Hong Kong: Revised Departmental Interpretation and Practice Notes No. 33 - Insurance agents 

Oct 2009
  
The Hong Kong Inland Revenue Department ("IRD") issued a revised Departmental Interpretation and Practice Notes No. 33 - Insurance Agents ("revised DIPN 33") in October 2009.  The revised note replaces the one that was first issued in June 1998.
    
The major revisions to the note are (1) clarification of the current assessing practice of the IRD in respect of certain income and expense items commonly encountered by insurance agents and (2) reference to recent Board of Review decisions and court judgments in relation to taxation of insurance agents.
   
Independent contractors vs employees
   
The relationship between an insurance company and its insurance agents can vary from case to case depending on the way in which the insurance company operates.  This relationship affects how the income of insurance agents is taxed in Hong Kong.  The fundamental question is: whether the individuals should be treated as self-employed and subject to profits tax or as an employee and subject to salaries tax?
  
Whether an insurance agent is an independent contractor or an employee is a question of fact (i.e. whether the individual solicits and negotiates insurance contracts on behalf of an insurance company as an employee of the company or acts as an independent agent who facilitates the contracting process between a prospective customer and an insurance company).  Following the established principles in common law, revised DIPN 33 mentions the following objective tests that can be applied by the IRD in assessing the relationship between the insurance agent and the insurer:

1. The control test - the degree of control exercised by the insurance company over the insurance agent providing the services;
     
2. The integration test - the extent to which the insurance agent is part and parcel of the insurance company for which services are rendered;
     
3. The economic reality test - the amount of financial risks borne and the opportunities faced by the insurance agent (e.g. whether the individual provides his own tools and equipment or hires his own assistants and to what extent the individual has an opportunity to profiting from sound management in the performance of his tasks, etc.); and
     
4. The mutuality of obligation test - whether the insurance agent and the insurance company have a mutual obligation in the way that the insurance company has an ongoing obligation to provide work to the insurance agent and there is a corresponding ongoing obligation on the insurance agent to accept and carry out the work.

Revised DIPN 33 also indicates that the contract / agreement between the insurance agent and the insurance company may serve as the best document for the IRD to determine the true legal relationship in question i.e. whether it is a contract of services (an employment arrangement) or a contract for services (an independent contractor arrangement).
   
Tax treatments for independent contractors vs for employees
   
Revised DIPN 33 discusses the tax treatments of income and expenses for insurance agents who are regarded as an independent contractor and as an employee.  The following table summarises the views expressed in the revised DIPN:
  

1. Examples of upfront payments received by insurance agents are: initial signing fee, goodwill payment and sign-on bonus, etc.  These upfront payments may have to be repaid by the insurance agents if they fail to remain in service for a minimum service period or "lock-up" period.  In cases of self-employed insurance agents, the upfront payments may have to be set off against commission income earned by them over a period of time.
      
2. The IRD will examine the terms of the contract entered into between the insurance company and the agent to ascertain the year in which the upfront payments accrued to the taxpayer as income.  Revised DIPN 33 has made it clear that the IRD will not accept assessing the upfront payments on a pro rata basis over the minimum service period or assessing the whole amount of upfront payments only upon the expiration of the minimum service period (i.e. when the right to ask for repayment of the amount is waived by the insurance company).
      
3. Revised DIPN 33 includes a list of commonly allowed expenses incurred by self-employed insurance agents whereas Appendix A of the revised DIPN provides examples of questions that may be raised by the IRD in establishing whether a deduction will be allowed for different types of expenses.  Where an expense is not wholly incurred in the production of assessable profits (e.g. overseas travelling expenses for a trip partly for business and partly for private purpose), it should be apportioned such that only the amount that is incurred for producing chargeable profits is allowed for deduction.  Inland Revenue Rule 2A and Departmental Interpretation and Practice Notes No. 3 (Revised) - "Profits tax - Apportionment of expenses" provide further guidance on the basis upon which such apportionment should be made.
      
4. This is considered as a relatively high threshold.  Also, expenses that are not directly referable to the performance of duties / work required under an employment contract might be considered as incurred "for" instead of incurred "in" the production of assessable income and therefore non-deductible.  Further guidance as to the deductibility of expenses under salaries tax is contained in Departmental Interpretation and Practice Notes No. 9 (Revised) - Major deductible items under salaries tax.
     
5. The IRD will follow the Board of Review's decision in Case No. D26/07.  That is, the sum repaid is not considered as being wholly, exclusively and necessarily incurred in the production of assessable income and is of a capital nature (which means it is not deductible for salaries tax purpose).

Our comments
   
Revised DIPN 33 is relevant to both insurance companies and insurance agents.
   
From the perspective of insurance companies, a determination has to be made as to whether the amounts paid to individual insurance agents should be reported on Form IR 56B - Employer's Return of Remuneration & Pensions (as employment income) or Form IR 56M - Notification of Remuneration paid to Persons other than Employees (as payments to independent contractors).
  
For individual insurance agents, the primary concern would be whether the amounts received are subject to salaries tax (as employment income) or profits tax (as business income).  Because of the relatively less stringent requirements for expense deduction under profits tax, an independent contractor arrangement may be more preferential than an employment arrangement from a tax perspective.  There are, of course, other commercial and legal factors to consider in deciding how the relationship should be structured.
   
As can be seen from revised DIPN 33, the determination of the true relationship between an insurance agent and an insurance company for tax purpose and the tax treatment of the income / expenses of the insurance agent (e.g. the timing of taxation of an upfront payment) will very much depend on how the arrangement between the two parties is structured and the terms of the contract / agreement concluded between the two parties.  Both insurance companies and individual insurance agents should therefore carefully review their existing arrangements / agreements to ensure proper tax reporting form is being used to and correct tax treatment is being applied to the income / expense concerned.  On the other hand, before entering into a contract / agreement, insurance companies and individual insurance agents should carefully consider how the terms of the contract / agreement should be structured so as to achieve the intended outcome for tax purpose.