capital market seminar - pwchk.com€¦ · importantly, to market integrity. • reminding deal...

Capital Market Seminar13 January 2020

PwC

Agenda

2

Time Details8.30am – 9.10am Registration

9.10am – 9.15am Welcome address by Kennedy Liu

9.15am – 9.50am Sponsor due diligence practices – delivering the regulatory standards by Adams Chan and Marie Chow

9.50am – 10.10am IPO due diligence – experience from other markets by Daniel Barker

10.10am – 10.30am Tea break

10.30am – 10.50am Cybersecurity – sponsor responsibility by Felix Kan

10.50am – 11.10am Accounting – reminders and current focus by Ginny Huang

11.10am – 12noon Recent tax development and listing consideration by Gwenda Ho and Catherine Tsang

12noon – 12.05pm Closing remarks by Edmond Chan

Presentation by Adams Chan and Marie Chow 13 January 2020

Sponsor due diligence practices – Delivering the regulatory standard

PwC

Our speakers

4January 2020

Marie ChowSenior Manager, Financial Services Risk and RegulationsT: +852 2289 8437E: [email protected]

Adams ChanPartner, Financial Services Risk and RegulationsT: +852 2289 2784E:[email protected]

PwC

Agenda

5January 2020

1. Introduction 2. SFC’s expectations over sponsor activities 3. Challenges in practice4. Q&A

Introduction

PwC 7January 2020

Why focusing on “sponsor due diligence”?

Between 2009 and now, Hong Kong has remained one of the top listing venue for Initial Public Offerings (“IPO”) in terms ofthe funds raised. The Securities and Futures Commission of Hong Kong (“SFC”) has been attempting to tighten its grip onregulations in the city and to improve protection for investors, especially in relation to IPOs from China.

“Sponsor failure” is one of the misconduct identified by the SFC leading to disciplinary actions of the licensed corporationsconcerned.

The SFC expects and requires sponsors to uphold the highest standards and carry out proper due diligence which is afundamental safeguard in the listing process.

PwC

Why focusing on “sponsor due diligence”? (cont’d)

8January 2020

Under the rules, the purpose of due diligence is to enable thesponsor to know and understand the listing applicant and besatisfied that it complies with the Listing Rules and other legaland regulatory requirements.

The SFC highlighted that in many cases investigated bythem, sponsors failed to scrutinise and verify key informationin a prospectus and examine information with professionalscepticism.

Sponsors are expected to ensure the listing documentcontains sufficient particulars and information to enable areasonable person to form a valid and justifiable opinion ofthe shares, the financial condition and the profitability of thelisting applicant.

PwC 9January 2020

Current regulatory landscape

• One of the key regulatory topics and focuses of the regulator• There are codes, guidelines and circulars issued by the SFC governing sponsor business, e.g. :

• Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission Chapter 17

• Corporate Finance Advisor Code of Conduct (October 2013)• Report on the Thematic Review of Licensed Corporations Engaged in Sponsor Business

(March 2018)

• Report on Sponsor Theme Inspection Findings (March 2011)

PwC 10January 2020

Recent enforcement casesFinancial Institution acting as sponsor Key findings on sponsor failures Penalties

Sponsor A

– Sponsor for Company A

Enforcement Time: 27 May 2019

As a sponsor, Sponsor A failed to:• Conduct adequate due diligence process with respect to

a deregistered customer• Perform adequate due diligence on third party payments• Perform adequate due diligence on the suppliers and

customers

HK$27 million

Sponsor B1 and Sponsor B2

– Sponsor for Company B

Enforcement date: 14 March 2019

As a sponsor, Sponsor B1 and Sponsor B2failed to:• Examine and verify the business of China Forestry

including its compliance with relevant laws and regulations, insurance covers and customers

• Take reasonable step to follow up on red flags• Perform appropriate interview practice

Sponsor B1:HK$375 million and suspension of license (For Company B and Company C case)

Sponsor B2:HK$59.7 million

PwC 11January 2020

Recent enforcement cases (cont’d)Financial Institution acting as sponsor Key findings on sponsor failures Penalties

Sponsor B1

Sponsor C1

Sponsor C2

–Sponsor for Company C


As a sponsor, Sponsor B1, Sponsor C1 and Sponsor C2 failed to:• Perform appropriate interview practice• Take reasonable step to follow up on red flags raised in

an interview

Sponsor B1: HK$375 million and suspension of license (For China Forestry and Tianhe case)

Sponsor C1:HK$224 million

Sponsor C2: HK$128 million

Sponsor D

–Sponsor for Company D

Enforcement date: 9 July 2018

As a sponsor, Sponsor D failed to:• Take reasonable step to follow up on red flags• Perform appropriate interview practice• Maintain sufficient audit trail for the work performed

HK$24 million

PwC

Recent enforcement cases (cont’d)

12January 2020

Financial Institution acting as sponsor Key findings on sponsor failures Penalties

Sponsor E

–Sponsor for Company E

Enforcement date: 17 May 2018

As sponsor, Sponsor E failed to:• Perform appropriate interview practice• Provide proper supervision and resources with the

appropriate level of experience

HK$57 million

Sponsor F

–Sponsor for Company F


As sponsor, Sponsor F failed to:• Conduct all reasonable due diligence before submitting

an application • Ensure that all material information has been included in

the Application Proof• Ensure that all information provided to the regulators is

accurate and not misleading

HK$15 million

SFC’s expectations over sponsor activities

PwC

The SFC’s sponsor regulatory regime came into effect in October 2013. Since then, the SFC has carried out anumber of inspections and has recently published the results of their thematic review findings. These primarilyrelated to deficiencies and non-compliance with respect to the due diligence performed, internal systems andcontrols and record retention requirements. These include failings in the following areas.

SFC’s expectations over sponsor activities

14

January 2020

• Exercising reasonable judgement and applying professional skepticism Understanding the listing applicant Due diligence plan and checklist Relying on experts Relying on third parties Identifying and following up on red flags

• Interview practices Determining who to interview and establishing they are an appropriate

interviewee Follow up actions in response to irregularities and other matters arising

Due diligence

PwC

SFC’s expectations over sponsor activities (cont’d)

15January 2020

• Establishing appropriate systems and controls in respect of due diligence processes

• Adequacy of resources and technical capabilities must be thoroughly considered in the deal team's composition

• There should be clear involvement of senior management and governance committees

• An annual assessment must be carried out to ensure that systems and controls remain effective

Resources, Systems and Controls

PwC

SFC’s expectations over sponsor activities (cont’d)

16January 2020

• Maintaining a detailed due diligence plan, including subsequent changes made to the plan

• Maintain clear documentation on work performed in respect of key risks and how management were involved in making decisions

• As a general principle, sufficient audit trails should be maintained to evidence work performed

Record Retention

PwC

Key elements of a due diligence program

17January 2020

• Assessing financial literacy, experience and competence

• Reviewing past records of performance• Identification of potential ‘red flags’ relating

to previous roles, behaviours or actions

• Assessing the expert’s competence, qualifications, experiences and resources

• Scoping and reviewing the expert’s work to assess whether disclosures have been made completely, accurately and appropriately

• Review key aspects of the applicant’s business (e.g. business model, connected relationships, financial balances)

• Evaluating the legal and regulatory risks of the applicant’s business activities

Directors andsenior

management

Listing document

disclosures and other

information

Expert sections of the listing document

Governance and internal

controls

Business, financial, legal and regulatory

Qualifications for listing

• Evaluating the corporate governance structure, and accounting and management systems against the Corporate Governance Code

• Evaluating the impact of significant transactions outside the ordinary course of business

• Verifying whether the applicant meets the minimum listing requirements (e.g. the profit test)

• Ensuring the consistency of disclosures made in the listing document to the due diligence results obtained

Challenges in practice

PwC

Challenges in practice

19January 2020

We have set out below common deficiencies / issues that we have seen across the industry.

