Tax Concessions for Intellectual Property Income – Patent Box Regime

Patent Box Regime (the Regime)

Intellectual property has become an essential capital for enterprises in a knowledge-based economy. Encouraging the industrial and research and development (R&D) sectors as well as the creative industries to create and exploit intellectual property will stimulate and promote the development of intellectual property trading. Enhanced R&D and intellectual property trading activities will in turn lead to more creation and exploitation of intellectual property through, for example, acquiring foundation technologies or intellectual property and conducting R&D on products and services by enterprises, followed by obtaining patent protection for the newly developed technologies or inventions, and in turn the pursuit of commercialisation of the patents in-house or through licensing, thereby creating business opportunities to facilitate the upgrading of products or services to move up the value chain. Prosperity of intellectual property trading activities will also create more opportunities for professional services such as intellectual property legal, valuation, management, consultation and agency services to further develop vigorously.

Many jurisdictions have employed tax incentives such as a “patent box” regime for encouraging the industrial and R&D sectors, creative industries and intellectual property users to engage in more intellectual property trading activities. In Hong Kong, the Inland Revenue (Amendment) (Tax Concessions for Intellectual Property Income) Ordinance 2024 (the Amendment Ordinance) was enacted on 5 July 2024 to provide profits tax concessions for certain assessable profits from an eligible intellectual property income (eligible IP income).

Tax Concessions under the Regime

A taxpayer that meets the specified requirements under the Regime is eligible to tax concessions under which the concessionary portion of the taxpayer’s assessable profits derived from eligible IP income can be chargeable to profits tax at the concessionary tax rate of 5% (the Tax Concessions).

The Regime applies in respect of a year of assessment beginning on or after 1 April 2023.

Requirements for the Regime

To enjoy the Tax Concessions, a taxpayer must meet 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.

R&D activity

An R&D activity is –

an activity in the fields of natural or applied science to extend knowledge;
a systematic, investigative or experimental activity carried on for the purposes of any feasibility study or in relation to any market, business or management research;
an original and planned investigation carried on with the prospect of gaining new scientific or technical knowledge and understanding; or
the application of research findings or other knowledge to a plan or design for producing or introducing new or substantially improved materials, devices, products, processes, systems or services before they are commercially produced or used.

For more details on “R&D activity”, please refer to paragraphs 6 to 9 of Departmental Interpretation and Practice Notes No. 55 – Deduction for Research and Development Expenditure.

Eligible patent

An eligible patent is –

a patent granted under the Patents Ordinance (Cap. 514) or granted by a patent office of any place outside Hong Kong, and if the date of filing of the application for the patent is on or after the specified date, the patent is not a standard patent (R). A reference to a patent granted by a patent office of a place outside Hong Kong includes the registration of a utility model by the patent office, and a utility certificate and an inventor’s certificate issued by the patent office; or
a patent application made under Cap. 514 or filed with a patent office of any place outside Hong Kong, and if the date of filing of the patent application is on or after the specified date, the application is not a standard patent (R) application. If a patent application is an international application, the reference to the patent application filed with a patent office of any place outside Hong Kong is a reference to the patent application having validly entered its national phase in the patent office in which the national phase is entered.

“Patent office”, in relation to a place outside Hong Kong, means a competent authority in that place that receives or processes patent applications, or grants patents.

“Application for a standard patent (R)” and “standard patent (R) application” have the meaning given by section 3 of Cap. 514.

The following expressions have the meanings given by section 2(1) of Cap. 514:

application for a short-term patent and short-term patent application;
application for a standard patent (O) and standard patent (O) application;
international application;
Patent Cooperation Treaty;
short-term patent;
standard patent (O);
standard patent (R);
substantive examination.

Date of filing

Under section 1(1) of Schedule 17FD to the IRO, different meanings of “date of filing” are provided for different types of patents as follows:

in relation to a patent application filed with, or a patent granted by, a patent office of any place outside Hong Kong –

(a)

if the patent application, or the application for the patent, is an international application that has validly entered its national phase in a patent office ─ the international filing date accorded to the international application for the purposes of Article 11 of the Patent Cooperation Treaty; or

(b)

in any other case ─ the date of filing accorded to the patent application, or the application for the patent, by the patent office with which the application is filed;

in relation to a standard patent (R) application or a standard patent (R) –

(a)

if the corresponding designated patent application within the meaning of section 4(2)(b) of Cap. 514 is an international application that has validly entered its national phase in the corresponding designated patent office ─ the international filing date accorded to the international application for the purposes of Article 11 of the Patent Cooperation Treaty; or

