Hong Kong has passed the “patent box” tax incentive to provide a concessionary profits tax rate of 5% (instead of the general 16.5% profits tax rate) on qualifying profits sourced in Hong Kong and derived from eligible intellectual properties (IP) created through research and development (R&D) activities. The Inland Revenue (Amendment) (Tax Concessions for Intellectual Property Income) Ordinance 2024 which implements this incentive was gazetted on 5 July 2024. It should be noted that the patent box does not apply to offshore sourced profits, which are either tax exempt or taxable at the general profits tax rate if received in Hong Kong pursuant to the Foreign Source Income rules that took effect on 1 January 2023.
To enjoy the tax concession under the patent box, a taxpayer must meet the following requirements:
- The taxpayer is an eligible person;
- The taxpayer derives eligible IP income from an eligible intellectual property; and
- An election is made in respect of the eligible intellectual property.
Eligible person
“Eligible person” means a person who is entitled to derive eligible IP income from an eligible intellectual property. An eligible person can be a person other than the owner of an eligible intellectual property so long as that person has a right to derive income from the property. For example, a licensee who obtains a licence to use an eligible intellectual property from its owner and then sub-licenses the eligible intellectual property to another person for earning a sub-licensing fee falls within the meaning of “eligible person”. The licensee can benefit from the tax concessions provided that it has incurred eligible R&D expenditures in respect of the eligible intellectual property and other conditions of the Regime are satisfied.
Eligible intellectual property
In accordance with the nexus approach adopted by the Organisation for Economic Co-operation and Development (OECD), only income derived from an eligible intellectual property could benefit from the preferential tax treatment based on the nexus ratio under the Regime. Under the nexus approach, eligible intellectual properties that could qualify for preferential tax treatment are limited to patents and other intellectual property assets that are functionally equivalent to patents if those intellectual property assets are both legally protected and subject to similar approval and registration processes. In Hong Kong, a more liberal approach has been taken with a view to enhancing the competitiveness of the Regime. For instance, eligible intellectual properties include applications for patents and plant variety rights, as well as those patents and plant variety rights granted in or outside Hong Kong.
“Eligible intellectual property” is defined in section 1(1) of Schedule 17FD to the Inland Revenue Ordinance (IRO) to mean any of the following intellectual property that is generated from an R&D activity:
- an eligible patent;
- an eligible plant variety right;
- a copyright subsisting in software under the Copyright Ordinance (Cap. 528) or under the law of any place outside Hong Kong.
Qualifying profits comprises income derived from the exhibition or use of an eligible IP asset, which generally covers most royalties and licensing income, a disposal gain of an eligible IP asset, IP income embedded in sales of products or services and insurance, damages or compensation derived in relation to an eligible IP.
Other points worth noting are:
- eligible IPs can be registered in different places around the world while their related profits sourced in Hong Kong can benefit from the patent box tax incentive;
- eligible IPs must be developed by taxpayers themselves. If the R&D process involves acquisition of other IPs, or outsourcing part of the R&D activities, the amount of profits eligible for the concessionary tax rate may be reduced proportionally; and
- enterprises must obtain local registration for their inventions or new plant varieties in order to enjoy the tax incentive (this requirement will only start to be implemented 2 years after the patent box tax incentive comes into operation).
The Amendment Ordinance took effect from 5 July 2024. Taxpayers can apply for the patent box tax incentive starting from the year of assessment 2023/24. The Inland Revenue Department will provide further administrative guidance on its website.