Planning and scoping the due diligence program

Governance and management oversight

Involvement of third parties and experts

• Due diligence templates being used with little to no modifications.• Significant modifications after planning may indicate insufficient scoping was performed.• Insufficient analysis and profiling of the listing candidate to identify material businesses.• Inadequate risk assessment to identify areas of focus and procedures to address such risks.

• Significant issues that were logged by the transaction team were not escalated to management or dealcommittees.

• Incomplete or unclear records of meetings / discussion and evidence of decisions made bymanagement or governance committees.

• Principals being stretched across multiple engagements, leading to challenges in demonstratingadequate supervision.

• Due diligence conducted by staff over key areas without sufficient experience, guidance and / orsupervision.

• Lack of clarity on how the scope of work was determined.• Insufficient evidence of involvement in overseeing the work performed and resolution of issues arising.• Unclear how inconsistencies were resolved between the reports received from third parties and experts,

and areas of due diligence conducted by the transaction team.

PwC

Challenges in practice (cont’d)

20January 2020

Execution of due diligence plan

Record keeping

• Planned procedures were not executed and alternative procedures were inadequate to address the relevant risks.

• Certain key stakeholders were not interviewed as part of the due diligence process.• Inadequate justification of how the sample of customers / suppliers was determined to be appropriate.• Customer identities were not authenticated prior to interviews (in person or over the phone) being

conducted.• Confirmations were not sent to customers to confirm business relationships and / or transaction amounts. • Control was not maintained over the confirmation process, resulting in confirmations being received

directly from the listing applicant.• Insufficient follow up on negative news searches on directors / key management of the listing applicant.

• Insufficient audit trails / documentation retained in the deal files to evidence procedures performed and conclusions drawn.

• Conclusions are not drawn in respect of due diligence procedures performed.• Insufficient evidence of how changes to the initial due diligence plan were approved.

PwC

Some suggestions to enhance the control framework . . .

21January 2020

01Industry

Guidelines

02Enhanced

Procedures

03Deal

Lookback

• Building a library of industry specific risk considerations, along with suggested due diligence procedures to help deal teams to tailor their due diligence plans.

• Defining minimum standards, due diligence procedures and templates to be applied in specific areas (e.g. scoping material businesses). This will enable deal teams to demonstrate robustness of their planning and execution.

• Implementing checks to assess the sufficiency of due diligence procedures performed against the disclosures made in the prospectus. This should instil greater diligence in the execution and documentation in respect of key risk areas.

PwC

Some suggestions to enhance the control framework . . . (cont’d)

22January 2020

04Training

05Documentation Requirement

• Reinforcing the dual responsibility a sponsor has to their clients and more importantly, to market integrity.

• Reminding deal teams of the requirement for professional skepticism and the expected standards of their work.

• Defining documentation requirements such as trackers for material issues, deviations from initial due diligence plans and completion checks.

• Formalising sign-offs of the principal, senior management and governance bodies.

06Compliance

Review

• Establishing a more comprehensive and in-depth compliance review programme which goes beyond the “minimum” requirements and looks into individual deals.

pwchk.com

Thank you!

This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.© 2020 PricewaterhouseCoopers. All rights reserved. PwC refers to the Hong Kong member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.

Presentation by Daniel Barker13 January 2020

IPO due diligence –experience from other markets

PwC

Please get your mobile ready…

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PwC 27

PwC

Feedback on the Hong Kong IPO process

28

“My finance team was deluged with due diligence requests, many of which were repetitive and ultimately unnecessary”

“If I had known better at the start of the process what really mattered to the investors, we would have structured the process much more efficiently”

“The banks gave excellent advice on the core judgements but at times this got lost in translation when it came to implementation”

“It was hard to interpret and assess the feedback from the banks throughout the process in order to know properly where we stood”

“The banks did a great job but my impression was that they were constantly trying to game each other” “I was surprised at how quickly legal and advisory

costs racked up – in the heat of execution it was easy to lose track of that and in hindsight this should have been monitored more carefully”“I think our owners probably underestimated the task

of getting our systems ready for listed company life. We could have done with much more help around that”

PwC

Still not working well?

29

PwC

IPO costs

30

5.5%

7.4% 7.7% 8.2%9.1%

12.5%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

Euronext Deutsche Borse NYSE LSE NASDAQ Hong Kong

Comparison of IPO costs

PwC 31

1.9% 2.6%1.2%

4.9%

2.1%

10.0%3.6%

4.8%6.5%

3.3%7.0%

2.5%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%


Comparison of IPO Costs - components Non-underwriting Underwriting

IPO costs

PwC

Underwriting commission

32

-

100

200

300

400

500

600

700

800

900

1,000

<1 >1 <2 >2 <3 >3 <4 >4 <5 >5 <6 >6 -

1

2

3

4

5

6

7

8

Higher underwriting commission for dual listings in HK + US

Lower underwriting commission from SoEs

Smaller companies generally have a higher underwriting cost

PwC

Capital market due diligence models

33

US UK Hong KongProspectus liability Underwriter Sponsor SponsorLegal opinion 10b(5) opinion Fairness opinion Fairness opinionAudit opinion Addressed to issuer Addressed to issuer and

SponsorAddressed to issuer and

SponsorAuditor comfort letter Yes Yes

(no auditor due diligence meetings)

Yes

Reporting on financial history

- Detailed due diligence report and assurance opinion

addressed to issuer and Sponsor

-

Reporting on working capital forecasts

- Detailed due diligence report and assurance opinion


Assurance opinion addressed to issuer

Reporting on internal controls

Detailed due diligence report and assurance opinion


Factual findings report addressed to issuer +/-

Sponsor

PwC

Our client base is different…1. High proportion of Asian frauds involve

direct or indirect misappropriation of resources via related third parties using hidden or disguised transactions.

2. Earnings manipulation takes place to cover up disappearing assets and to increase the company’s ability to raise further capital.

3. Different from many Western frauds, where more often there is earnings manipulation from individuals only within the organisation simply to boost the share price and/or to disguise liabilities and failing business models.

