Slash Your Taxes: Hong Kong's Strategic Tax Reduction for Innovators
5% Profits Tax Rate offered under Hong Kong Patent Box Tax Incentive
Prepared by Henry Kwong, Senior Tax Advisor of ONC Lawyers
1. Introduction to Hong Kong's Patent Box Tax Incentive
Hong Kong's introduction of the Patent Box Tax Incentive as announced in the 2023-2024 Budget, marks a crucial development in fostering innovation and technology. This initiative offers tax concessions for profits derived from qualifying patents generated through research and development (R&D) activities in Hong Kong. Aimed at bolstering Hong Kong's status as a regional intellectual property (IP) hub, this incentive aligns with global trends of using tax policies to stimulate technological advancement.
The Patent Box Tax Incentive operates on the OECD's nexus approach, linking tax benefits to the R&D expenditures incurred in developing IP. This approach not only encourages genuine innovation efforts but also ensures a fair and efficient distribution of tax advantages. By adopting such a strategic policy, Hong Kong is poised to attract businesses and talent focused on long-term innovation, thereby enhancing its global competitiveness in technology and intellectual property development.
In the following sections, we will explore the details of this incentive, including eligibility criteria and the tax implications.
2. Detailed Analysis of the Proposed Patent Box Tax Incentive
The proposed Patent Box Tax Incentive is poised to significantly bolster Hong Kong's innovation and technology sector. This analysis sheds light on the key components of this initiative, with a special focus on eligibility criteria and tax rate specifics.
Eligibility Criteria for IP Assets
Central to the incentive is the eligibility of intellectual property assets. To qualify, patents and similar IP assets must result from R&D activities conducted within Hong Kong.
For the purposes of the patent box tax incentive, eligible IP assets are specifically defined. These include:
· Patents: This category extends to other IP assets that are functionally similar to patents, provided they are legally protected and undergo comparable approval and registration processes.
· Copyrighted Software: Software protected under copyright law.
· Plant Variety Rights: Rights accorded to individuals or organizations that have bred, discovered, or developed new plant varieties, as governed by the Plant Varieties Protection Ordinance (Cap.490).
This broad inclusion of various forms of IP income ensures a comprehensive coverage of the innovation sector.
Eligible IP assets encompass both applications and granted patents or plant variety rights, irrespective of whether these are filed or granted within or outside Hong Kong. To qualify, these assets must be registered under the Hong Kong original grant patent system and the plant varieties protection system, in compliance with local registration requirements.
Preferential Tax Rate
The incentive proposes a preferential tax rate for profits derived from eligible IP assets. Based on the draft legislation, the Profits Tax rate is expected to be as low as 5%. While the final rate is yet to be determined, it's anticipated to be competitive on a global scale. For instance, current concessionary tax regimes in Hong Kong generally apply a tax rate of 8.25%. In contrast, international patent box regimes vary, with rates like 4.99% (Luxembourg), 6.25% (Ireland), and 5% or 10% (Singapore). Hong Kong's approach aims to align with or surpass these benchmarks, making it an attractive landscape for international R&D investments.
3. Criteria for Eligible Expenditures
Criteria for Eligible Expenditures
The calculation of the nexus ratio, crucial for the patent box incentive, considers only certain R&D expenditures:
Ø Expenditures must be directly linked to the development of the eligible IP asset.
Ø They include R&D activities undertaken by the taxpayer both in and outside Hong Kong, activities outsourced to unrelated parties (regardless of location), and activities outsourced to related parties residing in Hong Kong.
Ø Notably, acquisition costs for an eligible IP asset are excluded, as they do not fall under R&D expenditures.
Ø However, the QE in the nexus ratio can be increased by 30% with a cap at 100% of the total related R&D expenditures.
4. Scope of Eligible IP Income
Eligible IP income under this incentive encompasses:
· Revenue generated from the use, exhibition, or licensing rights of the eligible IP asset, whether within or outside Hong Kong.
· Income derived from the sale of the eligible IP asset.
· The portion of the sales price of a product or service that can be attributed to an eligible IP asset.
These components collectively define the scope and applicability of Hong Kong’s Patent Box Tax Incentive, setting clear guidelines for businesses seeking to benefit from this scheme.
5. Implementation Timeline and other support on R&D activities in Hong Kong
Hong Kong government plans to introduce necessary legislative amendments for the Patent Box regime in the first half of 2024. This timeline is crucial for businesses and investors, as it provides a clear framework for planning and adapting to the new tax environment.
It is suggested that the tax incentive will create a conducive environment for businesses to invest in R&D endeavors, crucial for stimulating economic growth. They emphasize the importance of considering related measures, such as talent strategy, subsidies, and non-tax support, to enable effective R&D activities in Hong Kong. Additionally, Taxpayers should be fully aware of eligibility assessment, compliance concerns, and the ongoing tracking of relevant figures for each eligible IP asset.
6. The 2023/2024 Hong Kong SAR Budget
The 2023/2024 Hong Kong SAR Budget provides essential context for the Patent Box Tax Incentive. Amidst significant economic challenges, including a notable fiscal deficit due to fluctuating markets and increased public spending, the budget underscores the need for innovative economic revitalization strategies.
The Patent Box Tax Incentive emerges as a pivotal measure within this framework, aimed at stimulating growth in technology and intellectual property sectors. It aligns with the budget’s broader relief measures, balancing immediate economic support with long-term fiscal sustainability. This initiative is designed to attract more R&D activities to Hong Kong, transforming it into a hub for innovation and positioning it for sustainable, high-tech industry-led growth.
7. Our insights
We believe that the new R&D tax incentives and Patent Box tax regime are going to promote the R&D development in Hong Kong. However, for interested R&D companies in Hong Kong and Mult-national enterprises, the below tax issues should be thoroughly considered:-
- For Multi-national enterprises with consolidated revenues of over EUR 750 million, the BEPS Pillar 2 regime is going to effective on 1 January 2025 may hinder these companies from enjoying R&D tax incentives and Patent Box tax regime;
- Under the latest FSIE regime, offshore claim on R&D income is complex and difficult. Companies should instead examine the concessionary tax rates offered under R&D tax incentives and Patent Box tax regime;
- As a general reminder, recharge of R&D expenses from overseas related companies to Hong Kong companies are unlikely to be deductible under Hong Kong Profits Tax and fulfill the above eligible expenses; and
- The Hong Kong Inland Revenue Department has been implementing strict requirements on definition of R&D activities. Taxpayers should thoroughly seek for advice from tax consultants in determining their eligibility to R&D tax incentives and Patent Box tax regime.
