Following the enactment of the Inland Revenue (Amendment)(No.3) Ordinance 2011 in December 2011, the Hong Kong Inland Revenue Department (HKIRD) issued the Departmental Interpretation and Practice Note (DIPN) No.49 on 10 July 2012. DIPN No. 49 sets out the HKIRD's interpretation and practices in relation to the deduction from profits tax for capital expenditure on relevant intellectual property rights (i.e. patent rights, rights to know-how, copyrights, registered designs and registered trade marks) and the taxation of royalties derived from the licensing of intellectual property rights.
Consequently, DIPN No. 5 and DIPN No. 21 have been revised accordingly as follows:
|-||Part (c) of DIPN No.5 (deductions for expenditure on (a) research and development; (b) technical education; (c) patent rights, etc.; (d) building refurbishment; (e) prescribed fixed assets; and (f) environmental protection facilities) is updated to include a reference to DIPN No.49 (paragraph 29). A copy of the revised DIPN No.5 may be downloaded from http://www.ird.gov.hk/eng/pdf/e_dipn05.pdf.|
|-||Paragraph 45(g) of DIPN No.21 (locality of profits) is updated to include a reference to DIPN No.49 in relation to the taxation of royalties derived from the licensing of intellectual property rights. A copy of the revised DIPN No.21 may be downloaded from http://www.ird.gov.hk/eng/pdf/e_dipn21.pdf.|
DIPN No. 49 consists of two parts: Part A – Profits tax deduction of capital expenditure on relevant intellectual property rights (IPRs) and Part B – Taxation of royalties derived from licensing of intellectual property rights. While DIPN No.49 mainly expands on the provisions as reported in January, several points are worth noting:
Part A – Profits tax deduction of capital expenditure on relevant IPRs
|-||A deduction will be allowed as long as it is substantiated that the right concerned constitutes one or more of the IPRs falling with the scope of the Inland Revenue Ordinance (IRO). In order to ascertain the nature of the IPR for tax deduction, the HKIRD will refer to the relevant statutory registration regime (patents, registered designs and registered trade marks) or, where there is no registration system (know-how or copyright), the relevant agreement for sale and purchase;|
|-||Tax deduction is only allowed for capital expenditure incurred on the outright purchase of an IPR. Licence fees paid for acquiring the right to use an IPR for a specific period are not allowable under section 16E or 16EA of the IRO. However, such fees may be allowable under the normal deduction rules under section 16(1) of the IRO provided that they are incurred in the production of chargeable profits and not regarded as capital in nature;|
|-||In order to qualify for tax deduction, the IPRs must be used in producing profits that are chargeable to tax in Hong Kong, and whether this is so will be based on the facts of the case. For example, where an IPR is registered in multiple jurisdictions but is only used in some of the jurisdictions, and a deduction is claimed for expenditure incurred to acquire the IPR in all the jurisdictions on the ground that the expenditure was necessary to protect the registration in the jurisdictions in which the IPR is actually used, DIPN No.49 indicates that the HKIRD would accept and allow the deduction only if the taxpayer can provide substantive and reasonable evidence to prove that the IPR registered in the jurisdictions where it is not used has direct and actual impact on the production of profits chargeable to tax in Hong Kong; and|
|-||DIPN No.49 sets out clarifications and numerous examples illustrating the operation of the anti-avoidance provisions in section 16EC of the IRO. In particular, section 16EC(4)(b), which mirrors section 39 of the IRO, denies a deduction for an IPR used wholly or principally outside Hong Kong by a person other than the taxpayer under a licence agreement. The HKIRD states that it is prepared to adopt a pragmatic approach in applying the provisions, taking into account the peculiar nature of IPRs, the territorial registration system and protection of the rights and the wide scope in which the rights can be used, and provides some examples of when a deduction may be allowed or denied under this particular section.|
Part B – Taxation on royalties derived from licensing of IPRs
The HKIRD takes the view that whether royalties derived from the licensing of IPRs (other than those deemed chargeable), are taxable depends on the facts and circumstances of each case. For illustration purposes, the HKIRD provides some general examples:
|-||Where an IPR is created or developed by a taxpayer carrying on business in Hong Kong and licensed to another party for use outside Hong Kong: the royalties will be considered to be a Hong Kong source;|
|-||Where an IPR is purchased by a taxpayer and licensed to another party for use outside Hong Kong: the royalties will be considered to be a non-Hong Kong source; and|
|-||Where a taxpayer obtains a licence to use an IPR and sub-licences to another party for use outside Hong Kong: the HKIRD will look at the place of acquisition and granting of the licence to ascertain whether the royalties have a Hong Kong source.|
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