34

• Making fictitious buyout offers• Under-reporting bank loan balances• Creating non-existent or fictitious shell companies as

customers with no verifiable revenue• Creating fictitious shell companies• Suppliers with no verifiable revenue• Under-reporting insider transactions and money

transfers• Indulges in insider trading that is never disclosed• Indulges in pump and dump schemes• Stealing company's assets by transferring it to

insiders leaving the shareholders with empty shell company owning no asset

• Forging employee numbers• Uses the companies cash to secure the debt of

companies privately owned by insiders,• Posting fake cash and fake revenue in their financial

statements• Collaborating with local bank officials in China to

inflate profit margins and dupe shareholders, underwriters and auditors

PwC

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35

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PwC 36

PwC

Data for diligence is becoming increasingly important

37

0.8 1.3

7.9

35

1

6.3

28

0.42.4

10.5

2009 2010 2015 2020

Data

External

Public filings

Market data

Internal

Financial

Operating

PwC

Guidance…

38

2010: 6 pages 2015: 778 pages

PwC

What is reasonable?

39

“We, ..........., are the sponsor appointed by .............. (the “Company”) on [Date] […]

Under rule 3A.13 we declare to [the SEHK] (the “Exchange”) that:

(a) all of the documents required by the Exchange Listing Rules, the [CWUMPO and other applicable laws and regulations] to be submitted to the Exchange […] in connection with the Company’s listing application have been submitted;(b) having made reasonable due diligence inquiries, we have reasonable grounds to believe and do believe that:

[…](iii) the Company’s listing document contains sufficient particulars and information to enable a reasonable person to form as a result thereof a valid and justifiable opinion of the shares, the financial condition and profitability of the Company at the time of the issue of the listing document;(iv) the information in the non-expert sections of the listing document:

(A) contains all information required by relevant legislation and rules;(B) is true, accurate and complete in all material respects and not misleading or deceptive in any material respect […][…]

(vii) there are no other material issues bearing on the Company’s application for listing of and permission to deal in its securities which, in our opinion, should bedisclosed to the Exchange;[…](d) in relation to the information in the expert reports, we, as a non-expert, after performing reasonable due diligence inquiries, have no reasonable grounds to believe and do not believe that the information in the expert reports is untrue, misleading or contains any material omissions.

Signed: ..........................................................Name: ............................................................For and on behalf of: ........................................ [insert the name of sponsor]Dated: ...........................................................

PwC

Framework does exist…

40

PwC 41

PwC

So why is it not being used?

42

1.9% 2.6%1.2%

4.9%

2.1%

10.0%

3.6%

4.8%6.5%

3.3%7.0%

2.5%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%


Comparison of IPO Costs - components

Non-underwriting Underwriting

PwC

Range of options to consider…

43

Agreed upon procedures

Focused scope due diligence reporting

Full scope due diligence reporting

+/- assistance with methodology

PwC 44

PwC 45

PwC 46

PwC

Assistance with methodology

Perform the following procedures for distributors and retailers selected based on either a risk-based method (eg. Those with former employees, related party relationships, newly appointed, etc), statistical sampling method, randomly or a hybrid of the 3 methods:

Distributors:(i) Analyse distribution contracts and produce a summary of key terms.(ii) Conduct physical interviews with distributors identified as above; describing the distribution model, sell through rates, pricing and their key customers, credit terms etc through interview with distributor management.(iii) Visit warehouses of the selected distributors; observe inventory, test inventory movement records and take photographs.

Retailers:(i) Analyse retail contracts and produce a summary of key terms.(ii) Perform site visits to a sample of retail premises to observe volume of stock on sale, retail prices and perform customer count

For other distributors and retailers not selected above, we can also perform the following procedures:(i) Analyse distribution and retailer contracts and produce a summary of key terms.(ii) Analytical review of historical financial information relating to distributors and retailers for FYE 2012 and FYE 2013(iii) Obtain, to the extent possible, the local corporate information of distributors and retailers, including identification of key principals, ultimate beneficial owners, and incorporation data through use of third party sources such as SinoTrust search and other sources.(iv) Perform adverse media reviews and interrogating social media sources to identify any red flag issues.(v) Send confirmations to a further sample of distributors/retailers requesting confirmation of trading volume and amounts due across the track record period.

47

PwC

Summary

1. Due diligence doesn’t have to be done in-house

2. Outsourcing options are available

3. Approach can be tailored to address specific risk areas

48

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Thank you!


Presentation by Felix Kan13 January 2020

Cybersecurity - sponsor responsibility

PwC

Sharing on Cybersecurity

51January 2020

PwC

Today’s agenda:

1. The new norm: we are exposed already2. Why would we care3. Cyber due diligence

52January 2020

Felix KanPartner, Risk Assurance – Cybersecurity

Presented by:

PwC

$85 billion

Market size of cocaine

Source: The United Nations Office on Drugs and Crime, World Drug Report 2011

$114 billion,

cybercrime in 2011

Market size of cyber crime market

Source: PwC’s The Global State of Information Security Survey 2015

$8 trillion, in 5 years time

Cyber crime damage to global market

Source: Juniper Research

Cyber black market is bigger the “cocaine” market

53January 2020

The new norm: we are exposed already

PwC 55January 2020

PwC 56January 2020

Why would we care?

PwC

Source: https://www.experian.com

Your identity is valuable on the Dark Web

January 20209

Cyber due diligence

PwC

Key questions to ask (don’t jump to Protections)

Crown jewelsFrequencies

How to access

From Where

Who has access

Where are they stored?

January 202011

pwchk.com

Thank you!


Presentation by Ginny Huang13 January 2020

Accounting - reminders and current focus

Accounting reminders and current focus –New accounting standards

PwC

Accounting reminders and current focus — New accounting standards

65January 2020

2018 and 2019 IPOs: Commonly seen accounting question: --

The HKEx expects…• Full retrospective application, in particular for those with stub period/last report period commencing

on or after effective date of new accounting standards.

• Additional criteria if the entity would like to apply prospectively.

PwC

Accounting reminders and current focus — New accounting standards (cont’d)

1 Jan 2018 1 Jan 2019 1 Jan 2020 1 Jan 2021

• IFRS 16 (Leases)— effective for periods commencing on or after 1 Jan 2019

• Amendments to IFRS 3 (Definition of a Business)— effective for periods commencing on or after 1 Jan 2020

• IFRS 17 (Insurance Contracts)— effective for periods commencing on or after 1 Jan 2021

• IFRS 15 (Revenue) & IFRS 9 (Financial Instruments) — effective for periods commencing on or after 1 Jan 2018

66January 2020

PwC

Accounting reminders and current focus – (1) IFRS 9Key differences between IAS 39 and IFRS 9

IAS 39 (Old) IFRS 9 (New)

Impairment model of financial assets based on:Incurred losses

Impairment model of financial assets based on:

Expected credit loss

Less relax effectiveness testing Effectiveness testing 80-125% removed for hedging accounting

Recognises impairment until credit loss event

Recognises expected credit loss at the reporting date and requires use

of forward-looking information

Classification affects the basis of measurement

Simplify classification and emphasis on the business model

Impairment of financial assets

Hedging accounting

Classification and measurement

67January 2020

PwC

HUGE IMPACT!

