In this blog we will discuss some examples related to the sale and purchase commission. Then we will explore some other aspects of departmental interpretation and practice notes 21. These will include group service companies, offshore claim processing, agency, book profit and E-commerce.
The income in the form of commission may also arise where in Hong Kong a business is carried on but the activities that generates the commission are not in Hong Kong. In these type of cases, the tax is not allowed on the commission. The examples given below are taken from the department interpretation and practice notes 21 and describe these typical situations:
Example - Purchase or Sales agencies (DIPN 21)
The ‘Far East Area’ purchase or sales responsibility for a single product or group of products is held by a company named as F. That company sells these products into the area or sources in the area by principal’s related concerns. Its associates and concerned company itself are members of a group. That group is under the control of an ordinary parent organization. The appointed agent for that area is company F. It is appointed either by an instruction from parent or by formally accomplished agreements. That company is reimbursed by a ‘commission’ on all purchases and/or sales in its area. Company F may also:
Example - Passive Commission (DIPN 21)
This example is related to a same type of organizational set-up to the agencies as described in above example. But this new Hong Kong open company that was given the responsibility of purchases or sales in the ‘Far East Area’ as a principal is company G. According to the facts, Hong Kong open company G is not able to handle all or any of the group range of products. So, the purchases or sales into from the area are completely made by the associated concerns. It is never planned that, any sales or purchasing function will be performed by that company G. A violation commission is being paid to company G but it does nothing. The only thing it does is possibly the providing of some ‘sales service’ ex-Hong Kong.
On the other hand, it may be the scenario that, company G buys or sells the group products in Hong Kong. (Subsequent profits may be subject to Hong Kong profits tax according to the principals expressed under the description of trading profits). And as inclusion Company G receives ‘commission’ on purchases or sales by associated concerns in the ‘Far East Area’. In accomplishment of a parent organization directive these commissions are rewarded. In association to the ‘associates transactions’ in the ‘Far East Area’ Company G has no contractual position or formal function, i.e. either as agent, principal or sale representative it has no ‘area responsibility’ and it also provides no service in regard of the commission it receives.
DIPN 21 - Group Service Companies
Group service companies refer to the scenario where a Hong Kong company usually as a member of multinational group which provides support services to other group members. These support services include training and marketing and these are provided to the members that are located all over the Asia-Pacific region. The services are provided in Hong Kong significantly. At an agreed mark-up of cost (consistently 5% to 10 %), inter-group charges are constructed. These represent a discounted reward for the services rendered plus a compensation of 100% of the costs included by the Hong Kong company. The reference for these statement is taken from the para 51 of departmental interpretation and purchase notes 21.
The Inland Revenue department considered the profits being mark-up, obtained by the company in Hong Kong for its services as completely assessable. Where the inter-group charges have been prevented to mirror the forcing of withholding tax by the country on the service charges, in which the group organization receiving the services is resident, it would be allowed by the Inland Revenue department to that set up company in HK to withdraw the overseas withholding tax paid from the service which charged free. The main effect is to gauge the company of Hong Kong on the net service fee received. This mirrors the principle set out in departmental interpretation and practice notes 28 ‘Deductibility of overseas taxes, Profits tax’ regarding the confirmability of overseas taxes that are imposed on earnings, not dependent on whether profit is made or not. The reference for these statement is taken from the para 50 of departmental interpretation and practice notes 21.
DIPN 21 - Offshore Claim’s processing by the Inland Revenue Department
For the determination of source of a profit, not all the taxpayer’s operations are relevant. The method to identify the source of profits may vary. It depends on the context in which the transaction occurs and nature of in question transaction.
According to the departmental interpretation and practice notes 21, it is duty of taxpayer providing Hong Kong incorporation services to be ready to prove in their returns. The required documents to prove the returns include supporting documentary to show that revenue which was gained from the operation was gather from other than Hong Kong. For the purpose to raise the assessment for making of enquiry, the evaluator has a legal responsibility. In this method, the assessor is given power by Section 51 (4) to pursue for full information in regard to any matter that may affect any responsibility, obligation or liability of a person. A request about the operations of a transaction in a query would consist of a sensible demand as so required by the public interest. After the case of ING Baring, the power of information-seeking under Section 51 (4) of Hong Kong tax law has not been reduced or restricted in any way. The reference for these statement is taken from the para 56 of Departmental interpretation and practice notes 21.
