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September 12, 2023
2023-1507

Hong Kong introduces new patent-box tax incentive; accepting comments until 30 September

  • Hong Kong has proposed a new patent box tax incentive regime that complies with the Organisation for Economic Co-operation and Development's Base Erosion and Profit Shifting (BEPS) Action 5.
  • Taxpayers may want to review their intellectual property structures and assess eligibility for the potential tax changes.

Executive summary

Hong Kong issued a consultation paper on 1 September 2023 regarding the introduction of a new patent box tax incentive, proposing that eligible intellectual property (IP) income derived from eligible patents or patent-like IP assets be taxed in Hong Kong at a concessionary tax rate.

Subject to the views collected in a one-month consultation period ending on 30 September 2023, the proposed tax incentive will be codified by the first half of 2024.

Detailed discussion

Eligible IP assets under the proposed patent box tax incentive regime are patents, copyrighted software and plant-variety rights. These eligible IP assets are required to be both legally protected and subject to approval and registration processes, where such processes are relevant. In particular, patents and plant-variety rights will need to be locally registered after a 24-month transitional period.

Under the proposals, Hong Kong-sourced eligible IP income includes:

  • Income derived from the exhibition or use of an eligible IP asset, which generally covers most royalties and licensing income
  • Disposal gain of an eligible IP asset
  • Sales of products or services that include an amount attributable to an eligible IP asset

While most of the existing Hong Kong preferential tax regimes offer a concessionary tax rate at 8.25%, the government is aware of the lower rates offered by other patent box regimes and welcomes public comments. The extent of the eligible IP income that will be taxed at the concessionary rate will be determined based on the "nexus approach" under the BEPS Action 5 and a jurisdictional approach will be adopted. The nexus ratio will be calculated by dividing the qualifying research and development (R&D) expenditures (QE) by the total expenditure incurred to develop the eligible IP asset. The QE refers to expenditures incurred for (i) R&D activities that the taxpayer undertakes within or outside of Hong Kong or outsources to unrelated parties, and (ii) R&D activities undertaken in Hong Kong that are outsourced to domestic related parties. Acquisition costs of an IP asset are specifically excluded from the QE. However, the QE in the nexus ratio can be increased by 30% with a cap at 100% of the total related R&D expenditures.1

There will be transitional measures to ease the burden on tracking pre-regime incurred expenses. Loss set-off across different tax regimes is permitted with tax-rate difference adjustment.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young Tax Services Limited, Hong Kong

Ernst & Young LLP (United States), Hong Kong Tax Desk, New York

Ernst & Young LLP (United States), Asia Pacific Business Group, New York

Ernst & Young LLP (United States), Asia Pacific Business Group, Chicago

Published by NTD's Tax Technical Knowledge Services group; Carolyn Wright, legal editor

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ENDNOTE

1 For example, if you incur $100 QE out of $150 total expenses, the ratio would be $100 x 130% / $150.

 

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