Commission Income Tax: Mixing Sales Commissions and Base Salary in Calculations

For the 2025/26 tax year, the Inland Revenue Department (IRD) has signalled increased scrutiny on commission-based income structures, particularly where a taxpayer receives both a fixed salary and variable commissions from the same employer. A key driver is the IRD’s ongoing project to audit “disguised employment” arrangements, where individuals are classified as self-employed but receive a base salary plus commissions—a practice that can shift tax liability from salaries tax (which offers a progressive rate cap at the standard rate) to profits tax (which may be lower for high earners). This focus is compounded by the 2025 Budget’s confirmation that the standard tax rate remains at 15%, making the distinction between employment income and self-employment income critical for mid-career professionals and small business owners in Hong Kong. For a taxpayer earning a base salary of HKD 600,000 plus HKD 400,000 in commissions, a misclassification—or even a simple miscalculation of personal assessment eligibility—can mean a difference of over HKD 50,000 in tax payable. This article examines the legal boundaries of commission income under the Inland Revenue Ordinance (Cap. 112), the specific rules for mixing salary and commissions, and the strategic options for Hong Kong residents to optimise their tax position without crossing into aggressive avoidance.

The Legal Framework: Commission Income Under the Inland Revenue Ordinance

Employment Income vs. Self-Employment Income

The core distinction in Hong Kong’s territorial tax system lies between employment income, which is chargeable to salaries tax under Section 8 of the Inland Revenue Ordinance (Cap. 112), and self-employment income, chargeable to profits tax under Section 14. The IRD has long held that a commission paid by an employer to an employee, even if calculated as a percentage of sales, constitutes “income from employment” if the recipient is an employee. This position was affirmed in the landmark case of Commissioner of Inland Revenue v. Li Yuen Yee (1995), where the Court of Final Appeal ruled that the source of commission income is the employment contract, not the individual sales transactions. Therefore, mixing a base salary with sales commissions does not automatically convert the commission portion into profits tax territory.

For the 2025/26 tax year, the IRD’s Departmental Interpretation and Practice Notes (DIPN) No. 21 (Revised) provides clear guidance: where an individual has a single employer and receives a salary plus commissions, the entire amount is assessable under salaries tax. The key test is the “control test”: if the employer dictates how, when, and where the work is performed—including sales targets and reporting lines—the relationship is one of employment. This is particularly relevant for sales professionals who receive a base salary (e.g., HKD 30,000 per month) plus a commission structure (e.g., 10% of gross sales). The IRD will look at the totality of the arrangement, not just the payment label.

The “Personal Assessment” Election: A Strategic Option

Where a taxpayer has both employment income (salary + commissions) and other income streams—such as rental income from a property or profits from a sole proprietorship—the IRD permits an election for personal assessment under Section 41 of the IRO. This election aggregates all income and applies a progressive tax rate (capped at the standard rate of 15% for 2025/26). For a high-earning sales professional with, say, HKD 1.5 million in salary and commissions plus HKD 200,000 in net rental income, personal assessment may yield a lower tax bill than separate assessment under salaries tax and property tax. However, the election must be made in writing to the IRD by the filing deadline (typically 3 May for the year of assessment, or within one month of the date of the assessment). The 2025 Budget has not changed these deadlines, but the IRD’s eTAX system now allows for electronic submissions.

The Mixing Problem: When Base Salary and Commissions Are Paid by Different Entities

Single Employer, Dual Payment Streams

A common scenario in Hong Kong’s financial services sector involves a salesperson employed by a brokerage firm who receives a base salary from the firm’s Hong Kong entity and commissions from an offshore affiliate (e.g., a BVI company). The IRD’s position, as stated in DIPN No. 10 (Revised), is that where the offshore payment is “effectively connected” with the Hong Kong employment, it is chargeable to salaries tax. The test is whether the commissions are paid for services rendered in Hong Kong. If the salesperson solicits clients in Hong Kong, even if the commission is paid by a related offshore entity, the full amount is subject to Hong Kong salaries tax. For the 2025/26 tax year, the IRD has intensified its information exchange with offshore financial centres under the Common Reporting Standard (CRS), making it riskier to rely on offshore payment structures without proper documentation.

Dual Employment: Two Contracts, One Taxpayer

Another mixing scenario arises when a taxpayer has two separate employment contracts—one for a base salary (e.g., as a part-time consultant) and another for commissions (e.g., as a sales agent). The IRD will assess each contract independently under salaries tax if both are employment relationships. However, if the commission contract is structured as a self-employment arrangement (e.g., the taxpayer is not an employee of the commission-paying entity), the commission income may be assessable under profits tax. This requires careful structuring: the taxpayer must demonstrate that they are genuinely in business on their own account, with multiple clients, their own business premises, and the ability to subcontract work. The IRD’s DIPN No. 21 (Revised) provides a checklist of factors, including the degree of control, the provision of tools and equipment, and the taxpayer’s exposure to financial risk.