The last step in profit generating process should not be alleged necessarily as determinative of the source’s locality of profits. The judge Latham CJ said in case of Hillsdon Watts Ltd. that, income collected by a person might be the result of complete series of operations organized in different countries. In the case of Kirk, the judge Lord Davey said that, the misconception of the lower courts was to leave the initial stage hidden and tie up the attention solely on the final stage in income production. The reference for these statement is taken from the para 57 of departmental interpretation and practice notes 21.
DIPN 21 - Agency
The judge Lord Millet NPJ in case of ING Baring while discussing the business of stockbrokers said that, it was not mandatory to establish that, the transaction that generated the profits was carried out by agent of taxpayer or by himself in the full legal sensation. It was enough if that was carried on his behalf and for his description by a person who was reacting on his instructions. The reference for these statements is taken from the para 58 of departmental interpretation and practice notes 21.
The Inland Revenue department considers that, the act of any person that was carried out by him in foreign should not be accredited willingly to a taxpayer in Hong Kong. The judge Lord Millett NPJ in case of ING Baring referred to the allowance of service and grossing of a commission by shared transactions in a market in the foreign. In actual, Judge Lord Millett NPG agreed with Judge Barma J and prohibited the proposition strongly that, ‘commercial reality’ dominated that, source of profits of one member of group of companies could be assigned the ventures of another. The reference for these statements is taken from the para 59 of departmental interpretation and purchase notes 21.
DIPN 21 - Booked profits
The survival of a business that is being carried on in Hong Kong is not conclusive of a source of profits subject to profits tax. The performance of activities in Hong Kong that do not themselves produce the profits, also do not themselves regulate the locality of profits. These activities include rental of office properties, general staff’s recruitment etc. If, however, on sales profits, commissions, fees etc. relate to sales or services provided to Hong Kong customers, the profits as a result will continue to be liable to profits tax generally. The department of Inland Revenue proceeds an important view of devices and schemes to find income outside from the Hong Kong. The general rules of avoiding the allowances which not to pause for applying in these type of cases and impose sanction where suitable in obvious case involving the non-acknowledgment of related facts. The taxpayers having sole proprietorship HK are need to authorize indicatives required to complete the return regarding transactions. The reference for these statement is taken from the para 60 of departmental interpretation and practice notes 21.
For the purpose of providing the reliability, the Inland Revenue department publicizes advance ruling on the locality of profits business, concern to the payment of a fee.
A classical tour operator in respect of its profits from the departing tours was subject to tax in full. These departing tours are tours to foreign locations even though agents are secured by the tour operator in the respective countries for providing the foreign tour services. It was observed in the case D 14/96 that, this was because the customers were engaged with the taxpayer having sole proprietorship HK.
In case of D 77/94 the division on a 50:50 bases were accepted. In that case a company in Hong Kong published the magazines for sale outside the Hong Kong and earned the advertising income from these magazines. Editing and editorial both were provided outside the Hong Kong. Type setting and printing were performed by the subcontractors in Hong Kong. The royalties from the publisher were held to be completely taxable outside the Hong Kong.
Land Transportation income outside Hong Kong
Per departmental interpretation and practice notes (DIPN 21), commonly the place of raise of goods or passengers will be the place where the profits are obtained. However, division will not be allowed, where the agreement of carriage does not distinguish between inward and outward transportation.
DIPN 39 – E-commerce
The fundamental principles are applicable. The Inland Revenue department shows that the only presence of a server with participation of human agents would not amount to be holding a business. Selling of the goods through an owned server, operated or rented in Hong Kong does not represent to a business in Hong Kong, this is due to the reason that, the presence of a person physically and/or place is denoted by the IRR5.
The locality of profits is not determined by the location of server. A physical office usually carries out the core business operations. The locality of the profits is determined generally by the location of physical business operation preferably than the location of the server alone. The major focus is on the physical operations rather than what was accomplished electronically.
Sometimes, a major question arises that, as specific receipts generated from e-commerce by a non-resident are allowed to pay tax under Section 14 (1) or 15 (1 )(a), (b) or (ba) of Hong Kong tax law. The basic test is that, whether the receipt is:
The question for the software is that whether the receipt is:
The examples of former point are the right to:
For downloading the software or pre-packed software, the contract would only grant the customer generally a license to use the software to a limited extent, i.e. to use the software either on the specified number of computers of customer or on a single computer or network servers. Moreover, the customer would have no right to modify, reduce or transform the software program or otherwise utilize the copyright in the software. Basically the payment of the software is for simple use of it not for the accession of any right to use the copyright, hence the payment is not considered as a royalty purpose of profit tax. Thus it is not included in the Section 15 (1) (b) of Hong Kong tax law.