On July 5th, 2024, the Hong Kong SAR Government enacted the Inland Revenue (Amendment) (Tax Concessions for Intellectual Property Income) Ordinance 2024, introducing a “patent box” tax incentive regime (“Patent Box Regime“). This regime offers tax concessions on qualifying profits derived from eligible intellectual property (IP) developed through research and development (R&D) activities within Hong Kong. By implementing this regime, Hong Kong seeks to stimulate the growth of IP trading, encourage companies to engage in IP-related activities, and solidify its position as a leading regional hub for intellectual property.
This article delves into the intricacies of the Patent Box Regime, highlighting its objectives, key features, eligibility criteria, and implications for businesses.
Objectives of the Patent Box Regime
The primary aim of Hong Kong’s Patent Box Regime is to encourage the creation, development, and exploitation of intellectual property. By offering tax concessions on profits derived from eligible IP income, the regime seeks to:
- Promote R&D and IP Trading: By incentivizing R&D activities and the trading of IP, the regime aims to bolster Hong Kong’s position as a hub for innovation and technology.
- Enhance Competitiveness: The tax concessions make Hong Kong an attractive destination for businesses looking to invest in IP-related activities, thereby enhancing the region’s competitiveness on the global stage.
- Support Economic Growth: Increased IP trading and development activities are expected to create business opportunities, leading to economic growth and the creation of high-value jobs in sectors such as legal, valuation, management, and consulting services related to IP.
Key Features of the Patent Box Regime
The Patent Box Regime, enacted through the Inland Revenue (Amendment) (Tax Concessions for Intellectual Property Income) Ordinance 2024, offers significant tax benefits to eligible businesses. Here are the key features:
- Concessionary Tax Rate: The concessionary portion of the taxpayer’s assessable profits derived from eligible IP income are subject to a reduced profits tax rate of 5%, significantly lower than the standard profits tax rate (16.5%).
- The Nexus Approach: In calculating the concessionary portion, the Nexus Approach is adopted, a standard endorsed by the Organisation for Economic Co-operation and Development (OECD).
- Scope of Application: The regime applies to profits derived from eligible IP income in respect of a year of assessment beginning on or after April 1, 2023.
- Election Mechanism: Taxpayers must make an election in writing to benefit from the regime. Once made, the election applies to the elected year and all subsequent years, without the need for annual re-election.
Eligibility Criteria
To benefit from the tax concessions under the Patent Box Regime, taxpayers must meet specific eligibility criteria:
- Eligible Person: Any individual or entity entitled to derive income from eligible IP can qualify as an eligible person. This includes owners of IP as well as licensees who derive income from sublicensing the IP.
- Eligible Intellectual Property: The regime covers patents, plant variety rights, and copyrighted software generated from R&D activities. The IP must be legally protected and subject to similar approval and registration processes.
- Eligible IP Income: Income eligible for tax concessions includes:
Income from exhibiting or using the IP, or the right to exhibit or use the IP, both within and outside Hong Kong.
Income from imparting or agreeing to impart knowledge directly or indirectly related to the use of the IP.
Income from the sale of the eligible intellectual property.
Portion of the sale price of a product or service attributable to the eligible IP, calculated on a just and reasonable basis.
Amounts derived from insurance, damages, or compensation related to the eligible IP.
Election Mechanism for Tax Concessions
Eligible persons can opt for tax concessions on their intellectual property (IP) income under an election mechanism in Hong Kong’s Patent Box Regime. This election must be made in writing and, once made, applies to the current and all subsequent years of assessment without requiring annual re-election. The election is irrevocable, ensuring consistent application of the reduced tax rates on eligible IP income, which provides long-term fiscal certainty and encourages sustained investment in IP development and commercialisation.
Additional specifications apply to certain types of eligible intellectual properties. Specifically:
Granted Patents and Divisional Patent Applications:
- If an election is made for a patent application, it is automatically extended to include patents granted from the original patent application and any divisional patent applications related to the original application.
Non-Standard Patents Filed On or After the Specified Date:
- For patents that are not standard patent (O), standard patent (O) applications, short-term patents, or short-term patent applications, and filed on or after the specified date, the election is valid only if there is a corresponding local patent.
Plant Variety Rights Filed On or After the Specified Date:
- For plant variety rights that are neither a grant nor an application as defined by section 2 of Cap. 490, and filed on or after the specified date, the election is valid only if there is a corresponding local plant variety right.
Additionally, the term “divisional patent application” includes requests for records of divisional patent applications and subsequent divisional patent applications related to the original application, whether made under Hong Kong’s Cap. 514 or with patent offices outside Hong Kong.
