In brief
\nThe bill proposing an enhanced tax deduction for research and development (R&D) expenditure\u00a0in Hong Kong was gazetted on 20 April 2018. Subject to certain conditions, there will be a 300% tax deduction for the first HK$2 million of qualifying R&D expenditure incurred by enterprises and a 200% tax deduction for the remaining amount, without limit. R&D expenditure that does not qualify for the enhanced deduction may continue to enjoy a normal 100% tax deduction subject to fulfilment of the specified conditions. Once the bill is enacted into law, the new R&D tax deduction regime will take effect retrospectively for expenditure incurred, or payment made on, or after, 1 April 2018.<\/p>\n
While the bill represents a significant move in the right direction by the HKSAR Government to promote R&D activities in Hong Kong, the proposed enhanced R&D tax deduction regime is considerably complex. It specifies numerous conditions to be able to enjoy the enhanced tax deduction, introduces various deeming provisions treating certain R&D-related receipts that would otherwise not be subject to profits tax as taxable trading receipts, and includes anti-avoidance provisions to safeguard against abuse of the tax deductions (both normal and enhanced) for R&D expenditure.<\/p>\n
Hong Kong companies that are engaging in, or planning to engage, in R&D activities in and\/or outside Hong Kong should review their R&D activity arrangements in light of the proposed regime. They should also assess how to best structure their R&D activities so as to benefit from the enhanced R&D tax deduction in Hong Kong.\u00a0<\/p>\n
In detail
\nThe current tax deduction for R&D expenditure
\nThe current tax deduction for R&D expenditure is provided in section 16B of the Inland Revenue Ordinance. Under this section, R&D expenditure incurred by a taxprayer related to its trade, profession or business (including capital expenditure on plant or machinery but excluding capital expenditure on land or buildings or in acquiring any rights in, or raising out, of R&D) can be filly deducted (i.e. a 100% tax deduction) in the year of assessment in which the expenditure is incurred, subject to certain conditions.<\/p>\n
Based on the Inland Revenue Department\u2019s (IRD) interpretation, in order to qualify for the deduction, the R&D expenditure must either be (1) incurred in respect of in-house R&D activities undertaken by the taxpayer itself or (2) a payment made to an approved research institute (i.e. for subcontracted R&D activities). For a cost sharing arrangement within a group, the IRD\u2019s view is that only the actual staff costs of the employees of the Hong Kong taxpayer participating in the R&D activities, instead of the full amount of the R&D costs allocated to the Hong Kong taxprayer, can qualify for the deduction.<\/p>\n
For R&D expenditure incurred by a taxpayer outside Hong Kong (i.e. expenditure on R&D activities carried outside Hong Kong), an apportionment of the expenditure is required if the taxpayer\u2019s trade, profession or business is carried on partly in and partly outside Hong Kong (i.e. where only part of the tapayer\u2019s profits are taxable in Hong Kong).<\/p>\n
New Flash \u2013 Hong Kong Tax
\nThe proposed enhanced R&D tax deduction regime
\nTo encourage more enterprises to invest in R&D in Hong Kong and promote local R&D activities, the HKSAR Government proposed in the 2017 Policy Address to introduce an enhanced tax deduction for R&D expenditure. The Inland Revenue (Amendment) (No. 3) Bill 2018 (the Bill), which was gazette on 20 April 2018, set out the details of the proposed normal and enhanced tax deduction for R&D expenditure in Hong Kong. Once the bill is enacted into law, the new regime will take retrospective effect for qualifying expenditure incurred or qualifying payment made on or after 1 April 2018.<\/p>\n
With the introduction of the enhanced R&D deduction, section 16B is revamped and a new schedule (i.e. Schedule 45) is introduced to specify the details for the deduction of R&D expenditure. As specified in Schedule 45 there are two types of tax deductible R&D expenditure, namely Type A expenditure (which qualifies for enhanced tax deduction of 300% for the first HK$2 million and 200% for the remaining amount). R&D expenditure that does not qualify for the enhanced deduction may continues to enjoy a normal 100% tax deduction subject to the fulfillment of the specified conditions.<\/p>\n
