Revised DIPN 39 raises controversies over an apparently inconsistent application of the source principles A look at the revised DIPN on the digital economy issued by the Inland Revenue Department The digital economy is rapidly changing ways of doing business. For tax authorities worldwide, this is creating challenges to implementing or modifying existing tax rules to deal with digital businesses, where physical nexus or tangible presence such as headcount or assets are minimal. It is therefore welcoming that the Hong Kong Inland Revenue Department (IRD) has revised its Departmental Interpretation and Practice Note (DIPN) 39 on the digital economy, first issued in 2001. The revised version, Profits Tax – Digital Economy, Electronic Commerce and Digital Assets, published in March, provides more guidance on its view on taxation of digital businesses. In a change from its previous position, the IRD indicates that a non-Hong Kong resident enterprise that only maintains a server in Hong Kong, without the involvement of human activities in Hong Kong, is now exposed to tax in Hong Kong. Revised DIPN 39 also extends the scope of the old DIPN 39 to cover the tax treatment of digital assets, including the tax position of an issuer in an initial coin offering, and what constitutes a permanent establishment (PE) in the context of e-commerce (e.g. the potential application of the anti-fragmentation rule, anti-abuse rule for the specific activities exemption from constituting a PE, and the dependent agent PE). Revised DIPN 39 also notes that the IRD’s position may change as a result of the conclusion of the current international discussion regarding changing the rules for taxing the digital economy under the Organization for Economic Cooperation and Development’s (OECD) Base Erosion May 2020
and Profit Shifting 2.0 initiatives, with consensus expected to be reached by the end of 2020. It is therefore worth noting that the IRD’s position is based purely on how the IRD considers the current provisions of the Inland Revenue Ordinance (IRO) would apply to the issues covered by the revised DIPN.
would not be regarded as carrying on a business in Hong Kong and, therefore, would previously not be exposed to tax in Hong Kong. However, under the current definition of PE, Revised DIPN 39 indicates that the IRD now follows the OECD’s interpretation that the mere presence of a server in Hong Kong can constitute a PE in Hong Kong.
Recent change in the definition of PE in the IRO
Only if a server “at the disposal” of an enterprise is “an essential and significant part” of the business would there be a PE
The IRO’s definition of PE changed in 2018 to mean “a fixed place of business in Hong Kong through which the business of [a non-Hong Kong resident enterprise] is wholly or partly carried on…” This was from “a branch, management or other place of business... [in Hong Kong].” This current definition is modelled on how the term is defined under the Model Tax Convention on Income and on Capital 2017 (MTC) for tax treaties of the OECD.
IRD’s change of its position as a result of the change in the definition of PE Under the previous definition of PE, the IRD considered that the words “branch, management or other place of business” implied a physical presence of a “place” and personnel. Previously therefore, the IRD did not consider the presence of a mere server in Hong Kong, without the involvement of human activities in Hong Kong, of a non-Hong Kong resident enterprise would constitute a PE in Hong Kong. This would generally mean that such an enterprise
It should be noted that not all servers maintained in Hong Kong by a non-Hong Kong resident enterprise would expose the enterprise to tax in Hong Kong. That is, not all servers create a PE in Hong Kong. Following the OECD’s position in its commentary on the MTC, the IRD states that (i) it is only where a server is “at the disposal” of an enterprise, and (ii) “an essential and significant part” of the business of the enterprise is conducted through the server that the PE exposure exists. These two conditions are discussed below. (i) “At the disposal” Regardless of whether a server is owned or leased by an enterprise, the revised DIPN indicates that if the enterprise can have effective control over the use of, and access to, the server, i.e. it can operate the server on its own, the place where such a server is located can constitute a PE of the enterprise. However, a website of a non-Hong Kong resident enterprise which is hosted on the Hong Kong server of a 19
