On June 29, 2018, Hong Kong issued a press release on the expanded scope of profits tax deductions for capital expenditure incurred by companies purchasing intellectual property (IP) rights. See BEPS Action 5.
Hong Kong expanded the scope the profits tax deductions to encourage companies to develop an IP trading business, and to promote Hong Kong as an IP trading hub in the Asia-Pacific region. On June 20, 2018, the Legislative Council passed the Inland Revenue (Amendment) (No. 5) Ordinance 2018 (the “Amendment Ordinance”), which was published in the Gazette, and entered into force on June 29, 2018.
The Amendment Ordinance expands the scope of profits tax deductions for capital expenditure incurred from purchasing IP rights from five types to eight, with effect from the year of tax assessment 2018/19. The additional three types of IP rights include rights in layout design (topography) of integrated circuits, plant varieties, and performances. The original five types of IP rights are patents, know-how, copyright, registered designs, and registered trademarks.
Capital expenditure incurred by companies for the purchase of various major types of IP rights, as well as expenses for the registration of IP rights under applicable regimes, is deductible under section 16E of the Inland Revenue Ordinance Chapter: 112.
Under BEPS Action 5, countries agreed that the substantial activity requirement used to assess preferential regimes should be strengthened to realign the taxation of profits with the substantial activities that generate them. Consensus was reached on the “nexus approach” for IP regimes. This approach allows taxpayers to benefit from an IP regime only to the extent that they incurred qualifying research and development (R&D) expenditures that gave rise to the IP income.
Qualifying expenditures must have been incurred by a qualifying taxpayer, and they must be directly connected to the IP asset. Qualifying expenditures will be included in the nexus calculation at the time they are incurred, regardless of their treatment for accounting or other tax purposes. “It is not the amount of expenditures that acts as a direct proxy for the amount of activities. It is instead the proportion of expenditures directly related to development activities that demonstrates real value added by the taxpayer and acts as a proxy for how much substantial activity the taxpayer undertook.”
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