December 23, 2024
Intangible Assets

Hong Kong Offers Patent Box Incentive to Compete for IP Investors


The Hong Kong Inland Revenue Department enacted the patent box tax incentive July 5 as an initiative to boost Hong Kong’s position as a regional location for development and housing of new intellectual property. The incentive has been introduced with an aim of developing strategic industries such as life and health tech, data science, fintech, and advanced manufacturing.

Planning for Tax Optimization

While the patent box offers attractive tax efficiency potential, multinational enterprises need to be conscious of how to manage overarching international tax considerations when planning their regional IP arrangements around the incentive.

The implied substance implications are significant. Not only is a Hong Kong entity and registration required, but the nexus approach also creates a need to calibrate the research and development functions and risks around economic substance in Hong Kong, and balance the value contributions of other group R&D entities, such as related outsourced R&D centers.

Such restructuring activity also comes with a significant shift in functions and risks and accompanying transfer pricing implications. MNEs should remain vigilant on clearly documenting economic IP ownership, ensuring arm’s-length terms for related party usage of IP and ensuring that any transferred IP assets are valued using methodologies consistent with the arm’s-length principle.

MNEs should also be conscious of the development and future application of the global minimum tax in Hong Kong under the OECD’s Pillar Two initiative, and how the tax incentive rate may be impacted once top-up taxes and substance carve outs are accounted for.

Incentive Terms

To promote R&D activities and encourage companies to invest in innovation in Hong Kong, the patent box tax incentive grants eligible taxpayers a concessionary tax rate of 5% (reduced from the nominal tax rate of 16.5%) on their qualifying profits derived from eligible IP income sourced in Hong Kong.

Eligible IPs that can benefit are patents, plant variety rights, and copyright subsisting in software generated from an “R&D activity,” defined by the government as “an activity working for tomorrow to develop new products, new lines and improvements to present production.”

The patent box tax incentive takes effect from a year of assessment beginning on or after April 1, 2023.

In simple terms, the patent box grants the concessionary tax rate to an eligible person who derives eligible IP income from eligible IP. The definition of an eligible person is one entitled to derive the IP income, and the entitlement is structured such that economic ownership is prioritized over legal ownership, linking the incentive opportunities to critical transfer pricing considerations and opportunities.

The alignment of these requirements with the concepts of IP ownership introduced in paragraph 6.32 of the Organization for Economic Cooperation and Development’s Transfer Pricing Guidelines gives MNEs an opportunity to assess the available tax benefits in Hong Kong compared to the rest of the region and develop a robust IP holding policy.

In determining the profits qualifying for the concessionary tax rate, the Inland Revenue Department has complied with global standards and adopted the OECD’s nexus approach, applying a nexus requirement between the income qualifying for the preferential tax treatment and expenditure on R&D undertaken by the taxpayers contributing to that income.

The nexus approach ensures that any value created and economic activity will be localized in Hong Kong and will benefit the local economy. This concessionary portion of profit is ascertained by applying the “R&D fraction” to the assessable profits from the eligible IP income. Eligible IP income refers to:

  • Income arising from activities of licensing or sale of eligible IP
  • Income attributable to eligible IP embedded in the price of a sale of product or service
  • Insurance, damages, or compensations derived in relation to an eligible IP

The R&D fraction is calculated as the ratio of eligible R&D expenditure with a 30% uplift against the sum of all eligible and non-eligible R&D expenditure incurred in respect of the subject IP. The fraction calculation is capped at 100% of assessable profits.

Broader Strategy

The generosity of the patent box system highlights the Hong Kong government’s broader strategy to enhance Hong Kong’s overall competitiveness in IP development.

Other key measures by the government include:

  • The Stock Exchange of Hong Kong Limited implementing a new listing regime under Chapters 18A and 18C of the Listing Rules, allowing the listing of pre-revenue biotech companies and specialist technology companies to raise funds
  • Enhancing the Copyright Ordinance to strengthen copyright protection in the digital environment and artificial intelligence technology development
  • Enhancing the Technology Talent Admission Scheme to attract non-local talent
  • Establishing the Office for Attracting Strategic Enterprises to assist strategic industry talents such as fintech and AI with setting up operations in Hong Kong

Competing for IP

Similar tax incentives can be seen around the region as Asia’s economic hubs jostle for position in the IP development race.

China offers a 15% preferential corporate income tax rate for manufacturing and R&D companies qualified as High-New Technology Enterprises, although the requirements are stringent and tax authorities are diligent in reassessing a company’s eligibility every three years, often requesting substantial supporting documents.

Singapore also offers the IP Development Incentive, which grants a tax concessionary tax rate of 5% or 10% on eligible IP income—however, there are restrictive conditions such as explicit economic substance requirements on the number of skilled employees and additional annual total business expenditure.

With its lower concessionary tax rate and fewer restrictions, Hong Kong’s patent box tax regime appears both competitive and straightforward.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Eu-Kim Chan is senior director with Alvarez & Marsal Tax in Hong Kong. He has over 11 years’ experience in transfer pricing, corporate tax, and private wealth planning.

Joyce Au is director with Alvarez & Marsal Tax in Hong Kong. She has over 10 years’ experience in mergers and acquisitions and corporate tax.

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