Please refer to Table 1 in the Appendix for the key features of the proposed normal and enhanced tax deductions for R&D expenditure, including the R&D activities qualifying for the deduction and what are regarded as Type A expenditure and Type B expenditure. One point that is worth to note is if any rights generated from the R&D activity are not, or will not be, fully vested in the taxpayer, no deduction (both Type A and Type B expenditures) will be granted. This requirement is not clearly specified in the existing section 16B.<\/p>\n
Comparing to other countries that also offer tax incentives for R&D activities, some features of the proposed regime in Hong Kong are more competitive whereas the others are less attractive. Taking the Mainland China as an example, the current rates of enhanced tax deduction for qualifying R&D expenditure are only 175% (for qualified small and medium-sized technical enterprises) or 150% (for other enterprises), which are lower than the 300% \/ 200% enhanced deduction rates in Hong Kong. On the other hand, while payments made for subcontracted R&D activities are generally not eligible for enhanced deduction in Hong Kong (unless the subcontractor is a designated local research institution), 80% of the expenditure incurred for R&D activities subcontracted to a related or unrelated party (either an organization or individual) is eligible for enhanced tax deduction in the Mainland China provided that the R&D activities are conducted by a local Chinese party in China.<\/p>\n
Certain receipts in relation to R&D deemed as taxable trading receipts
\nIn order to maintain tax symmetry, the following provisions (which are originally in section 16B are retained in Schedule 45, with modifications to reflect the proposed enhanced R&D tax deduction.
\n\u03bbProceeds from sale of plant or machinery used for an R&D activity where the capital expenditure on such plant or machinery has been allowed as a deduction under section 16B, with the deemed taxable amount limited to the amount of deduction previously allowed; and
\n\u03bbProceeds from sale of any rights generated from one or more R&D activities for which the expenditure have been allowed as a deduction under section 16B, with the deemed taxable amount limited to the amount of deduction previously allowed.<\/p>\n
The Bill also introduces provisions that deem the following receipts as taxable Hong Kong sourced trading receipts.
\n\u03bbRoyalties received for the use, or the right to use, outside Hong Kong of any intellectual property or know-how generated from any R&D activity in respect of which a R&D deduction is allowable under section 16B; and
\n\u03bbSums received for imparting or undertaking to impart knowledge directly or indirectly connected to the use outside Hong Kong of any intellectual property or know-how generated from any R&D activity in respect of which a R&D deduction is allowable under section 16B.<\/p>\n
Assessment of eligibility for the R&D tax deduction
\nFor the purpose of assessing a claim or an advance ruling application made in relation to a deduction for R&D expenditure under section 16B, the Bill proposes to empower the Commissioner of Inland Revenue (CIR) to seek advice from the Commissioner for Innovation and Technology (CIT) in ascertaining whether (1) an activity falls within the scope of R&D activities qualifying for the tax deduction and (2) the expenditure should be regarded as incurred in relation to an R&D activity qualifying for the tax deduction. The CIR may disclose to the CIT any details which he considers necessary for the purpose of such consultation. However, the final decision on whether a deduction should be allowed for the R&D expenditure concerned will be made by the CIR.<\/p>\n
The takeaways
\nWhile the Bill represents a significant move of the HKSAR Government in the right direction for promoting local R&D activities in Hong Kong, the proposed enhanced R&D tax deduction regime is considerably complex as it specifies numerous conditions for enjoying the enhanced deduction, introduces various deeming provisions that treat certain receipts in relation to R&D that would otherwise not subject to profits tax as taxable trading receipts and includes anti-avoidance provisions to safeguard against abuse of the tax deductions (both normal and enhanced) for R&D expenditure.<\/p>\n
Hong Kong companies that are engaging or planning to engage in R&D activities in and\/or outside Hong Kong should review their R&D activity arrangements in light of the proposed regime and assess how to best structure their R&D activities for benefiting from the enhanced R&D tax deduction in Hong Kong.<\/p>\n
#Resource: PWC\/Apr 2018, Issue 7<\/p>\n","protected":false},"featured_media":2155,"template":"","class_list":["post-2386","blog_en","type-blog_en","status-publish","has-post-thumbnail","hentry"],"yoast_head":"\n