Accounting reminders and current focus – (2) IFRS 16 Key differences between IAS 17 and IFRS 16 (on lessees’ accounting)

IAS 17 (Old) IFRS 16 (New)

Either as operating lease (off balance sheet) or as finance leases (on balance sheet) Recognise the leased asset as

ROU and corresponding lease liability (on balance sheet)

subject to exemptions

No asset recognisedAssets

Liability

Incomestatement

No liability recognised

Operating lease expense

Operating Lease Finance Lease

Finance lease asset

Finance lease liability

Depreciation & interest expense

Right-Of-Use (ROU) asset

Lease liability

Depreciation & interest expense

68January 2020

Off balance sheet On balance sheet

PwC

IAS 18 RevenueSale of goods

Rendering of servicesRoyaltiesDividendsInterest

IAS 11 Construction ContractsConstruction contracts

IFRS 15 Revenue from contracts with customers 5 steps model for revenue recognition

Accounting reminders and current focus – (3) IFRS 15Scope

69January 2020

Sale of goodsRendering of servicesRoyaltiesDividends(moved to IAS 39)Interest (moved to IAS 39)

Construction contracts

Performance obligations satisfied over time and

at a point in time

Contract assets Contract liabilities

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IAS 18/11 (Old) IFRS 15 (New)

Separate models for:• Construction contracts• Goods• Services

Single model for performance obligations:• Satisfied over time• Satisfied at a point in time

Focus on risk and rewards Focus on control

Limited guidance on:• Multiple element arrangements• Variable consideration• Licences

More guidance on:• Separating elements, allocating the

transaction price, variable consideration, licences, options, repurchase arrangements, contract modifications and so on…

Accounting reminders and current focus – (3) IFRS 15Key differences between IAS 18/11 and IFRS 15

Contract assets and liabilities

70January 2020

PwC

Accounting reminders and current focus – (3) IFRS 15Principal vs Agent (Presentation)

Principal

Agent

Entity whose performance obligation is to provide the specified goods or services itself

Entity whose performance obligation is to arrange for those goods or services to be provided by another party

Nature of promise

71January 2020

“Gross” basis

“Net”basis

RevenueSeller is able to control the specified goods and services beforetransferring to the customers?

Yes

No

Control indicators1) Primary obligor2) Inventory risk3) Pricing discretion4) Credit risk (IAS

18)

Accounting reminders and current focus –Amendments to IFRS 3 (Definition of a Business)

PwC

Accounting reminders and current focus – Overview of Amendments to IFRS 3 (Definition of a Business)Background, key changes and implication

January 202073

Asset acquisition Business acquisition (IFRS 3)

Business acquisitionAsset acquisition

Old: BoarderBusiness definition (i.e. input + process = output)

New: Narrowed

Key changes are…New! Concentration Test

• Optional simplified assessment• Focus on whether substantially all of the FV of the gross assets

acquired concentrated in a single (group of similar) identifiable asset

• If met, conclusive and no need for substantive assessment

New!Substantive Assessment

• Focus on substantive processes

Narrowed definition of output• Focus on goods or services

provided to customers

Yes, concentrated

Not concentratedSubstantive Assessment

No Yes

PwC

Revised Definition of a Business – Decision treeElection of concentration test?

Substantive AssessmentAre there outputs

at the acquisition date?

Is substantially all of the FV of the gross assets acquired concentrated in a single

identifiable asset or group of similar identifiable assets?

Process critical to produce outputs and organised workforce acquired orprocess is unique, scare or cannot be

replaced without significant cost/effort/delay?

Process critical to ability to convert inputs and organised workforce

acquired and other input that workforce can convert to outputs

acquired

Business Asset

No Yes

No

Yes No

YesYes YesNo No

74January 2020

PwC

Definition of business under existing IFRS 3

Input Process Output

Examples: • Non-current assets• Intellectual property• The ability to access

necessary materials or rights• Employees

Examples: • Strategic management

processes• Operational processes• Resource management

processes

Examples: • Return in terms of dividends• Lower cost• Other economic benefit

75January 2020

Consider the ability of market participants of replacing the missing

elements

PwC

ProcessSubstantive process

Key changes – definition of a business

Input OutputContribute to the ability to

create

Market participants can replace the missing elements

and continue to produce outputs

Ability to reduce cost

Goods and services provided to customers√ investment income and

other income from ordinary activities X other economic benefitsX lower costs

Introduction ofnew assessments: - Concentration test; and - Substantive assessment

Assess on market participants’ perspective

76January 2020

Accounting reminders and current focus –Notifiable and connected transactions

PwC

IFRS 16 – Types of lease payment

Fixed paymentsIn-substance fixed paymentsVariable lease payments

Example: Monthly rent of $1M if lessee’s turnover is more than $1

Part of lease liability

Example: Monthly rent of $1M


Index / Rates

Example: Inflation, interest or market rental yield


Other variables

Depends on…

Example: Turnover-based rent, hours of operation

Not part of lease liability

Rental expense RoU RoU RoU

78January 2020

PwC

Lease agreement with third party (listed issuer as lessee)

Fixed rent #

Less than 5%

Notifiable Transaction

Not Notifiable Transaction

Notifiable transactionCompute Assets & Consideration ratios

MBLR14.07 and MBLR14.08(Numerator = RoU recognised by issuer

including PV of lease payment)FAQ 045-2018(c) ), FAQ 046A-2018 (a)

Variable rent

Recognised as RoU under IFRS 16. Regarded as acquisition of assets. Capital nature and not qualifying for

Revenue Exemption MBLR14.04(1)(g)FAQ 045-2018(a) & (b), FAQ 046A-2018 (a)

# Include variable portion depending on index/rate included in RoU under IFRS 16

Recognised as expenses under HKFRS 16. Revenue nature and incurred by the issuer in its ordinary and usual course of business.

FAQ 046A-2018(a)

Not Notifiable Transaction

How IFRS 16 impact notifiable transaction where listed issuers are lessees…

5% or more

79January 2020

What is the change?RoU may trigger notifiable transaction.

No change

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How IFRS 16 impact one connected transaction where listed issuers are lessees…

Lease agreement with connected party (listed issuer as lessee)

Agreement with fixed terms: One-off transaction FAQ 045-2018

Fixed rent # Variable rent

Whether ratio is below threshold and whether other exemption apply

MBLR14A.73, 76 (1) & 76(2)

Fully/Partially exempted for Connected Transaction requirement

Follow Connected Transaction requirement

Yes No

Calculate assets & consideration ratios (Numerator = RoU recognised by issuer

including PV of lease payment) FAQ 045-2018(c) & (d), FAQ 046A-2018 (b)

Connected transaction

Recognised as RoU under IFRS 16. Regarded as acquisition of assets.FAQ 045-2018(a), FAQ 046A-2018 (a)

Recognised as expenses under IFRS 16. Revenue nature and incurred by the issuer in its ordinary and usual course of business.

FAQ 046A-2018(a), FAQ 047-2018

Annual Cap Annual variable lease payment

Calculate revenue, assets & consideration ratios (Numerator = *Max. Annual Cap)

FAQ 046A-2018(b), FAQ 047-2018

Yes No

Fully/Partially exempted for

CCT requirement

Follow CCT requirement

Whether ratio is below threshold and whether other exemption apply

MBLR14A.73, 76 (1) & 76(2)

Continuing Connected Transaction

*If agreement for transaction covers over 1 year, transaction will be classified based on largest cap during the term of agreement. MBLR14A.78

Notifiable transaction

Same as lease agreement with third

party

80January 2020

What is the change?RoU may trigger one-off connected transaction.

