Executive summary

A new patent-box tax incentive bill in Hong Kong follows an announcement in the jurisdiction's 2024/25 Budget¹ indicating that an incentive was coming to encourage more research and development (R&D) activities for the creation of intellectual property (IP) for commercial exploitation. The related bill² was gazetted on 28 March 2024 and is now subject to legislative amendments proposed in the Legislative Council. The regime, if passed, will have retrospective effect for financial years ending on or after 1 April 2023.

Detailed discussion

The proposed patent box regime in the bill is similar to what was outlined in the original consultation.³ The concessionary portion of assessable profits from eligible IP income derived by an eligible owner or licensee of eligible IP will, on election, be subject to a concessionary tax rate of 5%. The election will be irrevocable once it is made.

For the purpose of the regime, eligible IP assets are patents, copyrighted software and plant-variety rights. Patents and plant-variety rights will need to be locally registered after a 24-month transitional period. If the application or grant of an eligible IP is subsequently abandoned, cancelled, declined, lapsed, revoked or withdrawn, the tax concessions previously granted will be withdrawn.

Under the proposal, Hong Kong-sourced eligible IP income includes:

• Income derived from the exhibition or use of an eligible IP asset, which generally covers most royalties and licensing income
• Disposal gain of an eligible IP asset
• Embedded IP income in sale of products or services
• Insurance, damages or compensation derived in relation to an eligible IP

The portion of eligible IP income that will be taxed at the 5% concessionary rate will be determined in a manner consistent with the "nexus approach" in Base Erosion and Profit Shifting (BEPS) Action 5.⁴

The nexus ratio will be calculated by dividing the qualifying R&D expenditures (QE) by the total expenditure incurred to develop the eligible IP asset. The QE refers to expenditures incurred for (i) R&D activities undertaken by the taxpayer or outsourced to unrelated parties, and (ii) R&D activities outsourced to domestic related parties that are undertaken in Hong Kong. Acquisition costs of an IP asset are specifically excluded from the QE. However, the QE in the nexus ratio can be increased by 30% with a cap at 100% of the total related R&D expenditure.

There will be transitional measures to ease the burden on tracking pre-regime incurred expenses. Specific rules are also proposed to allow combining R&D expenditures when there is entity amalgamation or there is an equity interest acquisition followed by IP transfer or licensing from the original owner to the Hong Kong taxpayer.