The Hong Kong Inland Revenue Department (IDR) on 27 March 2020 published a revised version of Departmental Interpretation and Practice Notes No. 39 – Profits Tax Digital Economy, Electronic Commerce and Digital Assets (“revised DIPN 39”) addressing various key issues concerning taxation of e-commerce transactions and digital assets.
The guidance concerns an evolving area of tax law, and as the government seeks to encourage the digital economy, it will be important for taxpayers in the sector to understand the basis on which they will be taxed. The revised DIPN provides practical guidance on the IRD’s views, but is of necessity a temporary measure pending the conclusion of global discussion on BEPS 2.0.
The revised DIPN 39 contains material changes in relation to the previous version of July 2001. The key highlights from the revised DIPN 39 are summarized below:
The updated DIPN 39 may be viewed as a welcome move in view of the seismic changes that have occurred in the field of electronic commerce and considering recent global developments in the context of the tax challenges arising from digitalisation of the economy. However, while it is useful in giving some practical insights into the IRD’s approach, it perhaps struggles to reconcile a source-based approach to taxation with the realities of digital business. It appears to be far from clear that the core operations and drivers of value creation set out by the IRD are the appropriate basis for determining source, or that the locations in which profits are sourced and business is carried on need necessarily coincide in the context of e-commerce.
The IRD has committed to reviewing its approach next year once the proposals on BEPS 2.0 and the taxation of the digital economy have been finalised.
The revised DIPN 39 indicates that the IRD had reshaped the profits tax principle to some extent by expanding on the previous emphasis on human presence when it comes to e-commerce. The IRD appears to be adopting a broader perspective by considering any Hong Kong-based core operation’s role in a transfer pricing type value creation analysis of the entire business. As such, there is an increasing concern that the IRD may in practice directly apply a transfer pricing principle to determine profit to be taxed in Hong Kong without due consideration of profits tax principle (source principle). It would be helpful for the IRD to further clarify how the source principle and transfer pricing interplay with each other.
The IRD is also silent on when and how additional PE profits are to be determined in DAPE situations. There is an expectation from the business community that no additional PE profit would result if the dependent agent has already received an arm’s length service fee from the related-party non-resident. It is understood that reference can be made to DIPN 60 on DAPE profit-attribution issues, and the IRD considers that it is possible that the result from the application of PE profit-attribution rule can differ from that of the arm’s length principle under an entity-to-entity context, even before the discussion of BEPS 2.0. For DAPE situations, the IRD would only accept that no additional PE profit (on top of arm’s length transfer pricing) would arise if the DAPE does not perform significant people functions on behalf of the non-resident in Hong Kong. In this regard, it is suggested that non-residents with potential DAPE arrangements in Hong Kong need to revisit their current arrangement with their dependent agent to mitigate the risk of creating PEs and potential additional taxable profits in Hong Kong.
For more information, contact the Global Leader of KPMG’s Global Transfer Pricing Services:
Komal Dhall | +1 212 872 3089 | firstname.lastname@example.org
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