A practical guide to Pillar Two and the Hong Kong minimum top-up tax for a large group

For a large multinational group with entities in Hong Kong, the arithmetic of Pillar Two arrived on 1 January 2025. From that date, fiscal years beginning on or after that date fall within the scope of Hong Kong's minimum top-up tax and the income inclusion rule. The question for group tax directors is no longer whether this regime applies. It is how the Hong Kong structure interacts with the group's global position – and where the exposure actually sits.

Hong Kong operates a minimum top-up tax and an income inclusion rule under its Pillar Two legislation, effective for fiscal years beginning on or after 1 January 2025, applying to in-scope multinational enterprise groups with consolidated revenue of at least EUR 750 million. The governing instrument is the Inland Revenue Ordinance as amended to implement the OECD's GloBE rules. The territorial basis of Hong Kong's existing profits-tax system – 8.25% on the first HK$2 million of assessable profits and 16.5% above – means that many Hong Kong entities will meet or exceed the 15% global minimum for income genuinely sourced here. The cross-border risk lies in offshore income, holding entities, and the interaction between Hong Kong's foreign-sourced income exemption regime and the substance conditions the GloBE rules impose.

This guide walks through the decision the group faces, the sequence of steps, the gate at each stage, the most common structural mistake, and a decision checklist. It is addressed to group tax directors, chief financial officers, and in-house counsel managing Hong Kong and Greater China exposure.

Why does the Hong Kong minimum top-up tax matter for your group's cross-border structure?

The minimum top-up tax matters because Hong Kong sits, for most large Asian groups, at the intersection of two income streams: locally sourced operating profit taxed under the territorial system, and offshore income routed through a Hong Kong holding or treasury entity that, until recently, bore little or no Hong Kong tax. Pillar Two targets the second stream directly.

Hong Kong's nominal profits-tax rate of 16.5% clears the 15% GloBE minimum on locally sourced income. That is the comfortable part of the analysis. The discomfort comes from income that the Hong Kong entity earns but that the existing foreign-sourced income exemption – the FSIE regime (the rules under which certain categories of foreign-sourced income are exempt from profits tax subject to economic-substance conditions) – treats as non-taxable or taxable only on a remittance basis. Under the GloBE rules, that income may still count in the effective-tax-rate calculation for the Hong Kong constituent entity. If the effective rate for the Hong Kong jurisdiction falls below 15%, a top-up charge arises.

The interface between the FSIE regime and the GloBE computation is where most of the practical complexity lives. Our desk regularly advises groups that have optimised their Hong Kong structure under the FSIE rules without running the concurrent GloBE effective-tax-rate test. The two analyses are not identical. An entity that qualifies for the FSIE exemption may still produce a sub-15% effective rate under the GloBE formula because the GloBE computation uses adjusted covered taxes, not Hong Kong statutory profits tax.

A second pressure point is the two-tier rate. Only one connected entity per group may claim the lower 8.25% tier on the first HK$2 million of assessable profits. For a group with multiple Hong Kong constituent entities, the benefit is narrow. More importantly, income allocated to the lower tier in the profits-tax computation may depress the effective rate in the GloBE calculation for that entity.

The commercial stakes are real. A top-up charge in Hong Kong is a cash cost. But the greater risk is the parent jurisdiction's income inclusion rule applying to the Hong Kong entity's underpaid tax before Hong Kong's own qualified domestic minimum top-up tax can shelter it. Sequencing – and timing of implementation steps – determines which jurisdiction collects the top-up.

What is the governing instrument and how does Hong Kong's regime work?

Hong Kong's Pillar Two implementation amends the Inland Revenue Ordinance to introduce a qualified domestic minimum top-up tax and an income inclusion rule, both effective for fiscal years beginning on or after 1 January 2025. The domestic minimum top-up tax is designed to qualify under the OECD's GloBE rules, meaning that if Hong Kong collects the top-up first, the parent jurisdiction's income inclusion rule is displaced for Hong Kong-source income.

The in-scope threshold is consolidated group revenue of at least EUR 750 million in at least two of the four preceding fiscal years, consistent with the OECD model. Groups below that threshold are outside the regime. Groups at or near the threshold need to monitor revenue on a rolling four-year basis, because entry into scope is not a one-time assessment.

The GloBE effective-tax-rate calculation applies jurisdiction by jurisdiction. For Hong Kong, all Hong Kong constituent entities are aggregated. Adjusted covered taxes are divided by GloBE income. The result is compared to 15%. Where the rate falls short, the top-up percentage is applied to the entity's excess profit (GloBE income above the substance-based income exclusion). The substance-based income exclusion – a carve-out for payroll costs and tangible assets – reduces the base on which a top-up arises, which is why genuine substance in Hong Kong remains a structurally important tool even under Pillar Two.

