Executive summary

The bill introducing the new patent-box tax incentive in Hong Kong¹ has been passed largely in the current form. The related ordinance was gazetted² on 5 July 2024 and will have retrospective effect for financial years ending on or after 1 April 2023.

Detailed discussion

Under the new patent-box regime, 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%. It is critical to note that the election will be irrevocable once it is made.

For purposes of the regime, eligible IP assets are patents, copyrighted software and plant-variety rights, and 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 If the application or grant of an eligible IP is subsequently abandoned, cancelled, declined, lapsed, revoked or withdrawn, the tax concessions previously granted will be withdrawn.

The 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
• IP income embedded in sales 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 5.³

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 undertaken, whether inside or outside of Hong Kong 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 an overall cap at 100% of the total R&D expenditure. There are also transitional measures prescribed to ease the burden of tracking expenses incurred pre-regime.