Strategic Tax Planning for Commission-Based Income

Maximising Salaries Tax Allowances

For taxpayers whose entire income (salary + commissions) is assessable under salaries tax, the key optimisation lies in maximising the available allowances and deductions. For the 2025/26 tax year, the basic allowance is HKD 132,000, with additional allowances for single parents (HKD 132,000), dependent siblings (HKD 37,500 each), and elderly parents (HKD 50,000 per parent residing with the taxpayer). Self-education expenses (up to HKD 100,000) and home loan interest (up to HKD 100,000 per year for 20 years) are also deductible. For a sales professional earning HKD 1.2 million in total income (salary + commissions), claiming the maximum home loan interest deduction reduces assessable income to HKD 1.1 million, which, after the basic allowance, yields a tax bill of approximately HKD 114,000 under progressive rates—compared to HKD 165,000 under the standard rate cap.

The MPF Contribution Strategy

Mandatory Provident Fund (MPF) contributions are deductible for salaries tax purposes, up to HKD 18,000 per year for the employee’s mandatory contribution (5% of relevant income, capped at HKD 300,000 per month). For commission-based income, the “relevant income” is defined as the total of salary and commissions paid by the employer. Voluntary contributions (up to HKD 60,000 per year) are also deductible under the tax-deductible MPF voluntary contribution (TVC) scheme. For a taxpayer with a base salary of HKD 360,000 and commissions of HKD 400,000, the mandatory MPF contribution is HKD 18,000 (5% of HKD 360,000, capped). Adding a voluntary contribution of HKD 60,000 brings total MPF deductions to HKD 78,000, reducing assessable income accordingly. This is particularly effective for taxpayers in the highest marginal bracket (15% standard rate), as each HKD 1,000 of MPF contribution saves HKD 150 in tax.

The Personal Assessment: When to Elect

Personal assessment is not always beneficial. For a taxpayer whose only income is salary plus commissions, the standard salaries tax calculation (progressive rates capped at standard rate) will generally be the most favourable. However, where the taxpayer has a rental property with a mortgage, the property tax (15% of net assessable value) may be higher than the marginal rate under personal assessment. For example, a taxpayer earning HKD 1.5 million in salary and commissions and HKD 200,000 in net rental income would pay HKD 30,000 in property tax separately. Under personal assessment, the total income of HKD 1.7 million would be subject to progressive rates, yielding a tax of approximately HKD 229,500 (versus HKD 225,000 under salaries tax plus HKD 30,000 property tax). The saving of HKD 25,500 justifies the election. The IRD’s eTAX system allows taxpayers to run a preliminary calculation before submitting the election.

Common Pitfalls and the 2025/26 Audit Landscape

The “Disguised Employment” Trap

The IRD has identified commission-based arrangements as a high-risk area for “disguised employment,” where an individual is treated as a self-employed contractor but receives a base salary plus commissions. In the 2024/25 tax year, the IRD issued 1,247 audit letters targeting this issue, a 15% increase from the previous year. The penalties for misclassification can be severe: under Section 82A of the IRO, a taxpayer who knowingly understates tax liability by HKD 100,000 or more faces a penalty of up to three times the tax undercharged, plus a fine of up to HKD 50,000. For the 2025/26 tax year, the IRD has introduced a new “compliance checklist” for commission-based taxpayers, requiring a declaration of the nature of the relationship with each payor. This checklist is available on the IRD’s website and must be submitted with the tax return if the taxpayer has more than one source of commission income.

The Statute of Limitations and Voluntary Disclosure

The IRD has six years from the end of the year of assessment to issue an additional assessment, or ten years in cases of fraud or wilful evasion (Section 60 of the IRO). For a taxpayer who has inadvertently misclassified commission income (e.g., treating it as profits tax when it should be salaries tax), the IRD’s voluntary disclosure programme (VDP) offers a pathway to reduced penalties. Under the VDP, a taxpayer who makes a full and accurate disclosure before the IRD opens an investigation may face a penalty of only 5% of the tax undercharged, rather than the standard 100% to 300%. The 2025 Budget confirmed that the VDP remains in effect, but the IRD has tightened the eligibility criteria: the disclosure must be made within 12 months of the tax return filing date.

Actionable Takeaways

1. For the 2025/26 tax year, verify whether your commission income is classified correctly: if you have a single employer and receive both a base salary and commissions, the entire amount is assessable under salaries tax, not profits tax.
2. If you receive commissions from an offshore entity while working in Hong Kong, document the services performed in Hong Kong to support the IRD’s assessment under salaries tax—failure to do so may trigger an audit.
3. Maximise your salaries tax allowances by claiming all eligible deductions, including home loan interest (up to HKD 100,000 per year) and MPF voluntary contributions (up to HKD 60,000 per year), to reduce your assessable income.
4. Consider electing for personal assessment if you have rental income or other non-employment income—the IRD’s eTAX system allows you to compare the two calculations before filing.
5. If you have historically misclassified commission income, consider making a voluntary disclosure under the IRD’s VDP before the 2025/26 tax return deadline to qualify for reduced penalties.

本文不構成稅務建議。涉及個人稅務情況請諮詢持牌會計師或稅務師。 / This does not constitute tax advice. Consult a licensed CPA or tax advisor for your specific situation.