On July 5, 2024, the Government of the Hong Kong Special Administrative Region implemented the Inland Revenue (Amendment) (Tax Concessions for Intellectual Property Income) Ordinance 2024, commonly known as the “Patent Box Regime.”
Under this new regime, qualifying intellectual property (IP) income for eligible taxpayers is taxed at a reduced profits tax rate of 5 percent, instead of the standard 16.5 percent. However, opting for this preferential tax rate means that the taxpayer cannot benefit from the two-tiered profits tax rates.
Key Features of Hong Kong’s Patent Box Regime
The Patent Box Regime applies to patents, copyrighted software, and new plant variety rights. Intellectual properties registered worldwide can benefit from this regime when the profits are generated in Hong Kong. Taxpayers must develop the qualifying IPs themselves. If research and development (R&D) activities involve acquiring other IPs or outsourcing, the profits eligible for the reduced tax rate may be proportionately lowered. Enterprises must register their inventions or new plant varieties locally to benefit from the tax incentive. This registration requirement comes into effect on July 5, 2026, two years after the regime's implementation. With the Amendment Ordinance now effective, taxpayers can apply for the patent box tax incentive starting from the 2023/24 assessment year. This regime is designed to stimulate industrial, R&D, and creative sectors by encouraging the creation and use of IP, thereby promoting IP trading.
Understanding the Patent Box
A patent box is a special corporate tax regime designed to encourage R&D by offering lower tax rates on revenues from patents, as opposed to other commercial revenues. Also known as an IP box, innovation box, or intellectual property box, it is widely used in various countries.
Similar to the R&D super deduction policies in countries like Mainland China, the patent box aims to stimulate R&D spending and the creation of patented innovations. However, the approaches differ: while the R&D super deduction allows extra deductions for R&D expenses from taxable income, the patent box incentivizes the creation and profit generation from patents. This could lead to increased patent filings, as companies seek to maximise potential profits.
The patent box also encourages the practical use of intellectual assets through knowledge transfer and spillover effects, which is expected to attract companies with substantial patent portfolios to invest in the region.
Adoption of the Patent Box in Hong Kong
Hong Kong’s journey to adopting the patent box regime began with the Financial Secretary’s 2023-24 Budget Speech, which introduced the patent box tax incentive as a means to boost innovation and strengthen Hong Kong’s position as a regional IP trading hub.
Following this announcement, a consultation on the proposed incentive was conducted in September 2023. On March 28, 2024, the Inland Revenue (Amendment) (Tax Concessions for Intellectual Property Income) Bill 2024 was gazetted, detailing the provisions of the patent box tax incentive. The Legislative Council passed the Bill on June 26, 2024, and the Patent Box Regime was officially enacted on July 5, 2024, with retrospective application to financial years ending on or after April 1, 2023.
Eligibility Criteria for Hong Kong’s Patent Box Regime
To benefit from the tax incentives under Hong Kong’s Patent Box Regime, a taxpayer must meet the following conditions:
The taxpayer must be an eligible person.
The taxpayer must derive eligible IP income from a qualifying IP.
An election must be made in respect of the eligible IP.
Eligible Person
An “eligible person” includes individuals or entities entitled to derive income from eligible IP. This extends beyond the IP owner. For instance, a licensee who sublicenses an IP and earns a fee qualifies as an “eligible person.”
Eligible IP
Unlike the OECD’s nexus approach, which restricts eligibility to patents and equivalent IP assets, Hong Kong’s regime is more inclusive.
Eligible IP includes:
Eligible patents;
Eligible plant variety rights; and
Copyrighted software.
An eligible patent can be one granted under Hong Kong’s Patents Ordinance or by an external patent office. For patents filed on or after July 5, 2026, local registration in Hong Kong is required, as is the case with plant variety rights.
Eligible IP Income
Eligible IP income includes:
Income from the exhibition or use of an eligible IP asset, such as royalties or licensing income;
Income from imparting knowledge related to the eligible IP;
Income from the sale of an eligible IP;
IP income embedded in product or service sales; and
Insurance, damages, or compensation related to an eligible IP
The portion of embedded IP income attributable to the eligible IP must be calculated to ensure consistency with the OECD’s nexus approach.
Election Mechanism
To avail the tax concessions, an eligible person must make a written election. Once made, the election applies to the relevant assessment year and all subsequent years, and it is irrevocable.
Understanding the OECD’s Nexus Approach
The OECD’s nexus approach, under BEPS Action 5, ensures that preferential tax treatment is only granted when there is a direct connection between IP income and the R&D expenditures incurred to develop the IP. It uses a nexus ratio to evaluate tax regimes, ensuring benefits align with substantial economic activities.
Conditions for Withdrawal of Tax Benefits
The tax concession under the patent box regime can be withdrawn under specific circumstances, such as:
The unconditional revocation of the eligible patent.
Abandonment, refusal, or withdrawal of the eligible patent application.
Cancellation or expiration of the eligible plant variety right.
Non-compliance with the local registration requirement for patents or plant variety rights filed after July 5, 2024.
Taxpayer Obligations
Eligible persons must:
Report eligible IP income in the profits tax return for the relevant year.
Notify the commissioner in writing within four months of any circumstance that leads to the withdrawal of tax concessions.
Retain records related to eligible IP income transactions for at least seven years.
Impact on Investors
Hong Kong’s patent box regime offers significant opportunities for investors and businesses focusing on innovation and IP development. By fostering an R&D-friendly environment, Hong Kong aims to attract innovative companies, promote IP commercialization, and solidify its role as an IP trading hub.
The regime’s inclusion of globally registered IPs and the two-year grace period for local registration reflect Hong Kong’s commitment to creating a vibrant and diverse market for innovation.
Businesses that meet the eligibility criteria can expect enhanced returns on their R&D investments and a stronger competitive position in the global market.
Woodburn can support businesses in navigating the Patent Box Regime by:
Assessing eligibility for the regime.
Ensuring proper documentation and protection of IP.
Reviewing R&D expenditures to maximise tax benefits.
Guiding through the election process for the regime.
Managing compliance with tax regulations.
Providing strategic tax planning and keeping businesses informed of regulatory changes.
The Patent Box Regime represents a strategic initiative by Hong Kong to drive innovation and economic growth through IP development. Engaging with Woodburn can help you optimise your participation in this beneficial scheme and enhance your IP strategies effectively.
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