Freelance Interior Designer: Profit Calculation on Material Procurement and Design Fees

Hong Kong’s Inland Revenue Department (IRD) has, in recent assessment cycles, intensified its scrutiny of freelance professionals who blur the line between trading income and service income, particularly in design and creative sectors. For interior designers operating as sole proprietors, the 2025/26 tax year brings a critical inflection point: the IRD’s updated departmental interpretation and practice notes (DIPN) on source of profits and the deductibility of procurement costs. A designer who purchases furniture, fixtures, and fittings on behalf of a client may find those material costs recharacterised as trading stock, triggering profits tax on the entire gross margin rather than the net design fee. The distinction between a “contract for services” and a “contract for sale of goods” has never been more consequential. The 2024/25 Budget introduced no major rate changes for profits tax — the standard rate remains 16.5% — but the IRD’s focus on procurement-heavy business models means that a freelance interior designer with a turnover of HKD 1.2 million could face a HKD 50,000–80,000 tax liability swing depending on how the cost of materials is classified. This article provides a practical framework for calculating taxable profit when material procurement and design fees are interwoven, citing the Inland Revenue Ordinance (Cap. 112), relevant Board of Review decisions, and the IRD’s own guidance.

The Core Problem: Distinguishing Design Fees from Trading Profits

The foundational question for any freelance interior designer in Hong Kong is whether the income from a project is “profits arising in or derived from Hong Kong from a trade, profession, or business” under section 14(1) of the Inland Revenue Ordinance (Cap. 112). When a designer charges a single, all-inclusive fee covering both design services and the supply of materials, the IRD may treat the entire sum as trading receipts, subjecting the gross profit on materials to profits tax at 16.5%. The alternative — treating the design fee as professional income and the material cost as a reimbursable expense — requires rigorous segregation in the engagement letter and accounting records.

The “Contract for Services” vs. “Contract for Sale” Test

The Hong Kong courts have established a fact-based test to determine whether a contract is predominantly for services or for the supply of goods. In Commissioner of Inland Revenue v. Yip Kim Fai [1995] 1 HKRC 90-045, the Court of Appeal held that the substance of the transaction, not its label, governs the tax treatment. Key factors include: (a) whether the designer takes title to the materials before installation; (b) whether the designer bears the risk of loss or damage to the materials; and (c) whether the client is invoiced separately for materials and design fees.

A designer who purchases furniture from a supplier in Shenzhen, takes delivery at her own warehouse in Kwai Chung, and then installs it at the client’s flat has likely acquired trading stock. The IRD will treat the profit on that furniture — the difference between the purchase price and the amount charged to the client — as trading profit. Conversely, a designer who specifies materials, arranges for the supplier to deliver directly to the client, and charges only a procurement handling fee of 10% on the supplier’s invoice is likely earning professional fees.

The IRD’s Position in DIPN 21 (Revised 2023)

The IRD’s DIPN 21, Profits Tax — Source of Profits, provides guidance on how to determine the geographical source of profits but also contains implicit principles for characterising income. Paragraph 12 of DIPN 21 emphasises that the “operations test” applies: where the profit-generating activities occur determines the source. For a freelance designer, the profit on materials arises where the designer performs the procurement and delivery activities. If those activities occur in Hong Kong, the profit is chargeable to profits tax regardless of where the client is located.

The 2023 revision to DIPN 21 clarified that the IRD will examine the “totality of the operations.” For a designer who sources materials from Mainland China, arranges logistics through a Hong Kong freight forwarder, and installs in a Hong Kong property, the entire profit stream is sourced in Hong Kong. No offshore claim is available for procurement activities, even if the supplier is based outside Hong Kong.

Structuring the Fee Arrangement to Preserve Professional Income Status

A well-drafted engagement letter is the single most effective tool for a freelance interior designer to ensure that design fees are taxed as professional income under Schedule 1 of the IRO (salaries tax and profits tax for sole proprietors are calculated on the same basis) and that material costs are treated as reimbursable expenses or as a separate trading activity.

The Two-Invoice Approach

The most straightforward structure is to issue two separate invoices to the client: one for design fees and one for materials at cost plus a disclosed handling fee. The design fee invoice should describe the scope of work — concept design, space planning, project management — and should not include any line item for materials. The materials invoice should list each item purchased, the supplier’s invoice number, and the exact cost incurred, plus a separately stated handling fee (typically 10–20%).