(b)

in any other case ─ the date of filing of the corresponding designated patent application for a standard patent (R) application; or the deemed date of filing (within the meaning of section 38 of Cap. 514) of the application for a standard patent (R);

in relation to a standard patent (O) application or a standard patent (O) ─ the date of filing accorded under section 37M(2) or 37Z(2) of Cap. 514 to the standard patent (O) application or application for the standard patent (O); or

in relation to a short-term patent application or a short-term patent –

(a)

for a short-term patent application or an application for a short-term patent based on an international application designating the People’s Republic of China (PRC) that has entered its national phase in the PRC ─ the international filing date referred to in section 125(5) of Cap. 514 that is deemed to be the date of filing of the short-term patent application or application for the short-term patent; or

(b)

in any other case ─ the date of filing accorded under section 114(2) or 116 of Cap. 514 to the short-term patent application or application for the short-term patent.

“Specified date” means the date of expiry of a period of 24 months after the commencement date of the Amendment Ordinance. In other words, the specified date is 5 July 2026.

Eligible plant variety right

An eligible plant variety right is –

a right granted under the Plant Varieties Protection Ordinance (Cap. 490) or a corresponding right subsisted under the law of any place outside Hong Kong; or
an application as defined by section 2 of Cap. 490 or a corresponding application subsisted under the law of any place outside Hong Kong.

Copyright subsisting in software

In the Regime, copyrighted software refers to a copyright subsisting in software under Cap. 528 or under the law of a place outside Hong Kong. While registration of copyrighted software is generally not required under Cap. 528 or foreign law, it must fall within the scope of the relevant legal protection in order for it to be regarded as an eligible intellectual property.

Eligible IP income

“Eligible IP income” means an income of any one or more of the following descriptions:

income derived from an eligible intellectual property in respect of:

(a)

the exhibition or use of, or a right to exhibit or use, (whether in or outside Hong Kong) the property; or

(b)

the imparting of, or undertaking to impart, knowledge directly or indirectly connected with the use (whether in or outside Hong Kong) of the property;

income derived from the sale of an eligible intellectual property;

embedded IP income, i.e. if the price of a sale of a product or service includes an amount that is attributable to an eligible intellectual property — such portion of the income from that sale as, on a just and reasonable basis, is attributable to the value of the property; and

amount of insurance, damages or compensation derived in relation to an eligible intellectual property.

For the purpose of ascertaining the embedded IP income, the income attributed to the eligible intellectual property is to be calculated in the way that best secures consistency with the requirements and guidance in the OECD rules as defined in section 7(3) of Schedule 17FD to the IRO.

Election Mechanism

Basic features

An eligible person can elect for the Tax Concessions in respect of an eligible intellectual property through an election mechanism. The key features of the election mechanism are as follows:

the election must be made in writing;
the election, once made, will apply to the year of assessment for which the election is made and all subsequent years of assessment (i.e. no annual election is required); and
the election made is irrevocable.

Further requirements for elections in respect of certain eligible intellectual properties

An election in respect of certain types of eligible intellectual properties is subject to the following further specifications and/or requirements:

for a granted patent and a divisional patent application, if an election has been made in respect of an eligible patent that is a patent application (original patent application), the election is to be regarded as having also been made in respect of:

(a)

the patents granted in pursuance of the original patent application; and

(b)

the divisional patent applications of the original patent application and the patents granted in pursuance of such divisional patent applications;

for an eligible patent that is not a standard patent (O), a standard patent (O) application, a short-term patent or a short-term patent application, and the date of filing of which is on or after the specified date, an election is not valid unless there is a corresponding local patent as defined in section 6(3) and (4) of Schedule 17FD to the IRO; or

for an eligible plant variety right that is neither a grant nor an application as defined by section 2 of Cap. 490, and the date of filing of which is on or after the specified date, an election is not valid unless there is a corresponding local plant variety right as defined in section 6(3) and (5) of Schedule 17FD to the IRO.

“Divisional patent application” means –

in relation to a patent application made under Cap. 514:

(a)

a request to enter a record of a divisional patent application filed under section 22(1) of Cap. 514 for a standard patent (R) application;

(b)

a divisional standard patent (O) application filed under section 37Z of Cap. 514 for a standard patent (O) application; or

(b)

a divisional short-term patent application filed under section 116 of Cap. 514 for a short-term patent application; or

in relation to a patent application filed with a patent office of any place outside Hong Kong, an application for a divisional patent filed under the law, instruments or rules of the patent office applicable to that application.

