HK Taxation of E-Commerce

Hong Kong’s tax system has always been recognised as simple and straightforward, however, this system has faced challenges in recent years due to the development of the e-commerce industry. On 27 March 2020, Hong Kong’s Inland Revenue Department (“IRD”) issued a revised version of their Departmental Interpretation and Practice Notes No. 39 (“DIPN 39”) to provide updates on Hong Kong’s tax treatment of e-commerce businesses. In this article, we will discuss how DIPN 39 will impact treatment of e-commerce businesses and digital assets.

1. E-Commerce Transactions
Hong Kong utilizes a territorial basis of taxation whereby only income that arises in, or is derived from Hong Kong will be subject to Hong Kong Profits Tax. Therefore, a company that carries on business in Hong Kong but derives profits outside of the city may not be required to pay Hong Kong profits tax on those profits. To determine whether profits are subjectible to Hong Kong profits tax, the IRD will examine the following:

Permanent Establishment

The IRD takes into consideration the presence of a permanent establishment to determine if a company is carrying on a trade, profession or business in Hong Kong for the purposes of charging profits tax.

Previously, it could be argued that e-commerce transactions should not be subject to tax because the mere presence of a server does not constitute carrying on trade in Hong Kong and does not fully substantiate the presence of a permanent establishment. DIPN 39 revises this interpretation and clarifies what conditions an e-commerce transaction must meet to be subjected to Hong Kong profits tax.

In addition, to the extent that a website is stored and accessible on a server, the server may now constitute a “fixed place of business” even if no personnel are required to be on-site to operate the equipment.

Carrying on Business

To determine whether an e-commerce company has been carrying on business in Hong Kong, the IRD will inspect a company’s operations to establish where their core business operations and support activities took place – DIPN 39 lists out the “core operations and support activities” that they consider to be indications of such.

Locality of Profits

The IRD follows the broad guiding principle of “one looks to see what the taxpayer has done to earn the profit in question,” as a company’s presence in Hong Kong does not necessarily equate to deriving income in Hong Kong.

E-commerce transactions have been difficult to characterize as chargeable to profits tax as online transactions are conducted online with minimal staff involvement. To identify the locality of profits, DIPN 39 emphasizes the need to interpret the core operations of a business that generates the profits, and where those operations take place.

2. Digital Assets
Digital assets are often misunderstood and are characterised as similar to each other when in reality, each digital asset varies in their functionality and scope of use. DIPN 39 clarifies the view that it is the nature, not the form of a digital asset that determines its tax treatment.

Initial Coin Offerings (“ICO”)

Digital Assets Held For Investments

Cryptocurrency Businesses

3. Characterisation of Income
DIPN 39 sets rules for determining whether e-commerce payments would be deemed as royalties, specifically if the payments are for the use of, or the right to use a copyright, then the payments would constitute royalties. Any payments that are characterised as royalties, would be deemed as taxable and subject to Hong Kong withholding tax.

4. Transfer Pricing
Transfer pricing refers to the rules and methods for pricing a transaction between related companies. DIPN 39 states that general transfer pricing rules and arm’s length principles apply to e-commerce transactions in the same manner as transactions of tangible assets.

Conclusion
The IRD’s release of the revised DIPN 39 provides welcome clarity to the e-commerce and digital asset industry and helps lay the foundation for these industries to grow. As a licensed Hong Kong CPA firm, the FastLane Group has obtained extensive experience assisting businesses from all industries and we are happy to help with all your audit and taxation needs. Please contact the Fastlane Group for assistance!