Under section 16(1) of the IRO, expenses “wholly and exclusively” incurred in the production of chargeable profits are deductible. If the designer purchases materials and immediately invoices the client at cost, the cost is deductible against the materials income, and the handling fee is the only profit element. This structure ensures that the designer is not taxed on the gross value of materials.

The Agency or Procurement-Only Model

A more conservative structure is to act as the client’s agent for procurement. The designer does not take title to the materials. Instead, the designer issues a purchase order to the supplier on behalf of the client, the supplier invoices the client directly, and the designer charges a separate procurement management fee. This arrangement eliminates any argument that the designer is carrying on a trade in goods.

The IRD’s practice in assessing estate agents and travel agents (DIPN 43) provides a useful analogy. An estate agent who arranges a property sale does not take title to the property; the commission is treated as professional fees. A designer who acts as a procurement agent should similarly be taxed only on the fee, not on the gross transaction value.

The Cost-Plus Model with a Markup

Some designers prefer to charge a fixed percentage markup on materials — typically 15–25% — without separately itemising the handling fee. This is common in the industry because clients prefer a single, predictable total. From a tax perspective, this model is riskier. The IRD may treat the entire materials charge (cost plus markup) as trading receipts, and only the cost of materials is deductible under section 16(1). The markup is fully taxable as trading profit.

To mitigate this risk, the engagement letter should explicitly state that the designer is providing a procurement service and that the markup represents a service fee for sourcing, quality control, and logistics management. The designer should maintain a detailed procurement log showing the time spent sourcing each item, the supplier negotiations conducted, and the logistics arrangements made. This documentary evidence supports the argument that the markup is a service fee, not a trading profit.

Practical Profit Calculation: A Worked Example

The following example illustrates how a freelance interior designer should calculate taxable profit for the 2025/26 year of assessment, assuming the designer uses the two-invoice approach.

Scenario

• Design fee (invoiced separately): HKD 200,000
• Materials purchased from a Shenzhen supplier: HKD 500,000
• Handling fee charged on materials (10%): HKD 50,000
• Total invoiced to client: HKD 750,000 (HKD 200,000 + HKD 500,000 + HKD 50,000)
• Actual cost of materials: HKD 500,000
• Other deductible expenses: HKD 40,000 (rent for studio, software licences, travel to client site)

Profit Calculation Under the Two-Invoice Approach

Item	Amount (HKD)
Design fee income	200,000
Materials handling fee income	50,000
Total assessable profits	250,000
Deductible expenses	(40,000)
Net assessable profits	210,000
Profits tax at 16.5%	34,650

The cost of materials (HKD 500,000) is not deductible because it is not an expense of the designer — it is a pass-through to the client. The designer’s income is only the design fee and the handling fee. If the designer had instead invoiced a single fee of HKD 750,000 and treated the HKD 500,000 as cost of goods sold, the net assessable profit would still be HKD 210,000 (HKD 750,000 – HKD 500,000 – HKD 40,000), but the gross receipts would be higher, potentially triggering the IRD’s audit threshold for turnover above HKD 1 million.

The Audit Risk of the Single-Fee Model

A single-fee model with HKD 750,000 in gross receipts and HKD 500,000 in cost of goods sold will attract IRD attention because the cost ratio (66.7%) is high for a professional service business. The IRD’s 2024 Annual Report noted that the department conducted 1,247 field audits and 4,781 desk audits in 2023/24, with a particular focus on businesses with high cost-to-revenue ratios. A freelance designer reporting 67% cost of goods sold may trigger a desk audit requiring proof that the costs are genuinely deductible under section 16(1).

If the IRD recharacterises the cost of materials as trading stock, the designer must also consider whether the materials are “stock in trade” under section 2 of the IRO. If so, the designer must account for opening and closing stock, and any unsold materials at year-end are not deductible. This adds complexity to the tax return (Form BIR 60 for sole proprietors).

Deductible Expenses Specific to Interior Designers

Beyond the material procurement issue, freelance interior designers in Hong Kong should maximise deductions under section 16(1) for expenses wholly and exclusively incurred in producing chargeable profits. The following categories are frequently overlooked.

