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s operations in a state are adjusted upwards to increase the tax payable in that state (i.e. a primary profit reallocation adjustment) without a corresponding downward adjustment to the enterprise'

s profits from its operations in the other state. 5. In each of the DTAs of the Hong Kong SAR, the Associated Enterprises Article, which is modeled on Article

9 of the OECD Model Tax Convention on Income and on Capital (the OECD Model), provides for primary transfer pricing adjustments by a DTA state. The Associated Enterprises Article also provides a mechanism for relief from the resultant economic double taxation to be given by the other DTA state. 6. The Business Profits Article and the Methods for Elimination of Double Taxation Article, which are modeled on Article

7 and Article

23 respectively of the OECD Model, in each of the DTAs of the Hong Kong SAR provide for both primary profit reallocation adjustments and relief from the resultant juridical double taxation. 7. Each of the DTAs of the Hong Kong SAR contains a Mutual Agreement Procedure Article, which is modeled on Article

25 of the OECD Model, that provides, inter alia, for the resolution of cases where a taxpayer is faced with international double taxation. In that article, double taxation is usually regarded as taxation not in accordance with the DTA. The Mutual Agreement Procedure Article enables the competent authorities, which in the case of the Hong Kong SAR is the Commissioner of Inland Revenue (the Commissioner), to consult with each other with a view to resolving double taxation though it does not compel agreement. Paragraph

37 of the Commentary on Article

25 of the OECD Model, which is relevant to interpreting the Mutual Agreement Procedure Article, states: Paragraph

2 (of Article 25) no doubt entails a duty to negotiate;

but as far as reaching mutual agreement through the procedure is concerned, the competent authorities are under a duty merely to use their best endeavours and not to achieve a result ... Where no double tax agreement exists 8. Where either the Commissioner or the tax administration of another state makes a transfer pricing or profit reallocation adjustment and no relevant DTA exists, no bilateral procedures are in place. Accordingly, the question of any relief from the resultant double taxation does not arise.

2 Transfer pricing adjustment by a non-DTA state 9. Where economic double taxation arises from a transfer pricing adjustment made by the tax administration of a non-DTA state to increase the taxable income of an associated enterprise, there are no provisions under the Inland Revenue Ordinance (the IRO) permitting: (a) the profit which has been derived by the Hong Kong enterprise1 to be treated as not derived;

or (b) a deduction to be allowed to the Hong Kong enterprise where no expenditure has been incurred. 10. In these circumstances, the foreign tax paid is a liability of the associated enterprise in the other state. The adjustment does not affect the profits of the Hong Kong enterprise, and therefore no adjustment can be made to the profits of the Hong Kong enterprise. 11. Where juridical double taxation arises for a Hong Kong enterprise that is subject to a profit reallocation adjustment made by a non-DTA state, the profit which has been subject to double taxation will not be excluded from taxation in Hong Kong because the profit has been properly assessed to profits tax as Hong Kong sourced profits. Neither can relief by way of a t........