverge significantly from the statutory rate depending on the group's deferred-tax position, loss utilisation, and the treatment of certain credits.

Step one: determine whether your group is in scope

The threshold is binary: consolidated annual revenue of at least EUR 750 million in at least two of the four preceding fiscal years. If your group is at or above that threshold, Pillar Two applies. Below it, the rules do not apply, though the group may still have filing obligations in jurisdictions that have enacted a qualified domestic minimum top-up tax – which Hong Kong has.

Scoping is not always straightforward. Revenue consolidation follows the accounting rules applicable to the ultimate parent entity. Groups with complex ownership chains – a common feature of structures that have grown through acquisition or joint-venture arrangements in Greater China – must trace the consolidation boundary carefully. A joint venture that is proportionately consolidated may carry different implications from one that is equity-accounted.

The gate at this step: confirm the consolidated revenue figure, the applicable accounting standard, and the fiscal-year start date. The effective date of 1 January 2025 is the reference point for fiscal years. Groups with a non-calendar fiscal year should verify their specific commencement date and the transitional provisions that may apply.

Step two: map constituent entities and their jurisdictional effective tax rates

Once scope is confirmed, the next step is a full map of the group's constituent entities. Every entity that is part of the consolidated group – and is not an excluded entity under the rules – is a constituent entity. Excluded entities include certain investment funds and pension funds at the ultimate parent level; the specific carve-outs are defined in the Pillar Two rules as implemented in each jurisdiction, and they do not extend broadly to ordinary holding or operating companies.

For each constituent entity, the group must compute its jurisdictional effective tax rate using the Pillar Two-specific methodology. This is a distinct calculation from the entity's accounts. The key inputs are qualified domestic income (or loss) and adjusted covered taxes for the jurisdiction. Adjusted covered taxes include current and deferred taxes on qualifying income, subject to numerous adjustments for items that are not "covered" under the rules.

This step is where the tax positions analysis becomes critical. In a Hong Kong-anchored structure, the group must separately compute the Hong Kong jurisdictional effective tax rate across all Hong Kong constituent entities on a blended basis. Where the blended rate comes in above 15%, no top-up arises in Hong Kong. Where it falls below, the minimum top-up tax applies to the shortfall.

The substance-based income exclusion is a carve-out that can reduce the amount of income subject to the top-up charge. It is computed by reference to payroll costs and tangible asset values in a jurisdiction, subject to prescribed percentages. For groups with real operational substance in Hong Kong – actual employees, leased or owned premises, genuine business activity – the exclusion can be material. For a holding company with minimal headcount and no fixed assets, it will be small. The centre of gravity, under Hong Kong's territorial system, is not the headline rate: it is the relationship between source, substance, and the adjusted covered taxes the group actually pays.

Step three: assess the foreign-sourced income exemption interaction

Hong Kong taxes profits on a territorial basis. Profits arising outside Hong Kong are generally not subject to Hong Kong profits tax unless the foreign-sourced income exemption regime applies. The foreign-sourced income exemption (FSIE) regime – a set of rules that brought certain passive income streams into scope on a conditional basis, in force from 1 January 2023 as amended – changes the picture for dividends, interest, disposal gains, and royalties received by Hong Kong entities from associated offshore entities.

Under the FSIE regime, passive income of that kind is subject to profits tax in Hong Kong unless the receiving entity meets one of the prescribed exemption conditions: the participation exemption, the nexus condition (for intellectual property), or the economic-substance test. Where the entity meets the relevant condition, the income is exempt. Where it does not, it is taxable at the standard rate.

The interaction with Pillar Two runs in both directions. Passive income that is brought into Hong Kong charge under the FSIE regime may increase the group's covered taxes in Hong Kong, improving the jurisdictional effective tax rate. Passive income that qualifies for an FSIE exemption reduces taxable income but does not necessarily reduce the Pillar Two income base in the same proportion. Groups that have restructured passive income flows in response to the FSIE regime since 2023 may find that their Pillar Two effective-tax-rate computation does not mirror their profits-tax position. Both analyses must run in parallel.

See also our briefing on treaty access between Hong Kong and the Cayman Islands, which addresses the position of Cayman holding vehicles in a Hong Kong-anchored structure and how treaty access interacts with substance and source rules.

Step four: model the top-up liability and identify the collection point

Once the jurisdictional effective tax rates are mapped, the group can identify where a top-up liability arises. The primary collection mechanism is the qualified domestic minimum top-up tax: Hong Kong's own minimum top-up tax charge. If a Hong Kong constituent entity's share of the jurisdictional shortfall is calculated, and Hong Kong has enacted a qualifying domestic minimum top-up tax – which it has – then Hong Kong collects the top-up first. A parent jurisdiction with an income inclusion rule cannot collect on Hong Kong entities where Hong Kong's domestic charge applies and is treated as a qualified domestic minimum top-up tax under the Pillar Two rules.

This matters structurally. A group with a European parent in an income-inclusion-rule jurisdiction needs to know whether Hong Kong's domestic charge will shield Hong Kong constituent entities from an additional parent-level charge. The answer depends on whether Hong Kong's minimum top-up tax is treated as a qualified domestic minimum top-up tax by the parent jurisdiction – a question of that parent jurisdiction's domestic legislation, not Hong Kong's alone.

For subsidiary entities in other jurisdictions – BVI holding companies, Cayman special-purpose vehicles, or Mainland operating entities – the equivalent analysis runs under those jurisdictions' domestic rules or, where no domestic minimum top-up tax exists, under the income inclusion rule at the ultimate parent level. Groups with a Hong Kong ultimate parent will need to apply Hong Kong's income inclusion rule to their under-taxed subsidiaries elsewhere. This is a cross-border enforcement question as much as a tax question.