Hong Kong does not impose a withholding tax on dividends or interest in the general position, and there is no capital gains tax. Those features do not directly affect the GloBE computation. What does affect it is the treatment of taxes paid in other jurisdictions by Hong Kong constituent entities: those taxes are credited against the Hong Kong effective-tax-rate calculation only if they qualify as covered taxes under the GloBE rules. Foreign taxes that are refundable or contingent may not qualify.

The filing obligation follows the GloBE information return framework. The return is filed at group level by the ultimate parent entity (the top entity in the group's ownership chain) or a designated filing entity. For Hong Kong constituent entities, the deadline and the content requirements follow the Inland Revenue Ordinance as amended. Groups should verify the current filing timeline with counsel, as the Inland Revenue Department has issued supplementary guidance on the transition period.

For a structured read on how Hong Kong's source and territorial position interacts with offshore holding structures, see our briefing on Hong Kong's source and territorial position for a foreign group.

How does the FSIE regime interact with Pillar Two, and where does the cross-border risk sit?

The FSIE regime, in force from 1 January 2023 as amended, requires Hong Kong entities receiving foreign-sourced dividends, interest, royalties, and gains on disposal of shares or equity interests to satisfy economic-substance conditions to retain the exemption. Where the conditions are not met, the income is taxable in Hong Kong. That charge would count as a covered tax under the GloBE rules and would improve the effective-tax-rate calculation. So, counterintuitively, a Hong Kong entity that fails the FSIE substance test and pays profits tax may have a better Pillar Two position than one that qualifies for the exemption.

That is not a reason to fail the FSIE substance test deliberately. It is a reason to run both analyses simultaneously and to understand the net position across both regimes before committing to a substance model.

The cross-border dimension becomes acute when the Hong Kong entity is a holding company for Mainland China operations. Dividends remitted from a Mainland subsidiary to a Hong Kong holding company are potentially subject to a withholding tax charge under PRC domestic law, reduced by the Mainland–Hong Kong tax arrangement where the Hong Kong entity meets the beneficial-ownership and holding conditions. That Mainland withholding tax is a covered tax for GloBE purposes and flows into the Hong Kong effective-tax-rate calculation. The rate at which it is withheld – and whether it is credited, refunded, or reduces the GloBE base – affects the Hong Kong jurisdiction's effective rate materially.

Our desk regularly sees groups that have structured the Mainland–Hong Kong holding layer to optimise the Mainland withholding tax but have not mapped the flow-through into the GloBE computation. The GloBE rules require taxes to be allocated to the entity that earns the underlying income, using a specific allocation methodology. A tax credit arrangement that reduces cash tax below what the GloBE allocation assumes can produce an unexpected top-up charge.

For treaty access and the beneficial-ownership conditions relevant to the Mainland–Hong Kong holding layer, see our guide to treaty access between Hong Kong and Mainland China.

What is the practical sequence, and what is the gate at each step?

A large group approaching Pillar Two compliance for its Hong Kong entities should work through a defined sequence. Each step has a gate: a condition that must be satisfied before the next step can be completed reliably.

The first step is entity scoping. Identify every Hong Kong constituent entity in the group. The gate is the GloBE definition of constituent entity: broadly, any entity that is consolidated line-by-line, plus any permanent establishment. A Hong Kong branch of a non-Hong Kong entity is a constituent entity. A Hong Kong entity that is equity-accounted rather than consolidated line-by-line may or may not be a constituent entity depending on its ownership percentage and the group's specific structure. Until scoping is complete, the effective-tax-rate calculation cannot be built.

The second step is income allocation. For each Hong Kong constituent entity, map the income streams: locally sourced operating income, foreign-sourced income qualifying for FSIE exemption, foreign-sourced income not meeting the FSIE conditions, and any income from Mainland or other jurisdictions subject to foreign withholding. The gate here is the GloBE definition of income, which differs from Hong Kong profits-tax income. Timing differences, permanent differences, and the treatment of excluded dividends all affect the GloBE base and must be mapped against the entity's statutory accounts.

The third step is covered-tax identification. For each income stream, identify the taxes that qualify as covered taxes: Hong Kong profits tax actually charged, Mainland withholding tax paid and not refundable, and any other creditable foreign tax. Deferred-tax assets and liabilities require specific treatment under the GloBE rules. The gate is confirmation that the taxes are not subject to refund or contingent recovery in a way that would exclude them from covered taxes.