Nexus Approach and R&D Fraction
The Patent Box Regime employs the Nexus Approach, a standard endorsed by the Organisation for Economic Co-operation and Development (OECD), to determine the concessionary portion of assessable profits.
The Nexus Approach
Established by the OECD under Action 5 of the 2015 BEPS (Base Erosion and Profit Shifting) Action Plan, the Nexus Approach is a method used to determine whether a preferential tax regime is potentially harmful by calculating a ration, known as the Nexus Ratio, which compares the qualifying expenditures of a taxpayer to its overall expenditures.
R&D Fraction
The R&D Fraction is a calculation to determine the portion of a taxpayer’s overall expenditures that is attributable to qualifying R&D activities. The R&D Fraction is calculated by dividing the qualifying expenditures for R&D by the overall expenditures of a taxpayer. This helps ensure that tax benefits are granted only to income that is derived from substantial R&D activities, preventing the misuse of preferential tax regimes for base erosion and profit shifting (BEPS) purposes.
Classification of R&D Expenditure
R&D expenditures, including capital expenditures, are categorised into Eligible Expenditure (EE) and Non-Eligible Expenditure (NE) based on who carries out the R&D activities and where these activities take place.
R&D Activities by the Eligible Person: Expenditures incurred directly by the eligible person are classified as EE.
R&D Activities by Non-Associated Persons on Behalf of the Eligible Person: Expenditures incurred by non-associated persons conducting R&D on behalf of the eligible person are classified as EE.
R&D Activities by Associated Persons:
- If an associated person, who is a Hong Kong resident, conducts R&D on behalf of the eligible person, the classification depends on the location of the R&D activities:
- In Hong Kong: Expenditures are classified as EE.
- Outside Hong Kong: Expenditures are classified as NE.
- If an associated person, who is a non-Hong Kong resident, conducts R&D on behalf of the eligible person, expenditures are classified as NE.
Specific Exclusions and Inclusions
Exclusions from EE:
- Interest payments.
- Payments for any land or building.
- Payments for any alteration, addition, or extension to any building.
- Expenditures incurred for obtaining the eligible intellectual property or any rights related to the property from another person.
Inclusions in NE:
- Any expenditure (including capital expenditure) incurred for obtaining the eligible intellectual property or any rights related to the property from another person.
- However, NE does not include interest payments and payments for any land or building, or for any alteration, addition, or extension to any building.
The Three-Year "Average" Transitional Measure
To allow sufficient time for taxpayers to adapt to the tracking and tracing requirements while complying with the general principles of the nexus approach, a three-year “average” transitional measure permits taxpayers to apply a three-year rolling average for calculating qualifying expenditures and overall expenditures used in the Nexus Ratio.
Tax Concessions and Withdrawal Conditions
The Patent Box Regime offers significant tax concessions, but these can be withdrawn under specific circumstances:
- Withdrawal Conditions: Concessions may be withdrawn if the IP is unconditionally revoked, abandoned, refused, or if specific conditions are not met.
- Taxpayer Obligations: Taxpayers must report eligible IP income in their tax returns, notify the Commissioner of Inland Revenue of any changes affecting eligibility, and retain relevant records for at least seven years.
Special Provisions and Additional Information
The regime includes special provisions for taxpayers who filed their profits tax returns for the year of assessment 2023/24 before the enactment of the Amendment Ordinance. These taxpayers will be notified of the procedures for claiming tax concessions.
Additionally, the Inland Revenue Department provides extensive resources and guidance on the regime, including links to the Inland Revenue Ordinance, OECD materials, and relevant departmental resources.
What CW Can Do For You
Hong Kong’s Patent Box Regime represents a strategic initiative to foster innovation and economic growth through the development and commercialization of intellectual property. As you consider leveraging Hong Kong’s patent box regime to enhance your intellectual property strategies, CW CPA can assist you in the following aspects:
- Eligibility Assessment: Determine whether your intellectual property qualifies for the regime.
- Documentation and Protection: Ensure your IP is properly documented and protected under local and international laws.
- R&D Expenditure Analysis: Conduct detailed reviews of your R&D expenses to maximize tax benefits.
- Regime Election Guidance: Assist with the process of electing to apply the patent box regime to eligible IP assets.
- Compliance Management: Manage ongoing compliance with tax laws, ensuring your business meets all regulatory requirements.
- Strategic Tax Planning: Provide strategic advice on tax planning to optimize your fiscal outcomes under the regime.
- Regulatory Updates: Keep you informed of any changes in the tax regime or related regulations that could affect your IP strategy.
Contact us to gain advice that help streamline your operations and capitalize on Hong Kong’s favorable IP environment.