No change

# Include variable portion depending on index/rate included in RoU under IFRS 16

Framework agreement may trigger continuingconnected transactions.

Accounting reminders and current focus –Other listing rule reminders

PwC

HKEx Guidance on the presentation of non-GAAP financial measures (GL103-19)Non-GAAP measures in listing documents, financial reports, announcement and circulars should be: • clearly defined• unbiased• not more prominent than GAAP measures• reconciled to comparable GAAP measures• presented consistently over time• should not exclude recurring charges• reconciling adjustments should be presented on gross basis before tax• associated information should be readily and easily accessible• examined by the sponsors, reporting accountants and other experts

“perform appropriate level of due diligence to ensure accurate presentation of non-GAAP financial measures in a listing document......”

82January 2020

PwC

Consultation on Codification of General Waivers and Principles relating to IPOs and Listed Issuers

83January 2020

The relevant rules:

Publication and distribution of annual results and reports

Publication and distribution of interim results and reports

For example: CG Code compliance App 16 financial information

and so on…

Not material (threshold 5%)and so on…

General Waivers or Principals

Not designed to circumvent the profit requirement and so on…

No need to apply waiver if conditions are met.

Disclosure of financial information of subsidiaries or businesses acquired or to be acquired after trading record period by new applicants.

Change of financial year period an so on…

Experience and qualification of company secretary CS assisted by a person who possesses the required qualifications or experience and so on…

Need to apply waiver

PwC

Reminder for IPO applicants to be listed shortly after the end of its most recent financial year

84January 2020

Jan 2020 Feb 2020 Mar 2020Date of Prospectus

Apply waivers for 1st annual result and report

Comply 4.04(1) if FY 2019 financial statements is included in the prospectus…

Not comply 4.04(1) if FY 2019 financial statements is NOT included in the prospectus

Apply waiver for Rule 4.04(1) List on the HKEx before 31 March 2020 Include profit estimate FY 2019 in the prospectus No material adverse change SFC certificate of exemption

HKEX-GL25-11

4.04(1) An entity must include in the accountants’ report its consolidated results for each of the three financial years immediately preceding the issue of the listing document

Apply waiver for Rule 4.04(1) List on the HKEx before 31

March 2020 FY2019 preliminary results

announcements in prospectus SFC certificate of exemption

Prospectus issued within 2 months Prospectus issued in March

pwchk.com

Thank you!


Presentation by Gwenda Ho and Catherine Tsang13 January 2020

Recent tax development and listing consideration

PwC

Items

1. Economic Substance Requirements in No or Nominal Tax Jurisdictions

2. China New Foreign Investment Law

3. BEPS 2.0 : Global Profit Allocation

4. Changes in Tax Treaties between China and Various Countries/Regions in response to BEPS

5. Challenges and Enquiries from HKEx on Tax Matters for IPO Cases

Agenda

87January 2020

Economic Substance Requirements in No or Nominal Tax Jurisdictions

PwC

• EU released first List of Non-Cooperative Jurisdictions (“Blacklist” and “Greylist”) in December 2017.

• Released a scoping document in June 2018 setting out expectations and examples for economic substance regulations.

• OECD issued a paper entitled “Resumption of Application of Substance Activities Factor to No or only Nominal Tax Jurisdictions” in November 2018.

• Objective: to level the playing field and prevent shifting of profits from certain mobile activities to “zero or nominal tax” jurisdictions without corresponding local economy activities.

Background of economic substance requirements

Source: https://www.consilium.europa.eu/en/infographics/tax-haven/89

January 2020

PwC

Adoption into local legislation – Examples (non-exhaustive)

Barbados Business Companies (Economic

Substance) Act, 2018-41 BVIEconomic Substance

(Companies and Limited Partnerships) Act, 2018

Cayman IslandsThe International Tax Co-

Operation (Economic Substance) Law, 2018

Income Tax (Substance Requirements) (Guernsey) (Amendment) Ordinance

2018

Jersey Taxation (Companies –Economic Substance)

(Jersey) Law 2019

Isle of ManIncome Tax (Substance

Requirements) Order 2018

BermudaEconomic Substance Act

2018

Certain jurisdictions have also issued amendments, detailed rules and/or guidelines

Guernsey

LabuanBusiness Activity Tax

(Requirements for Labuan Business Activity) Regulations 2018

Cabinet of Ministers Resolution No. 31 of 2019

Concerning Economic Substance Regulations

UAE

90January 2020

PwC

• A legal / relevant entity which carries on a relevant activity during any financial period must comply with the economic substance requirements in relation to that activity

• An entity that is resident for tax purposes in another jurisdiction* does not need to comply with the economic substance requirements

*which is not on the EU list of non-cooperative jurisdictions, under the BVI legislation

Headquarters

Distribution and service centre

Financing and leasing

Fund management

Banking

Insurance

Shipping

Holding company

Intellectual property

How is this interpreted?

Key points of the BVI and Cayman Islands legislation

Cayman Islands: Need to meet substance requirements only if there is relevant income

BVI: May need to meet substance requirements even if there is no income in certain situations

91January 2020

PwC

Adequate expenditure in the

Islands

Adequate no. of qualified

employees in the Islands

Relevant activity directed and

managed in the Islands

Adequate physical office / premises / equipment in the

Islands

• Adequate number of board meetings in the Islands.

• Directors attending such meetings must include adequate expertise to direct the relevant activities.

• Decisions must be minuted and minutes kept in the Islands.

IP Business: Presumption that a legal entity does not conduct CIGA in the Islands if it is a high risk IP legal entity, unless the evidential threshold for rebutting this presumption is satisfied

Substance requirements (other than for holding business)

Conduct core income generating activities (CIGAs)

in the Islands

92January 2020

PwC

Core Income Generating Activities – ExamplesRelevant activity Definition Core Income Generating Activities (“CIGA”)

Distribution and service centre business

• Purchasing from an entity in the same Group (i) components parts or materials for goods, or (ii) goods ready for sale, and reselling such components parts, materials or goods outside the Islands; and / or

• Providing services to an entity in the same Group in connection with the business outside the Islands

Does not include any activity included in any other relevant activity except holding companies business

i. Transporting and storing goods, components and materialsii. Managing stocksiii. Taking ordersiv. Providing consulting or other administrative services

Financing and leasing business

Providing credit facilities for any kind of consideration to another person but does not include financial leasing of land or an interest in land, banking business, fund management business or insurance business

i. Negotiating or agreeing fund terms ii. Identifying and acquiring assets to be leasediii. Setting the terms and duration of financing or leasingiv. Monitoring and revising financing / leasing agreements and

managing risks associated with agreements

Headquarters business

• Provision of senior management;• Assumption / control of material risk for activities carried out

by any of those entities in the same Group; or• Provision of substantive advice in connection with the

assumption or control of risks mentioned above, to an entity of the same Group. Excludes banking, financing & leasing, fund management, intellectual property, holding company, or insurance business

i. Taking relevant management decisionsii. Incurring expenditures on behalf of other entities in the Groupiii. Co-ordinating activities of the Group

93January 2020

PwC

Holding company business

Reduced requirement for holding company business

A pure equity holding entity, which carries on no relevant activity other than holding only equity participations in other entities and earing dividends and capital gains, has adequate substance if it:-

(a) Complies with its statutory obligations / filing requirements under the relevant company law; and

(b) Has adequate human resources and premises for holding / managing the equity participations.