The fourth step is the effective-tax-rate calculation. Aggregate adjusted covered taxes across all Hong Kong constituent entities and divide by GloBE income. If the rate is at or above 15%, no top-up arises. If below 15%, calculate the excess profit after the substance-based income exclusion, and apply the top-up percentage to that amount. The gate is the substance-based income exclusion calculation: payroll costs and the carrying value of tangible assets, reduced by a percentage that transitions over the implementation period. Groups with material substance in Hong Kong – genuine employees, real premises, active management – will have a larger exclusion and a smaller top-up base.

The fifth step is domestic minimum top-up tax filing and payment. Where a top-up arises, the Hong Kong entity files under the domestic minimum top-up tax provisions. If the domestic top-up tax is collected, the parent jurisdiction's income inclusion rule is displaced for that amount. The gate is the qualified status of Hong Kong's domestic minimum top-up tax: the regime is designed to qualify, but the parent jurisdiction's domestic legislation may impose its own conditions. Groups with ultimate parent entities in jurisdictions that have implemented Pillar Two need to verify that the Hong Kong domestic top-up is recognised as a qualified domestic minimum top-up tax in the parent jurisdiction's rules.

The sixth step is the GloBE information return. The return covers all constituent entities globally and is filed by or on behalf of the ultimate parent entity. The Hong Kong constituent entities' data feeds into the consolidated return. Co-ordination between the Hong Kong filing entity, the group's central tax function, and any locally licensed advisers handling the Hong Kong profits-tax compliance is essential to avoid inconsistencies between the profits-tax return and the GloBE information return.

Our tax positions practice covers the full sequence: Tax Positions at Lockhart & Yip.

What is the most common structural mistake, and how is it avoided?

The most common mistake we see in our cross-border practice is treating the Hong Kong profits-tax analysis and the GloBE effective-tax-rate analysis as the same computation. They are not. A group that has correctly managed its Hong Kong profits-tax position – whether through territorial sourcing, FSIE exemptions, or intercompany pricing – may still produce a sub-15% effective rate under the GloBE formula because the two computations use different income definitions, different tax bases, and different allocation rules.

A specific version of this mistake: a group with a Hong Kong treasury entity that earns interest income from Mainland subsidiaries. Under Hong Kong profits-tax principles, the source of that interest income is a factual question, but treasury operations of this kind can often be sourced outside Hong Kong. If the income is treated as non-Hong Kong-sourced and is not subject to profits tax, the covered-taxes numerator for that entity in the GloBE calculation is low. If the entity's income is also modest, the effective rate may clear 15%. But if interest income is large relative to the entity's other income, and the covered taxes are negligible, the effective rate falls below 15% and a top-up arises.

The route around this error is to run a GloBE model for each Hong Kong constituent entity at the time structural decisions are made, not as a retrospective compliance exercise. The substance-based income exclusion rewards entities with genuine payroll and tangible assets in Hong Kong. A treasury entity with one director and a registered address, but no real staff or equipment, will have a minimal exclusion and will face the full top-up on excess profit above 15%. Moving to a model with real treasury functions, experienced staff, and managed assets in Hong Kong changes the exclusion calculation and may eliminate or materially reduce the top-up charge.

What foreign counsel – particularly counsel from jurisdictions without a territorial tax system – sometimes get wrong is the relationship between source and effective rate. They assume that because Hong Kong tax is low on offshore income, the Pillar Two problem is large. That is true for entities with no substance. It is not true for entities with genuine Hong Kong-based management and operations, because the substance-based income exclusion protects a portion of income that corresponds to genuine economic activity.

A second common mistake is failing to account for the transition rules. The GloBE rules include transitional safe harbours and transitional penalty relief provisions. For the transition years, a group that qualifies for the transitional CbCR safe harbour (the country-by-country reporting safe harbour, which uses simplified data from the group's existing country-by-country report to determine whether the effective rate exceeds a simplified test rate) may be able to defer a full GloBE computation for Hong Kong while demonstrating compliance at a reduced administrative cost. Groups that overlook this safe harbour incur unnecessary compliance cost in the transition period.

How should the group assess its Hong Kong structure against Pillar Two: a decision checklist?

The checklist below maps the key decision points for a large group reviewing its Hong Kong constituent entities against the minimum top-up tax. It is a practical reference, not a substitute for a entity-by-entity analysis.