Studio Rent and Home Office Deductions

If the designer rents a separate studio, the full rent, rates, and management fees are deductible. If the designer uses a room in her own home as a studio, she may claim a portion of the home’s rent or mortgage interest (if the property is owned) and utilities, apportioned on a floor-area basis. The IRD’s practice is to allow a deduction for the business-use portion, but the designer must be able to demonstrate that the space is used exclusively for business. The Board of Review case D16/01 (2001) held that a 20% floor-area apportionment for a home office used exclusively for business was acceptable.

Software, Subscriptions, and Professional Development

Design software licences (AutoCAD, SketchUp, Adobe Creative Cloud), trade magazine subscriptions (Interior Design, Dezeen), and fees for continuing professional development courses are deductible. The IRD has not issued specific guidance on software subscriptions, but the general principle under section 16(1) applies: the expense must be incurred in the production of chargeable profits. A designer who takes a course on sustainable materials sourcing can deduct the course fee; a course on general business management may be deductible if it directly improves the designer’s professional capability.

Travel and Client Entertainment

Travel to client sites, suppliers, and showrooms is deductible. The IRD allows deduction for the actual cost of public transport or a mileage allowance for private vehicle use (HKD 2.10 per km for the first 10,000 km, HKD 1.30 per km thereafter, per the IRD’s 2024/25 rates). Client entertainment expenses, such as meals at showrooms or factory visits, are deductible under section 16(1) if they are directly related to the production of profits. The IRD’s practice is to allow 50% of meal expenses as a deduction, though this is not a statutory rule — the test remains “wholly and exclusively.”

MPF Contributions

For a sole proprietor, mandatory provident fund (MPF) contributions are not deductible under section 16(1) because they are personal expenses. However, if the designer employs an assistant or subcontractor, the employer’s MPF contributions (5% of relevant income, capped at HKD 1,500 per month per employee for the 2025/26 tax year) are deductible as staff costs.

The Tax Compliance Burden: Filing Requirements and Record-Keeping

Freelance interior designers in Hong Kong must file a profits tax return (Form BIR 60) annually if they have assessable profits exceeding the basic allowance (HKD 132,000 for the 2024/25 tax year). The IRD issues returns in April each year, and the filing deadline is typically 1–3 months after the issue date, depending on the taxpayer’s accounting period.

Record-Keeping Requirements

Section 51C of the IRO requires every person carrying on a trade, profession, or business to keep sufficient records for at least seven years after the completion of the transactions to which they relate. For a freelance interior designer, this means retaining:

• All engagement letters and contracts with clients
• All invoices issued to clients (design fee and materials separately)
• All supplier invoices, receipts, and delivery notes for materials
• Bank statements and payment records
• A detailed procurement log showing dates, suppliers, items, and amounts
• Records of travel, entertainment, and other deductible expenses

The IRD’s 2024 Annual Report stated that the department imposed penalties totalling HKD 1.2 billion in 2023/24 for non-compliance with record-keeping requirements. A designer who cannot produce supplier invoices for HKD 500,000 in materials may face a penalty of up to three times the tax undercharged (section 82A of the IRO).

The Statute of Limitations

The IRD can raise additional assessments within six years after the end of the year of assessment in which the profits were earned (section 60 of the IRO). For the 2025/26 tax year, the IRD can issue an assessment until 31 March 2033. If the IRD suspects fraud or wilful evasion, the limitation period extends to 10 years (section 60(3)). A designer who deliberately mischaracterises material costs as design fees to avoid profits tax faces a significantly longer exposure period.

Actionable Takeaways

1. Segregate design fees and material costs in every client engagement letter — issue two separate invoices and retain supplier invoices to support the cost pass-through, ensuring that only the handling fee is taxed as trading profit.
2. Use the agency or procurement-only model for high-value materials — have the supplier invoice the client directly and charge a separate procurement management fee to eliminate any argument that you are trading in goods.
3. Maximise deductible expenses under section 16(1) of the IRO — claim studio rent, software licences, travel costs, and client entertainment, but keep a detailed expense log with receipts for at least seven years.
4. File Form BIR 60 annually and report all income accurately — the IRD’s audit rate for sole proprietors with turnover above HKD 1 million is approximately 5%, and a single-fee model with high cost ratios increases audit risk.
5. Consider registering for profits tax and opening a separate business bank account — commingling personal and business funds is a red flag for the IRD and complicates the deduction of business expenses.

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