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April 18, 2024
2024-0817

Hong Kong introduces bill on patent-box tax incentive

  • Pursuant to the announcement in Hong Kong 2024/25 annual budget, a bill has been gazetted to introduce a new patent-box regime in Hong Kong under which qualifying income will be taxed at 5%.
  • The portion of eligible intellectual property income that will be taxed at the 5% concessionary rate will be determined in a manner that would be consistent with the "nexus approach" in BEPS Action 5 and will also take into account certain expenditures incurred by the previous owner of the intangible asset, if conditions are met.
  • Taxpayers may want to review their intellectual property structures and assess eligibility for the new Hong Kong regime.
 

Executive summary

A new patent-box tax incentive bill in Hong Kong follows an announcement in the jurisdiction's 2024/25 Budget1 indicating that an incentive was coming to encourage more research and development (R&D) activities for the creation of intellectual property (IP) for commercial exploitation. The related bill2 was gazetted on 28 March 2024 and is now subject to legislative amendments proposed in the Legislative Council. The regime, if passed, will have retrospective effect for financial years ending on or after 1 April 2023.

Detailed discussion

The proposed patent box regime in the bill is similar to what was outlined in the original consultation.3 The concessionary portion of assessable profits from eligible IP income derived by an eligible owner or licensee of eligible IP will, on election, be subject to a concessionary tax rate of 5%. The election will be irrevocable once it is made.

For the purpose of the regime, eligible IP assets are patents, copyrighted software and plant-variety rights. Patents and plant-variety rights will need to be locally registered after a 24-month transitional period. If the application or grant of an eligible IP is subsequently abandoned, cancelled, declined, lapsed, revoked or withdrawn, the tax concessions previously granted will be withdrawn.

Under the proposal, 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
  • Embedded IP income in sale of products or services
  • Insurance, damages or compensation derived in relation to an eligible IP

The portion of eligible IP income that will be taxed at the 5% concessionary rate will be determined in a manner consistent with the "nexus approach" in Base Erosion and Profit Shifting (BEPS) Action 5.4

The nexus ratio will be calculated by dividing the qualifying 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 undertaken by the taxpayer or outsourced to unrelated parties, and (ii) R&D activities outsourced to domestic related parties that are undertaken in Hong Kong. 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 expenditure.

There will be transitional measures to ease the burden on tracking pre-regime incurred expenses. Specific rules are also proposed to allow combining R&D expenditures when there is entity amalgamation or there is an equity interest acquisition followed by IP transfer or licensing from the original owner to the Hong Kong taxpayer.

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Endnotes

1 See EY Global Tax Alert, Hong Kong announces 2024/25 annual Budget with new patent-box regime, dated 7 March 2024.

2 The Inland Revenue (Amendment) (Tax Concessions for Intellectual Property Income) Bill 2024

3 See EY Global Tax Alert, Hong Kong introduces new patent-box tax incentive; accepting comments until 30 September, dated 12 September 2023.

4 Harmful Tax Practices — 2021 Peer Review Reports on the Exchange of Information on Tax Rulings: Inclusive Framework on BEPS: Action 5 | OECD/G20 Base Erosion and Profit Shifting Project | OECD iLibrary (oecd-ilibrary.org)

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Contact Information

For additional information concerning this Alert, please contact:

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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