It is not required to be directed and managed in the Islands.Can be outsourced to the registered agent

Holding non-equity investments at the same time will fall outside the scope (in the BVI)

94January 2020

PwC

Non-resident

BVI Cayman Islands

• Letter or certificate from, or issued by, the competent authority stating that the entity is considered to be resident for tax purposes in that jurisdiction

• Assessment to tax on the entity• Confirmation of self assessment to tax• Tax demand• Evidence of payment of tax• Any other document issued by the

competent authority

• Tax Identification Number• Tax residence certificate• Assessment or payment of a corporate

income tax liability on all of that entity’s income in the Islands from a relevant activity

Proof of residency of another jurisdiction

95January 2020

PwC

Key dates

2019 20212020

31 Dec 2018Accounting year-end

1 JanSubstance legislation effective

1 Jul Compliance by existing entities

31 Dec Filing of first report (no

later than 12 months after the last day of each

financial year commencing on or after 1 Jan 2019)

Authority’s assessments

Spontaneous exchange of information where applicable

1 JanSubstance legislation effective

Cayman Islands

BVI

30 Jun Compliance by existing

entities

29 Jun

First latest financial period to meet substance

requirements

Jan – Mar Notification

28 Dec First substance

reporting (i.e. within 6 months after

financial period end) Note: A new entity needs to satisfy the Economic Substance test when it commences the relevant activity

96January 2020

PwC

“Prescribed information”

Particulars of each registrable legal entity of the corporate and legal entity

Details of the parent for entity claiming itself to be a non-BVI resident

Particulars of beneficial owner(s) of the corporate or legal entity

Details of jurisdiction in which it is tax resident together with residency evidence

Particulars of each corporate andlegal entity

Details of CIGA that is carried out by another entity on its behalf

Details of relevant activities during a financial period

Details of the exempt person

Information required

• “Prescribed information” (mainly on BO and economic substance) needs to be reported under the expanded self-reporting regime and through the BOSS system

• Both a relevant entity and its registered agent have their respective obligations in respect of the prescribed information

• A list of specified information to be provided when a legal entity outsources work / relevant activity to another party

Spontaneous exchange of information under certain circumstances

BVI – Prescribed information to be reported via the Beneficial Ownership Secure Search (“BOSS”) System

97January 2020

PwC

Cayman Islands – Non-compliance

Failure to

satisfy ES

Penalty and

action required

Court order

• First year: KYD10K (US$12K)

• Subsequent year: KYD100K (US$120k)

• Take action to meet ES test by certain date

• Take a specified action

• Order that it is a defunct / struck-off entity

Determination notice issued by Authority (appeal available)

Information exchange

With competent authority of entity’s parent company, UPE, UBO / relevant overseas tax resident jurisdiction

Failed to satisfy test for 2 consecutive

years

For high risk IP business and entity claims to be overseas

tax resident, info will be exchanged regardless of whether ES is satisfiedOthers

• Failure to provide information / provision of misleading information: KYD10K fine and / or 2 / 5 years imprisonment

• Offence by officers (director, manager, secretary, etc.) are also punishable98

January 2020

PwC

• Penalties for failure to provide information or providing false or misleading information

• US$40,000 to US$75,000 and/or 2 to 5 years in prison.

• Penalties in breach of economic substance requirements • 1st offence: US$5,000 to US$20,000 (US$50,000 for high risk IP legal entity). • 2nd offence: US$10,000 to US$200,000 (US$400,000 for a high risk IP legal entity) • Potential strike-off • Disclosure of information of the legal entity in breach of the substance requirements to

the relevant overseas competent authority

Consequences for non-compliance

Exchange of information with jurisdiction in which an entity claims to be tax resident, and any EU member state where the entity has one or more beneficial or legal owners resident.

BVI – Non-compliance

99January 2020

PwC

Impact on Hong Kong listed groups

Cayman Listco

BVI Holdco (private)

BVI Holdco

HK Opco

Public

PRC Opco

100January 2020

PwC


Cayman Listco


BVI Holdco

HK Opco

Public

PRC Opco

Cayman Listco

• May potentially be engaged in one or more of the following relevant activities: Holding company business Financing and leasing business Headquarters business

• But likely to be able to claim itself as a Hong Kong tax resident for purposes of the economic substance legislation (and hence not required to fulfil substance requirements)

101January 2020

PwC


Cayman Listco


BVI Holdco

HK Opco

Public

PR Opco

BVI Holdco

• May potentially be engaged in one or more of the following relevant activities: Holding business Finance and leasing business Headquarters business Distribution and service centre business

• May also rely on non-resident carve-out if already registered in Hong Kong / obtained Hong Kong tax resident certificate

• If not, need to fulfil substance requirements, or otherwise restructure the business

102January 2020

PwC


Cayman Listco


BVI Holdco

HK Opco

Public

PR Opco

BVI Holdco (cont’d)

• Holding business Reduced substance requirement should be

able to meet easily

• Finance and leasing business E.g. if it lends money to group companies and

receives interest income (including bond issuers)

Consider making it interest-free, or restructure

• Headquarters business E.g. if it provides senior management, assumes

risks etc. Can fall within scope even if there is no income Need to consider restructuring

• Distribution and service centre business E.g. if it provides services to group companies

or purchases from group companies Need to consider restructuring

103January 2020

PwC


Cayman Listco


BVI Holdco

HK Opco

Public

PR Opco


• If just a pure equity holding company, should be easy to deal with

• But usually more complicated than that…

• Could be engaged in shares trading Still a pure equity holding company even if

actively trade the shares But need more to fulfil the reduced economic

substance requirements“the entity may actively manage its equity participations, in which case it should have adequate and suitably qualified employees, and appropriate premises, in the BVI to carry out this function” <Rules on Economic Substance in the Virgin Islands>

104January 2020

PwC

Restructuring options

Option Considerations

1. Cease operation and liquidate • Commercial feasibility?• Indirect transfer issues (e.g. in the

PRC)?

2. Claim as tax resident of another jurisdiction (e.g. Hong Kong)

• Late registration?• Historical risk?

3. Modify operation to make it out of scope

• Interim solution only?• Long-term sustainability?• Ongoing risk?

4. Redomicile / relocate operation to another jurisdiction

• Commercial and legal feasibility?• Complexity?• Tax incentives?

105January 2020

PwC

Immediate action (if not yet done)

1 Identify entities set up in no or nominal tax jurisdictions

2 Review their business activities and categorise them

3

Implement the action plan4

Come up with an action plan, e.g.:• Build up substance in place of incorporation• Build up substance / register in another jurisdiction• Streamline / trim down the existing structure to manage costs and address

historical issues • Relocate existing operations from existing entities to newly set up entities• Wind up inactive entities.

