Guide to Hong Kong’s proposed patent box regime
Lewis Lu and John Timpany of KPMG China discuss the patent box regime to be introduced by the Hong Kong SAR government and its potential impact on R&D in the region
As announced in the 2023-24 Budget speech, the Hong Kong SAR government will introduce a patent box regime to provide tax concessions for onshore profits from qualifying intellectual properties (IPs). The aim is to foster local development in the innovation and technology sector and enhance Hong Kong’s competitiveness as a regional IP trading centre.
The government launched a consultation on the proposed patent box regime and sought views from stakeholders on the key features and, in particular, the tax concessionary measure of the regime.
The proposed patent box regime
The tax concession
Under the proposed regime, a concessionary tax rate (the government is seeking views on the level of the concessionary tax rate) would be applied to a portion of the onshore eligible IP income derived from eligible IP assets calculated under the nexus approach, that is to be computed based on the nexus ratio (the eligible expenditures divided by the overall expenditures incurred by the taxpayer to develop the eligible IP asset).
Eligible IP assets
Only patents and other IP assets that are functionally equivalent to patents would qualify as eligible IP assets under the proposed regime. They include registered patents, copyrighted software, and plant variety rights.
Regarding patents and plant variety rights:
Those where the applications are filed under Hong Kong’s original grant patent (OGP) system would also be considered eligible IP assets. Nevertheless, if the OGP applications fail subsequently, the relevant tax concessions claimed would be clawed back.
Taxpayers would have to comply with the relevant local registration requirements – a transitional measure is proposed to extend the eligibility scope to applications made and granted outside Hong Kong if the date of filing of these two types of IP assets is within 24 months after the commencement of the patent box regime.
Eligible IP income
The eligible IP income will include:
Income derived from an eligible IP asset in respect of (i) the exhibition or use of, or a right to exhibit or use (whether in or outside Hong Kong), the asset; or (ii) the imparting of, or undertaking to impart, the knowledge directly or indirectly connected with the use (whether in or outside Hong Kong) of the asset;
Income arising from the sale of an eligible IP asset; and
The portion of income, determined on a just and reasonable basis (for example, based on transfer pricing principles), attributable to the eligible IP asset’s element included in a sale of a product or service.
Treatment of losses
Considering the requirements of the BEPS Action 5 report, where any tax losses associated with income benefiting from a preferential IP regime should be used in a manner that is consistent with domestic legislation and that does not allow the set-off of those losses against income that is taxed at the ordinary rate, the government proposes to allow a loss in relation to income benefiting from the proposed patent box regime to set off against the taxpayer’s other assessable profits, after being adjusted with reference to the tax rate difference (if any).
As one of the essential requirements of the nexus approach, taxpayers would need to track and trace the historical R&D expenditures and income derived from each individual eligible IP asset.
A transitional measure will be introduced to ensure that taxpayers would have sufficient time to adapt to the tracking and tracing requirements (on individual sets of data), under which a taxpayer will be allowed to apply a nexus ratio where qualifying expenditures and overall expenditures are calculated on a three-year rolling average. After the transition period, the taxpayer will need to adopt the cumulative nexus ratio (i.e., to include the expenditures from the first applicable year to all subsequent years).
The government plans to introduce a bill with the necessary legislative amendments into the Legislative Council in the first half of 2024.
KPMG is glad to see that the Hong Kong SAR government has taken commendable initiative in introducing a patent box regime aimed at promoting the local development of R&D activities and the commercialisation of the R&D results.
By providing the tax incentive, KPMG believes that a conducive environment can be created for businesses to invest in R&D endeavours, which could be crucial for stimulating economic growth and bolstering the overall competitiveness of Hong Kong as a regional IP training centre. In addition to the incentive, related measures would also have to be looked into to enable R&D activities to be undertaken in Hong Kong; for example, talent strategy, subsidies, and other non-tax support.
Businesses would also welcome a relaxation in various aspects relating to the proposed regime; for example, to cover more types of IP assets as eligible IP assets, and providing deductions for the acquisition of IPs (or so-called black-hole expenditures).
Businesses closely connected with IP investments should monitor the future developments in this area and be aware of the eligibility assessment and other compliance concerns arising from claiming the tax concessions, and the ongoing tracking and tracing of the relevant figures of each and every eligible IP asset.