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What Taxes Are My E-Commerce Company’s Profits Subject To?

The rapid development of the e-commerce industry brings about its own set of challenges for Hong Kong’s tax system. One of the issues that many business owners often faced is the taxation of their e-commerce company’s profits.

What profits are subject to tax, and what are the guidelines? In this article, we will explore these questions. At this point, we just want to let you know, if you need to quickly talk to an accountant on accounting for your E-commerce business, we’re here to help.

What is the Hong Kong Tax system?

Hong Kong uses a territorial basis of taxation. This means any income that arises or derives from the country will be subject to tax. But any income that is earned from outside of Hong Kong will be considered as foreign-sourced, and it will not be charged with tax. It is as simple as that. It also works on a two-tier tax system.

For the first HK$2 million earned, companies will be taxed at 8.25%. Subsequently, for anything above HK$2 million, the tax rate will be at 16.5%. Hong Kong’s low tax regime has attracted many entrepreneurs to start their businesses in the city. It has no capital gain tax and no withholding tax on dividends and interest. One of the other advantages of operating an e-commerce business in Hong Kong lies in its close proximity to the Mainland China market.

Read more: A Guide to Profits Tax Return in Hong Kong

The General Rule of Taxes for All Types of Businesses

Section 14 of the IRO states that every person who carries on a trade, business or profession in Hong Kong is chargeable to profits tax on the profits arising in or derived from Hong Kong. For E-commerce businesses, when you sell to Hong Kong, you might be taxed.

What Kind of Taxes Applies to E-commerce Business?

Every country has a different tax system for their e-commerce businesses. In Hong Kong, it comprises 2 components. They are mainly:

  1. Profit tax
  2. Sales tax

As a business owner, it’s important to understand how these components work and affect your e-commerce business. We understand taxation can be challenging and at the same time, confusing for many who are either starting a new business venture or have already operated one for a long time. So we break down these components into smaller parts for your reference.

Understanding Sales Tax

Sales Tax vs GST

Sales tax refers to an amount that is charged at the point of sale. It is normally collected by the retailer, or in this case, seller, and later on, passed on the government.

On the other hand, GST stands for Goods and Services Tax. It’s an indirect consumption tax that is usually borne by the consumer, who is the end-user, for his or her purchase.

Now, the good news is, Hong Kong doesn't impose any sales tax or GST! It is no wonder why this city is a shopping destination for many.

Do You Have to Charge Sales Tax for Your E-transactions?

You might be setting up a Woocommerce platform for your online store in Hong Kong. First, you plan to sell your products within the city. Slowly, you decide to widen your customer base by implementing international shipping. Now, this is where you might get confused. Should you charge sales tax for international shipping? This is one of the common questions many e-commerce business owners face during the initial phase of setting up their online store.

Since there is no sales tax or GST in Hong Kong, you do not need to include the sales tax during the e-transactions. However, you will need to inform the customers of certain tax regulations in their home country. For instance, they may have to pay tax in their own country when they purchase products from your online store in Hong Kong.

Understanding Profit Tax

Compared to a traditional business setting, e-commerce business does not require a fixed location, or even personnel. As a result, the profits earned can be derived from any parts of the world. Given the nature of business, profits that are subject to tax will be based on the following:

  • Permanent Establishment;
  • Core operations

John operates a small bakery in Central, Hong Kong. Though he has a physical shop in Central, he also sells his bake online to his customers. The main operations of his business – from the making to the sales of his products – take place in his shop. In this case, his small bakery is considered as a permanent establishment. As the core operation takes place in Hong Kong, the profits he earned will be subject to tax.

However, when it comes to e-commerce business, some things are not as straightforward as John’s case. It’s increasingly challenging to determine what profits are considered taxable, given that some companies may not have a presence in the country but have at least one server in Hong Kong. As a result, IRD updated certain rules in the revised DIPN 39 in 2020.

With the revision of DIPN 39, how will this affect your E-commerce business?

What is DIPN 39?

DIPN 39 stands for Departmental Interpretation and Practice Notes no. 39. It’s a principle guide that applies to electronic transactions and digital assets. The main purpose of this guide is to help e-commerce business owners – be it a local resident or a non-Hong Kong resident - navigate the basis of taxation in Hong Kong. The Inland Revenue Department (IRD) first issued DIPN 39 in July 2001.

