In our January 2022 edition, we will continue to study three issues highlighted in the 2020 Annual General Meeting between the Hong Kong Institute of Certified Public Accountants (“HKICPA”) and the Inland Revenue Department (“IRD”)
2.Royalty payment to overseas non-resident
[H2] Royalty fee is important in transfer pricing international tax planning, and is subject to withholding tax in Hong Kong
For royalty fees paid to overseas recipients, Hong Kong taxpayers have the obligation to withhold tax for onward payment to the IRD.
Under Section 21A of the IRO, 100% of the royalty income would be deemed as taxable receipt if the follow two conditions apply:-
- The recipient is a related party of the Hong Kong taxpayer; and
- The Intellectual Property (IP) has once been owned by a Hong Kong taxpayer.
In that case, it seems the basis of calculation of the royalty fee does not matter as the whole amount of the royalty income will be subject to Hong Kong Profits Tax while the royalty fees paid by the Hong Kong taxpayers should generally be fully deductible. In other words, it seems the transfer pricing domestic exemption apply as the pricing does not give rise to any potential Hong Kong tax advantage from the Group perspective.
Having said that, the IRD has reiterated that as the royalty recipient is a non-Hong Kong resident, the Domestic nature condition is not fulfilled, and thus the IRD is still empowered to make transfer pricing adjustments on the royalty fee. Taxpayers are reminded to carry out benchmarking study if the amount involved is significant.
Points to note
Royalty fee is usually calculated based on percentage of sales or gross profit. In view of the potential significant amount involved, it is an effective way to lower the MNC group’s effective tax rate.
Setting up economic substance to carry out DEMPE functions in a low-tax jurisdiction (e.g., Hong Kong) and charging royalty fee to operating entities in other tax jurisdictions would be one of the important international tax planning opportunities. Having said that, global tax authorities would certainly thoroughly review the transfer pricing policy of the royalty fee arrangements. MNCs should certainly carry out benchmarking study to look for comparables (i.e., industry peers with similar arrangements) in order to minimise their transfer pricing risk.
