On 27 March 2020, the Hong Kong Inland Revenue Department (IRD) published a revised version of Departmental Interpretation and Practice Notes No.39 (Profits Tax Digital Economy, Electronic Commerce and Digital Assets-revised DIPN 39). The revised Practice Note sets out the taxation principles that broadly apply to e-commerce transactions and digital assets. Revised DIPN 39 supersedes the previous version issued in July 2001 and it is expected that this Practice Note would require further updating after the introduction of new international tax rules, potentially later in 2020.

The following materials are included in the revised DIPN 39

E-COMMERCE MODELS

E-commerce models focus on conducting transactions through networks such as the internet. Products are sold online through the use of a range of digital technologies, including artificial intelligence, blockchain, the Internet of Things, and autonomous delivery devices, to facilitate e-commerce while payment services like mobile money and digital wallets widen the scope of e-commerce.

CHARGE OF PROFITS TAX

Currently, the Inland Revenue Ordinance (the Ordinance) does not contain any specific provisions that deal with the taxation of e-commerce. The tax consequences of e-commerce transactions are to be determined by reference to the profits tax provisions of the Ordinance which apply to a person carrying on a trade, profession or business in Hong Kong.

CARRYING ON BUSINESS IN HONG KONG

The question of whether certain operations or activities amount to the carrying on of a trade or business is a question of fact and degree upon consideration of all the circumstances. Although it is not essential for a person carrying on a trade or business to have an office, staff or organisation, where none of these attributes exists, there must be other clear evidence of carrying on a trade or business. Section 50AAK(1) of Cap. 112 provides that a non-Hong Kong resident person is regarded as carrying on a trade, profession or business in Hong Kong for the purposes of charging profits tax if the non-Hong Kong resident person has a permanent establishment in Hong Kong.

LOCALITY OF PROFITS

The Ordinance does not contain a comprehensive set of source rules. To determine the source of particular profits, guidance is often obtained from judicial precedents. In this regard, the courts have often stated that the determination of source is a practical, hard matter of fact. Furthermore, the courts have tended to emphasise certain factors as being relevant in determining the source of particular types of income.

TRANSFER PRICING

Revised DIPN 39 introduces a new transfer pricing section following the introduction of transfer pricing legislation in Hong Kong in 2018. In the context of e-commerce, the authorised OECD approach is to be applied to attribute profits to a permanent establishment. It is basically a two-step approach: use functional and factual analysis to hypothesise the permanent establishment as a distinct and separate enterprise; and apply the arm’s length principle to the hypothetical enterprise in accordance with the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (TPG), published on 10 July 2017, by analogy. Since intangible assets may be important in the earning of profits from e-commerce transactions, it is necessary to determine which part of the enterprise economically owns and has created the intangible assets used by the permanent establishment.