Step 1 – Confirm in-scope status. Is the group's consolidated revenue EUR 750 million or above in at least two of the four preceding fiscal years? If yes, the regime applies. If borderline, monitor on a rolling basis.

Step 2 – Map Hong Kong constituent entities. List every Hong Kong entity consolidated line-by-line and every Hong Kong branch of a non-Hong Kong entity. Confirm the ownership percentage and consolidation method for any entity near the threshold for inclusion.

Step 3 – Identify income streams. For each entity, categorise income as: locally sourced operating income; foreign-sourced income meeting FSIE substance conditions; foreign-sourced income not meeting FSIE conditions; and dividend or interest income from Mainland or other jurisdictions subject to withholding. Note whether each stream is subject to profits tax, exempt, or excluded.

Step 4 – Build the GloBE effective-tax-rate model. Use the GloBE income definition, not the Hong Kong profits-tax base. Apply the covered-taxes test to each tax charge. Run the effective-tax-rate calculation for the aggregated Hong Kong jurisdiction. If the rate is at or above 15%, document the basis and retain it for the information return.

Step 5 – Calculate the substance-based income exclusion. For each entity, identify eligible payroll costs and the carrying value of tangible assets in Hong Kong. Apply the applicable transition percentages. A larger exclusion reduces the excess-profit base on which the top-up is calculated.

Step 6 – Assess the domestic minimum top-up tax position. If a top-up arises after the exclusion, confirm that the Hong Kong domestic minimum top-up tax qualifies in the parent jurisdiction's rules. Where it does, file and pay domestically to displace the income inclusion rule in the parent jurisdiction.

Step 7 – Assess the transitional CbCR safe harbour. Does the Hong Kong jurisdiction satisfy the simplified effective-tax-rate test using CbCR data? If so, the group may qualify for the safe harbour and can defer the full GloBE computation for the transition period. Verify the current safe-harbour conditions and expiry timeline with counsel.

Step 8 – Co-ordinate the GloBE information return. Confirm the filing entity, the filing jurisdiction, and the data handoff from the Hong Kong profits-tax compliance file to the group GloBE return. Inconsistencies between the two sets of numbers create audit risk in both Hong Kong and the parent jurisdiction.

The sequence above describes the standard position. Your matter turns on the specific entities engaged, the income streams actually flowing through Hong Kong, and the parent jurisdiction's own Pillar Two implementation – which is where the effective-tax-rate outcome is won or lost. For a structured assessment of your Hong Kong constituent entities and the GloBE effective-tax-rate position across the relevant jurisdictions, write to us at info@lockhartyip.com.

What are the enforcement risks if compliance steps are missed?

Enforcement risk under Pillar Two is a cross-border calculation. If the Hong Kong domestic minimum top-up tax is not paid where it arises, the parent jurisdiction's income inclusion rule applies. That means the parent jurisdiction collects the top-up, and the group has lost the benefit of paying it domestically – including any domestic filing position or currency advantage.

For groups with ultimate parent entities in jurisdictions that have implemented the undertaxed profits rule – the backstop mechanism that applies where neither the domestic minimum top-up tax nor the income inclusion rule has collected the relevant amount – the exposure is multilateral. The undertaxed profits rule is allocated across jurisdictions by formula, and Hong Kong entities' income may contribute to that allocation in multiple jurisdictions simultaneously.

The Hong Kong Inland Revenue Department has powers to assess, impose penalties, and require information in connection with the minimum top-up tax, consistent with the existing profits-tax compliance regime as amended. The GloBE information return creates a global data trail that each tax authority in the group's chain can use. An error or omission in the Hong Kong data point in that return can produce enquiries not just from the Inland Revenue Department but from the parent jurisdiction's tax authority, which has access to the same consolidated data.

Groups that have not yet run a GloBE effective-tax-rate model for their Hong Kong entities are running an unquantified exposure. The risk is not necessarily large – for entities with genuine substance and locally sourced income, the effective rate may comfortably clear 15%. But until the model is built, the exposure cannot be sized, and it cannot be managed.

If an earlier assessment of your Hong Kong constituent entities produced an unclear or inconclusive result, a second read can identify the structural issue and the steps still available to address it. For a preliminary read on your Pillar Two position and the filing route across the relevant jurisdictions, email info@lockhartyip.com.

Related practices and further reading

Related practices

• Tax Positions – Cross-border tax structuring, FSIE, Pillar Two, and treaty analysis for large groups
• Holding Structures – Hong Kong and offshore holding entity design, substance, and governance

Speak with Lockhart & Yip

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

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