We regularly advise on the interaction between the Hong Kong filing position and the parent-level income inclusion rule in European and CIS-origin groups that have restructured their holding chains to run through Hong Kong over recent years. The modelling step requires consistent data across all constituent entities, not just those in the obvious high-risk jurisdictions.

Step five: confirm the filing and reporting obligations

Pillar Two imposes filing obligations as well as a potential charge. The group information return – a detailed document covering the group's constituent entities, jurisdictional effective tax rates, and top-up computations – must be filed by a designated filing entity in one or more jurisdictions. Jurisdictional coordination rules determine where the return is filed and how that filing is shared between jurisdictions through exchange-of-information mechanisms.

For a Hong Kong-anchored group, the designated filing entity may be the Hong Kong ultimate parent or a surrogate filing entity in another jurisdiction. The Inland Revenue Department receives the relevant return for Hong Kong, in accordance with the timetable set under the Inland Revenue Ordinance. Parties should verify the current filing timetable and any transitional filing relief available for early fiscal years under the rules, as these have been subject to ongoing guidance from the OECD and domestic implementing authorities.

A subsidiary question is the local filing obligation. Each constituent entity may have local Pillar Two reporting obligations in its own jurisdiction in addition to the group information return. The Mainland's domestic minimum top-up tax rules – and their interaction with the Hong Kong filing – are a distinct set of rules that operate under a separate implementing framework. Groups with significant Mainland subsidiaries should not assume that the Hong Kong filing discharges Mainland obligations, or vice versa. The two regimes are coordinated in principle through the OECD framework but administered separately in practice.

For groups with BVI or Cayman entities that are constituent entities, the reporting position in those jurisdictions is currently developing. Groups should verify the current reporting requirements in each offshore centre before the relevant filing cycle, as the position may have changed after the date of this guide.

The common mistake: treating Pillar Two as a headline-rate problem

The single error we see most often is the assumption that a group operating primarily in Hong Kong, with a headline profits tax rate of 16.5%, is immune from any Pillar Two exposure. It is not. The effective tax rate under Pillar Two is a computed figure, not a statutory one. It can fall below 15% even in a high-rate jurisdiction if the group carries deferred-tax assets, relies on reliefs that are not "covered" taxes under the Pillar Two rules, or has significant exempt income that reduces the adjusted covered taxes relative to the income base.

The reverse also applies. A group with entities in low-rate jurisdictions – the BVI charges no corporate income tax; the Cayman Islands similarly – may find that those entities benefit from the substance-based income exclusion if they hold real assets or employ real staff. A BVI holding company that is purely a letterbox, with no employees and no assets other than shares, will have a near-zero substance-based income exclusion and a jurisdictional effective tax rate close to zero. The top-up on that entity will be collected at the parent level.

The practical consequence is that the Pillar Two analysis must be done at the entity level, then aggregated to the jurisdictional level, then checked against the collection hierarchy. None of those three steps can be skipped, and the results of each feed the next. See our earlier discussion on tax review before a BVI exit or distribution for the specific intersection of BVI holding structures and the tax position on exit events, which interacts with the Pillar Two analysis for groups considering restructuring above Hong Kong.

Decision checklist before the next filing cycle

The following checklist reflects the questions a general counsel or tax director should be able to answer before the group's next Pillar Two compliance cycle. It is not exhaustive. It is the minimum necessary to identify whether a material exposure or filing obligation has been missed.

• Has the group confirmed its consolidated revenue for each of the four preceding fiscal years, and has the in-scope threshold been applied to the correct accounting standard?
• Has the group produced a full constituent-entity map, including BVI, Cayman, Hong Kong, Mainland, and any other jurisdictions where entities operate or are incorporated?
• Has the jurisdictional effective tax rate been computed under the Pillar Two methodology – not the statutory rate, not the accounts effective tax rate – for each jurisdiction?
• Has the substance-based income exclusion been calculated for each jurisdiction, with reference to actual payroll and tangible-asset data?
• Has the FSIE interaction been analysed for Hong Kong constituent entities that receive passive income from associated offshore entities?
• Has the group identified the designated filing entity and confirmed that the group information return will be filed on time in the appropriate jurisdiction?
• Has the group verified the local filing obligations for Mainland and offshore constituent entities separately from the group information return?
• Has the group assessed whether Hong Kong's minimum top-up tax will be treated as a qualified domestic minimum top-up tax by the parent jurisdiction, so that the parent-level income inclusion rule does not impose a duplicative charge on Hong Kong entities?
• Has the group reviewed its structure in light of the Pillar Two results to determine whether any entity-level changes are warranted before the next fiscal year begins?

The sequence above describes the standard position. Your group's filing turns on the specific entities engaged, the jurisdictions involved, and the order in which computations are run – which is where liability is determined or avoided.

For a structured read on your group's Pillar Two position across the relevant jurisdictions, write to us at info@lockhartyip.com.

If an earlier compliance cycle, a prior restructuring, or an advice received in another jurisdiction has left your group's Pillar Two position uncertain or internally inconsistent, a second read can identify the analytical gap and the steps still available before the next filing window closes.

To discuss how Hong Kong's minimum top-up tax and income inclusion rule interact with your group's cross-border structure, email info@lockhartyip.com.

Related practices

• Holding Structures – cross-border holding design, offshore entities, and substance analysis above the Hong Kong opco
• Corporate Counsel – ongoing governance and filing obligations for Hong Kong entities in a large group

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• Tax Positions
• Tax Review Before Bvi Exit Or Distribution Bvi 8
• Treaty Access Between Hong Kong Cayman Islands Cayman

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