Robust assessment is required

Observe compliance obligations5

Cayman notification is due soon

106January 2020

China New Foreign Investment Law

PwC

Background

2015.1.19Foreign Investment

Law (Discussion Draft for public consultation)

2019.3.15Foreign

Investment Law

1979.7.1Sino-foreign Joint

Equity Enterprises Law1986.4.12

Wholly Foreign-owned Enterprises Law

1988.4.13Sino-Foreign

Cooperative Joint Venture Law

1 42 3

2019.12.26The Detailed Implementation Rules (“DIR”) of Foreign Investment Law 2020.1.1

Foreign Investment Law

and the DIR

108January 2020

PwC

Major changes in foreign investment supervision system

Information report security review

for foreign Investment

Business registration

internal governance

Foreign Investment

Supervision

Foreign Investment Law

Company LawPartnership Law

Sino-foreign Joint Equity

Enterprises Law

《中外合作经营企业法》

Sino-Foreign Cooperative Joint

Venture Law

Sino-foreign Joint Equity

Enterprises Law

Three Laws Combined

1. Negative list (National and FTZ)

2. DIR and information reporting system;

3. Allow changes of corporate and organisational form within 5 years

109January 2020

PwC

Foreign investment administrationForeign investment refers to the investment activity directly or indirectly conducted by a foreign natural person, enterprise or other organisation, including:

Foreign investment administration

Pre-establishment national treatment Negative list

treatment given to foreign investors and their investments during the investment access stage, which is not lower than that given to their domestic counterparts

1special administrative measures for the access of foreign investment in specific fields as stipulated by the State

2

For foreign investment： 2019 National Negative List 2019 FTZs Negative List

For both foreign and local investment： 2019 Negative List for Market Access

A foreign investor makes investment to initiate a new project within the territory of

China, independently or jointly with any other investor

A foreign investor makes investment in any other way

stipulated by laws, administrative regulations or provisions of the

State Council

A foreign investor acquires shares, equities, property shares

or any other similar rights and interests of an enterprise within

the territory of China

A foreign investor establishes a foreign-funded enterprise within the territory of China, independently or jointly with

any other investor

01

02

03

04

Chinese individuals

110January 2020

PwC

Promote foreign investment and strengthen protection

Promote foreign investment

Investment protection

Strictly restrict nationalised collection

Complaint system

Government commitment

Protect confidentiality

Strengthen protection

Equal policy

Equal participation

Fair participation in government procurement

Broadening financing through open channels

Foreign exchangeliberation

IPprotection

111January 2020

PwC

Transitional arrangements and application of laws in Hong Kong, Macao and Taiwan

5 years since 1 January 2020Change of

organisational form

The original joint venture/cooperative enterprises are allowed to follow the agreed profit distribution basisProfit

distribution

HK and Macao investors• Follow Foreign Investment Law and the DIR unless otherwise

specified Taiwan investors

• Taiwan Compatriots Investment Protection Law and its DIR• Follow Foreign Investment Law and its DIR for issues not

addressed

Application of laws in

HK, Macao and Taiwan

112January 2020

BEPS 2.0: Global Profit Allocation

PwC

Programme of work to develop a consensus solution

Pillar One

Global Anti-base Erosion ProposalRevised Nexus and Profit Allocation Rules

Reallocating taxing rights to the market/user jurisdictions• new nexus rule• new profit allocation rules• implementation of the new

taxing rights

BEPS 2.0

Addressing the tax challenges of the

digitalisation of the economy

Pillar Two

Setting a minimum effective tax on profits of MNE groups• income inclusion rule /

switch-over rule• Under-taxed payments rule

/ subject to tax rule

Final report in 2020

114January 2020

PwC

Example:

3rd Party Distributor

Related Party Limited Risk Distributor

Country A Country CCountry B

Customers CustomersCustomers

Hong Kong

Sales (Direct)

Sales (3rd Party)Sales (Related Party)

HK Principal

115January 2020

PwC

Pillar 1: Unified approach

3rd Party Distributor

Related Party Limited Risk Distributor

Country A Country CCountry B

CustomersCustomersCustomers

New Nexus

Amount ANew

NexusAmount A

New Nexus

Amount A

Hong Kong

Impact on existing TP

arrangement?

Jointly liable to facilitate

administration

Sales (Direct)

Sales (3rd

Party)

Sales (Related

Party)Amount B+C

HK Principal

Unified approach: three tiered approach

Amount A Amount B Amount C

A share of deemed residual profit allocated to market jurisdictions using a formulaic approach, i.e. the new taxing right

A fixed remuneration for baseline marketing and distribution functions that take place in the market jurisdiction

(Existing TP or fixed remuneration?)

Additional profit where in-country functions exceed the baseline activity compensated under Amount B

(Existing TP)

116January 2020

PwC

HK

Overseas

Pillar 2: How could your business models be affected?Scenario 1: MNC group with HK entity making an offshore claim

>50%

Ultimate Parent Co.

Immediate Parent Co.

HK Co.

>50%

Payment$$

Implications for MNC groups

• Ownership threshold? Assuming >50%

• Minimum top up rate?

• Offshore claim will result in effective tax @ 0% for HK Co. => trigger the income inclusion rule or the undertaxed payments rule / subject to tax rule

• Untaxed income in HK attributed to Ultimate Parent Co. and Immediate Parent Co. and taxed in the parent jurisdictions at the minimum tax rate

• Payments (COS, service fees, interest & royalties, etc.) made by Investee Co. to HK Co. may be denied for tax deduction in the payer jurisdiction

• HK Co. may be denied the reduced WHT on passive income or PE protection for service fees under treaty in the source jurisdiction

Overseas

Effective tax rate @ 0%

Offshore claim on e.g.• Trading income• Service fee income• Interest income• Royalties

1. Income inclusion ruleUntaxed income attributed to shareholders and taxed in the parent jurisdictions

2. Undertaxed payments rule / subject to tax rule• Deny deduction of the payment in the

payer jurisdiction; OR• Deny treaty benefits (e.g. reduced

WHT rate) in the source jurisdiction

Investee Co.

117January 2020

PwC

HK

Country Y

Pillar 2: How could your business models be affected?Scenario 2: MNC group with HK entity making a capital claim

Parent Co.

HK Co.

Investee Co.(non-property

holding)

>50%

Implications for MNC groups



• Capital gain claim will result in effective tax @ 0% for HK Co. => trigger the income inclusion rule or subject to tax rule

• Untaxed income in HK attributed to Parent Co. and taxed in the parent jurisdiction at the minimum tax rate

• HK Co. may be denied the tax exemption for capital gains under treaty in the source jurisdiction

• The undertaxed payments rule does not apply to unrelated party payments

Country X

Effective tax rate @ 0%

Capital gain claim on e.g. • Disposal of shares

1. Income inclusion ruleUntaxed income attributed to shareholder and taxed in the parent jurisdiction

2. Subject to tax ruleDeny treaty benefits (capital gain exemption) in the source jurisdiction

Unrelated Buyer

Country ZPayment$$

118January 2020

PwC

Pillar 2: How could your business models be affected?Scenario 3: Business group enjoying tax concession (e.g. CTC) in Hong Kong (related-party payments)

HK

Overseas

Overseas

Group companies

HK CTC

Loans

Parent Co.

