Executive summary

The Hong Kong Government introduced a legislative bill (the Bill),¹ on 20 April 2018, proposing an enhanced tax deduction regime for qualifying research and development (R&D) activities.

Under the Bill, qualifying R&D expenditure on a qualifying R&D activity will be eligible for increased 200% to 300% tax deductions without limitation. Other R&D expenditure that does not qualify for the above deduction will continue to be eligible for the normal 100% tax deduction. The increased tax deductions are only eligible for payments made to a designated local research institute if the R&D activities are subcontracted out. For in-house R&D activities, the expenditure must be incurred for qualifying R&D activities undertaken and carried on by a taxpayer wholly within Hong Kong.

The Bill also deems certain amounts as taxable in Hong Kong if they are received for the use of, or right to the use, any intellectual property or know-how located outside of Hong Kong that is generated from tax deductible R&D activities.

Detailed discussion

Proposed new tax deduction regime for R&D expenditure

The Bill introduces a two-tier increased tax deduction for the following qualifying R&D expenditure on a qualifying R&D activity:²

(i) A payment to a designated local research institution for out-sourced R&D activities.

(ii) An expenditure in relation to an employee (excluding a director) who is engaged directly and actively in a qualifying R&D activity.

(iii) An expenditure on a consumable item that is used directly in a qualifying R&D activity.

There will be a 300% tax deduction for the first HK$2 million (US$250k) of expenditure and a 200% deduction for the remainder, without limitation. Other R&D expenditure that does not qualify for the increased deduction may continue to enjoy the current 100% normal tax deduction.

The new regime will be retroactively applicable to R&D expenditure incurred on or after 1 April 2018.

Safeguard measures to prevent abuse of the tax deduction regime

There will be an anti-abuse rule under which, no deduction will be allowed for R&D expenditure incurred by a person if any of the following applies:

• Any rights generated from the R&D activities (other than certain outsourced R&D activities) will not be fully vested in the person.
• The R&D activities are undertaken for another person.
• The expenditure is, or is to be, met directly or indirectly by government grants or subsidies.
• The expenditure is incurred under an arrangement and the main purpose, or one of the main purposes, of which is to take advantage of the tax deduction regime.

The Bill also empowers the Commissioner of Inland Revenue to seek advice from the Commissioner for Innovation and Technology when assessing deduction claims or advance ruling applications, during which the taxpayer's R&D activities may be disclosed.

Certain amounts will be deemed taxable income

The following amounts received by or accrued to a person on or after the law is enacted will be deemed taxable in Hong Kong:

• Royalties received for the use of or right to use any intellectual property or know-how located outside of Hong Kong that is generated from tax deductible R&D activities.
• Amounts received for imparting or undertaking to impart knowledge connected with the use outside Hong Kong of any intellectual property or know-how generated from tax deductible R&D activities.
• Proceeds from the sale of plant or machinery, or insurance or compensation money received where the plant or machinery is destroyed, both capped at the total amount previously allowed as deduction.
• Proceeds from the sale of any rights generated from the relevant R&D activities, capped at the total amount previously allowed as deduction.

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ENDNOTES

¹ The Bill referred to is Inland Revenue (Amendment) (No. 3) Bill 2018 and can be downloaded from: https://www.gld.gov.hk/egazette/pdf/20182216/es3201822169.pdf.

² It generally refers to the below activities which are wholly undertaken and carried on in Hong Kong:

(1) An activity in the fields of natural or applied science for the extension of knowledge

(2) An original and planned investigations carried on with the prospect of gaining new scientific or technical knowledge and understanding

(3) The application of research findings or other knowledge to a plan or design for producing or introducing new or substantially improved materials, devices, products, processes, systems or services before they are commercially produced or used

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CONTACTS

For additional information with respect to this Alert, please contact the following:

Ernst & Young Tax Services Limited, Hong Kong

• Tracy Ho
  tracy.ho@hk.ey.com
• Florence Chan, Financial Services
  florence.chan@hk.ey.com

Ernst & Young LLP, Hong Kong Tax Desk, New York

• Charlotte Wong
  charlotte.wong1@ey.com

Ernst & Young LLP, Asia Pacific Business Group, New York

• Chris Finnerty
  chris.finnerty1@ey.com
• Kaz Parsch
  kazuyo.parsch@ey.com
• Bee-Khun Yap
  bee-khun.yap@ey.com

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ATTACHMENT

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