What’s changed?

In March 2020, the IRD issued a revised DIPN 39, and this superseded the previous guide in 2001.

Previously, the presence of the server does not count as a permanent establishment. ‘Server’ refers to the source that conducts the main activities of your business. It can be providing information about the products and services to your customers, processing and fulfilling orders, or delivering goods and services electronically, or even processing payments.

However, in the revised DIPN 39, if the main core operations take place in the server, it will be regarded as a permanent establishment. The key thing is, what function does your server play?

Previous DIPN No 39 (2001)

Matilda is a non-Hong Kong resident who carries out her bag business in Hong Kong. Her online shop is hosted on a website server that is based outside of Hong Kong. She handles most the electronic transactions, answers customer enquiries and fulfils her orders through the server. Since there isn’t a business presence, and the server is located outside of Hong Kong, her server is not considered as a permanent establishment. In this case, the profits will not be subject to tax.

Revised DIPN No. 39 (2020)

Matilda is a non-Hong Kong resident who carries out her bag business in Hong Kong. The server for her online shop is hosted on a platform that is based outside of Hong Kong. However as she conducts most business dealings, such as providing information of her products, processing payments and fulfilling orders to the customers through the server, it will be considered as a permanent establishment.

Even though the server is located outside Hong Kong, the core operations are still performed in the city.

What is Meant by Core Operations?

You might be wondering what exactly is considered as core operations for your e-commerce business in Hong Kong. DIPN 39 has listed out the core activities as such:

  • Logistics – receiving, storing and delivery of goods to the customers.
  • Operations include purchasing raw materials, producing your goods and selling it to end-users.
  • Marketing and sales, which allows your customers to purchase the product.
  • Providing service as a way to maintain the value of the product.

If the core operations are mainly performed in Hong Kong, it will be considered as onshore sourced, regardless where the server is located.

How do you calculate Profit Tax for your e-commerce business?

Profits tax in Hong Kong is calculated based on the company's assessable income. You may use this formula to obtain your company’s taxable income.

Total assessable profits – non-assessable profits – qualified business expenses – unutilised losses + balancing charge – capital allowances = taxable income

Looks complicated? All you need is necessary information about your company's assessable and non-assessable profits and other expenses. Apply this formula, and you will get your taxable income.

Once you have your taxable income, apply the appropriate tax rate to determine your profits tax. The current tax rate is 8.25% or 16.5% for corporation’s assessable profits and 7.5% / 15% for unincorporated business.

What about a Non-Hong Kong Resident’s E-commerce Business, Are Their Profits Taxable?

It depends. There are many ways to look at it. A non-Hong Kong resident might use an Internet service provider in Hong Kong for his or her online shop. If the core operations are performed through this server, his or her profits will be subject to tax.

Now, let’s look at another scenario. If the website is used for information purpose and the core operations are performed through other place, this will not be regarded as a permanent establishment. In this case, he or she will not be subject to tax.

8 Key Takeaways as an E-commerce Company

  1. E-commerce business comprises three components: E-commerce tax, Profits tax & Sales tax.
  2. Profits from e-transactions are subject to tax based on two major criteria: Permanent establishment and Core operations.
  3. In March 2020, Hong Kong issued a revised DIPN 39 that addresses the concerns about the taxation of e-commerce businesses.
  4. Previously, a mere presence of a server in the city was not considered as permanent establishment. But now, with the updated guidelines, the presence of a server will be considered as permanent establishment as long as a significant and essential amount of business activity is conducted through this server.
  5. A server can be defined as a digital platform, such as website and computer equipment.
  6. If a non-Hong Kong resident uses his server to conduct transactions and communicate with his customers but perform his main business operations outside of Hong Kong, the profits are still liable for tax.
  7. There is no sales tax in Hong Kong.
  8. During e-transactions, you do not have to charge sales tax in your invoice.

Digital economy looks set to grow even more in the coming years, as more companies are turning to digitalisation. As e-commerce businesses thrive, taxation for e-commerce businesses set up in Hong Kong can also prove to be a real headache for many business owners, especially if the tax regulations are revised every other year. But you don’t have to handle it all by yourself. You can contact our experienced team today for advice on tax-related matters.

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