Hong Kong issues consultation on proposed patent box tax incentive

Hong Kong’s Commerce & Economic Development Bureau issued a consultation paper titled ’Introduction of a Patent Box Tax Initiative in Hong Kong’ on 1 September 2023. It sets out proposals for a concessionary tax regime for Hong Kong SAR-sourced intellectual property (IP) income.

The move was announced in the 2023-24 budget and is intended to encourage businesses in Hong Kong SAR to engage in more research and development (R&D) and IP trading activities.

The consultation paper proposes that the scope of eligible IP assets will include:

• Patents and other IP assets that hold functional equivalence to patents – they must be protected by law and subject to comparable registration and approval procedures.
• Copyrighted software.
• Plant variety rights (which give plant breeders exclusive rights to produce, sell, import and export new, protected varieties).

There will be a transitional period of 24 months following the implementation of the patent box tax regime during which eligibility will extend to patents and plant variety rights issued within or outside Hong Kong. After this period, it is proposed that qualifying IP assets will be limited to applications submitted via Hong Kong’s patent system and plant varieties protection system.

Hong Kong proposes to follow the OECD’s ‘nexus’ approach such that the method for calculating the amount of IP income eligible for the reduced tax rate would be based on the ratio of qualifying R&D expenditure to the total amount of R&D expenditure incurred in creating the IP asset.

In calculating the nexus ratio, only R&D expenditure that is directly connected to the eligible IP asset and incurred by the taxpayer to develop the IP asset would be taken into consideration. The acquisition cost of an eligible IP asset would not be regarded as eligible expenditure.

A jurisdictional approach would be adopted in determining the eligible expenditure, which would include expenditure on R&D activities undertaken by the taxpayer inside or outside Hong Kong SAR, or outsourced to unrelated parties to take place inside or outside Hong Kong SAR and outsourced to resident related parties to take place inside Hong Kong SAR.

The scope of eligible IP income would include income derived from an eligible IP asset in respect of the exhibition or use of the asset, or the right to exhibit or use the asset, whether in or outside Hong Kong SAR, or income arising from the sale of an eligible IP asset, or the relevant proportion of the sales price of a product or service that includes an amount attributable to an eligible IP asset calculated in accordance with transfer pricing principles.

The preferential tax rate for the patent box regime is still under consideration. A concessionary tax rate of 8.25% applies under the majority of the various preferential tax regimes currently available in Hong Kong SAR, but the government will also consider preferential tax rates available under competing patent box regimes in other jurisdictions.

Taxpayers would be required to keep sufficient information to track and trace the R&D expenditure and eligible income for calculating the nexus ratio on a cumulative basis. In general, any tax losses associated with the patent box tax incentive would not be available to set off against income that is taxed at the ordinary rate.

The consultation closed on 30 September and the Hong Kong SAR government aims to submit the legislative amendments to the Legislative Council in the first half of 2024.