Interest

>50%

Effective tax rate @ 8.25% under concessionary tax regime for CTC

$$

Implications for business groups



• Concessionary profits tax rate for HK CTC @ 8.25% => trigger the income inclusion rule or the undertaxed payments rule / subject to tax rule

• Undertaxed interest income of HK CTC attributed to Parent Co. and taxed in the parent jurisdiction at the minimum tax rate

• Deduction of interest payments may be denied in payer jurisdictions

• HK CTC may be denied the reduced / zero WHT on interest income under treaty in the source jurisdictions

• Similar issues for captive insurance concessionary tax regime

1. Income inclusion ruleLow-taxed income attributed to shareholder and taxed in the parent jurisdiction

2. Undertaxed payments rule / subject to tax rule• Deny deduction of the interest in the

payer jurisdictions; OR• Deny treaty benefits (e.g. reduced

WHT rate) in the source jurisdictions

119January 2020

PwC

Next step• More detailed technical work would be arranged in 2020;

• Target to reach consensus within IF members by 2020;

• Level of enthusiasm for pillar 2 appears mixed among IF members;

• OECD to ensure the basis that both pillars would be agreed together;

• Possible impacts?

• What can we do?

- Increase administrative burden

- Possibly increased tax burden depending on group structure(s)

- Monitor OECD development- Revisit group structure(s) - Assess implications of potential

new tax compliance obligation

120January 2020

Changes in Tax Treaties between China and Various Countries/Regions in response to BEPS

PwC

At a glance

• 2019 China-Italy DTA2019.3.23

• 2019 China-New Zealand DTA2019.4.1

• The Fifth Protocol to the Mainland-HK DTA2019.7.19

• The Forth Protocol to the Mainland-Macao DTA2019.11.28

• 2018 Protocol to China-India DTA 2018.11.26

China signed new Double Tax Agreements (“DTA”) or protocols with below treaty parties during late 2018 and 2019:

Not yet effective by the date of this report

Entered into force on 5 June 2019 Effective in China: 1 January 2020Effective in India: 1 April 2020

Entered into force on 6 December 2019Effective in the Mainland: 1 January 2020 Effective in HK SAR: 1 April 2020

Entered into force on 27 December 2019Effective: 1 January 2020

Not yet effective by the date of this report

122January 2020

PwC

New DTAs and protocols respond to BEPS recommendations

BEPS Action 6

BEPS Action 7

BEPS Action 6

Note: the contents in DTAs may differ from each other.

Articles Persons Covered(BEPS Action 2)

Resident(BEPS Action 6)

Permanent Establishment(BEPS Action 7)

Preamble Language & Entitlement to Benefits(BEPS Action 6)

2019 China-Italy DTA

Yes Yes Yes Yes

2019 China-New Zealand DTA

Yes Yes Yes Yes

Fifth Protocol to the Mainland-HK DTA

Yes Yes Yes

Forth Protocol to the Mainland-Macao DTA

Yes Yes Yes Yes

2018 Protocol to China-India DTA

Yes Yes Yes Yes

123January 2020

PwC

New DTAs and protocols respond to BEPS recommendations

• e.g. The income derived by or through a fiscally transparent entity or arrangement under the tax laws of either Contracting State shall be treated as income of a resident of that State only to the extent that the income is liable to tax in the resident State.

Newly add a provision dealing with fiscally transparent entities

• e.g. the competent authorities of both sides shall endeavour to determine the tax residency of such person by mutual agreement by taking into accounts its place of effective management, the place where it is incorporated or otherwise constituted and any other relevant factors. In the absence of such agreement, such person shall not be entitled to any relief or exemption from tax provided by the DTA.

Revised the tie-breaker rule for determining the residency status of a person other than an individual who is a tax resident of both sides

• e.g. Prevent the splitting up of contracts for Construction-site PE; expand the scope of Agent PE by introducing the concept of “commissionaire arrangement” and applying stricter definition for “independent agent”

Strengthened the definition of Permanent Establishment (PE)

• Revised preamble language to emphasise that in addition to the elimination of double taxation, the purpose of the DTA is also to prevent non-taxation or reduced taxation through tax evasion or avoidance

• Entitlement to benefits clause: a benefit under the DTA shall not be granted in respect of an item of income if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this DTA

Prevent the abusive use of tax treaty and the principal purposes test

Persons Covered

Resident

PE

Preamble language and Entitlement to Benefits

Note: the exact contents in each DTA may differ. 124

January 2020

PwC

Special features

The WHT rates for dividends are reduced from 15% to 5% under certain circumstances.

Reduced withholding income tax (WHT) rates for dividends, interest and royalties under certain circumstances

2019 China-

Italy DTA

stipulates that the income obtained by the government of one party from the other party-based funds it invested in and established based on cooperation with the other party that are mainly used for people's livelihood projects shall be exempt from tax in the other party, in order to relieve tax burden on cooperation projects that benefits people in the two places.

Adding a new “Teachers and researchers” article to grant tax exemption to teachers or researchers of one side for eligible remuneration received for services performed in the other side, which is designed to promote academic exchange and scientific research collaboration between the Mainland and Hong Kong

4th

Protocol to the

Mainland-Macao DTA

5th

Protocol to the

Mainland-HK DTA

2019 China –New Zealand

DTA

125January 2020

PwC

Takeaway

Evaluate existing business models to assess the PE exposure under the expanded scope of PE.

In general more stringent requirements on anti-tax avoidance (PE, principal purpose test, etc)

Lowered WHT rates for China-Italy DTA and China-New Zealand DTA, but no change for China-India DTA which still remain at 10% for dividend, interest and royalty.

126January 2020

Challenges and Enquiries from HKEX on Tax Matters for IPO Cases

PwC

Recent case regarding enquiries from HKEx

• Tax audit was conducted by the IRD before the track record period;

• Tax audit was finalised and settled during the track record period;

Recent case HKEx’s enquiry and request

• Detailed enquiry on the tax audit : e.g. detailed calculation and rationale for the settlement basis, reasons and circumstances leading to the tax audit, etc.

• Disclosure requirement: HKEx requested to disclose the identity of the tax adviser in the IPO documents, and the views of tax adviser on the matter challenged by the IRD

128January 2020

PwC

Fact finding on cases

Review current tax compliance status

Assess the likelihood to be challenged again

Disclosures in accounts and IPO documents

Frequently asked questions about tax

Review and assess

whether tax filing basis adopted are reasonable

or not

Detailed analysis on tax disputes or tax audit

cases

Transfer pricing

policy for inter-group

transactions

Disclosures in IPO

documents

What you need to do? Common questions from HKEx

• Tax disputes or tax audit cases• Outstanding or on-going enquiries

from the tax authorities

• Transfer pricing policy for inter-group transactions

• Reasonableness of tax filing basis adopted

• Tax clearance and filing for cross-border transactions

• Individual income tax compliance

• …… uncertainties due to changes in global tax environment (e.g.

BEPS)? 129

January 2020

pwchk.com

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