The R&D development in Hong Kong has been rapid with the substantial support from the government in recent years. Many fintech and biotechnology corporations have been set up in Science Park and Cyberport. Having said that, as Hong Kong is just a small city, it is common that Hong Kong entity will only carry out part of the R&D project while other entities in the multi-national group (e.g., The PRC, Taiwan, the US) will also take part in the same R&D projects.
First of all, it is common for all the R&D entities in the Group to enter into the Cost Contribution Arrangement (CCA) such that the proportionate R&D contributions borne by each entity should be determined based on its proportionate shares of benefits. In this regard, the IRD has emphasised in the 2020 Annual Meeting with HKICPA that expected benefits at the beginning of the CCA should be adopted rather than the actual results in the determining the contributions (costs) made by each group entity.
Secondly, no matter the Multi-National Corporations set up a Hong Kong subsidiary or a Hong Kong branch, under a CCA arrangements, part of the royalty income derived from the Intellectual Property (IP) would be subject to Hong Kong Profits Tax as long as the Hong Kong Subsidiary / Branch has participated in the value-creation process under either one of the following sections of the IRO:
Section 50AAK: A Non-Hong Kong resident person who had a Hong Kong permanent establishment was regarded as carrying on trade, profession or business in Hong Kong for the purpose of Hong Kong Profits Tax
Section 15(1)(bc): Any income received by a person for the right to use the IP generated by R&D activity where the tax deduction has been claimed on the costs of R&D activity under Section 16B of the IRO.
Section 15F: Please refer to here for details.
Points to note
We are aware that Multi-National Corporations in general lack awareness of special tax rule on R&D rule in Hong Kong, no matter on taxability of income generated from R&D activity or tax deduction on R&D expenses.
On one hand, they should build up the awareness to prepare a proper Cost Contribution Arrangement (CCA) at the beginning of the R&D project. More importantly, they should study whether their existing CCA fulfills the requirements set under DIPN 55.
More importantly, we are aware that a lot of Asian Group (e.g., the PRC, Taiwan) has assigned a Hong Kong group company to bear the R&D costs and become the IP owner to take up the income from the IP generated from the R&D activity, most probably due to the low Profits Tax rate in Hong Kong.
However, under most circumstances, none of the relevant R&D activities take place in Hong Kong. In other words, the Hong Kong group company only bears the financial burden of the R&D activity but sub-contracted the R&D work to non-Hong Kong group entities. In this regard, it is highly unlikely that the R&D expenses paid by the Hong Kong company to overseas group entities would be eligible to tax deduction under Section 16B of the IRO.
The Hong Kong company may end up paying substantial amount of tax in Hong Kong as a substantial portion of R&D costs may be disallowed by the IRD. While the Hong Kong entity may pursue offshore claim on income generated by the IP on the basis that all the relevant R&D work are performed outside Hong Kong, it may not be the best option under the latest BEPS Development.