A reference to a divisional patent application includes all subsequent divisional patent applications in respect of that application.

Concessionary Portion of Assessable Profits Derived from Eligible IP Income

The nexus approach is adopted to determine the portion of assessable profits to be charged to profits tax at the concessionary tax rate of 5%. That portion is referred to as the “concessionary portion”.

What is the nexus approach

The nexus approach is a minimum standard adopted by the OECD under Action 5 of the package of actions to tackle base erosion and profit shifting (BEPS) promulgated in 2015 (the BEPS Action 5 Report). It has been applied by the OECD Forum on Harmful Tax Practices to evaluate the harmfulness of preferential tax regimes for intellectual property income put in place by tax jurisdictions. All member jurisdictions of the Inclusive Framework on BEPS with such regimes have either adopted the nexus approach or abolished their non-compliant regimes.

Under the nexus approach, only income from a qualifying intellectual property asset can qualify for preferential tax treatment based on a nexus ratio which is defined as the qualifying expenditures as a proportion of the overall expenditures that have been incurred by a taxpayer to develop an intellectual property asset. The proportion of R&D expenditures is a proxy for substantial economic activities. This seeks to ensure that there is a direct nexus between the income receiving benefits and the expenditures contributing to that income.

Under the Regime, the provisions relating to the nexus approach should be read in the way that best secures consistency with the requirements and guidance in Chapter 4 of the BEPS Action 5 Report.

What is the R&D fraction

The definition of “R&D fraction” is modelled on the nexus ratio referred to in the BEPS Action 5 Report. The R&D fraction is calculated in accordance with the following formula and capped at 100%–

F =

EE × 130%

EE + NE

where

means the R&D fraction;

means the eligible R&D expenditure incurred in respect of the eligible intellectual property to which the eligible IP income relates (subject intellectual property); and

means the non-eligible expenditure incurred in respect of the subject intellectual property.

The R&D fraction is used to calculate the concessionary portion of the assessable profits from an eligible IP income, which is ascertained in accordance with the following formula:

P = I × F

where

means the concessionary portion;

means the assessable profits from the eligible IP income; and

means the R&D fraction applicable to those assessable profits.

What is R&D expenditure for the purpose of ascertaining the R&D fraction

For the purpose of ascertaining the R&D fraction in respect of eligible intellectual property to which the income relates, R&D expenditures (including capital expenditure) are classified into EE and NE as follows:

R&D expenditures	EE*	NE^#
For an R&D activity carried out
by the eligible person	✓
by a non-associated person on behalf of the eligible person	✓
by an associated person that is a Hong Kong resident person on behalf of the eligible person
- in Hong Kong	✓
- outside Hong Kong		✓
by an associated person that is a non-Hong Kong resident person on behalf of the eligible person		✓

EE does not include interest payments, payments for any land or building, or for any alteration, addition or extension to any building, and any expenditure (including capital expenditure) incurred by the eligible person for obtaining the eligible intellectual property or any right in respect of the property from another person.

NE includes any expenditure (including capital expenditure) incurred by the eligible person for obtaining the eligible intellectual property or any right in respect of the property from another person. However, it does not include interest payments and payments for any land or building, or for any alteration, addition or extension to any building.

Transitional arrangement

As a transitional measure, an eligible person is allowed to ascertain the R&D fraction where EE and overall expenditures (i.e. EE + NE) are calculated based on a 3-year rolling average. The purpose is to allow sufficient time for taxpayers to adapt to the tracking and tracing requirements while still complying with the general principles of the nexus approach. After the transitional period of 3 years, the eligible person would need transition from using the 3-year average to the R&D fraction.

The transitional period of the arrangement is the eligible person’s basis periods for the years of assessment from 2023/24 to 2025/26.

Where an eligible person has insufficient records to track and trace the R&D expenditures to calculate the R&D fraction, it may make use of the transitional measure. Readers may refer to the example of a transitional measure for tracking and tracing provided in Annex A of the BEPS Action 5 Report.

Tax Concessions Withdrawn under Certain Circumstances

Withdrawal of Tax Concessions

In case any of the specified circumstances occurs in relation to an eligible intellectual property in a year of assessment (relevant year), the following tax treatments will take effect:

The Tax Concessions do not apply in relation to the eligible IP income derived from the eligible intellectual property for the relevant year and subsequent years of assessment;
All concessionary portions of the assessable profits from the eligible intellectual property in respect of which the Tax Concessions were granted for the years of assessment preceding the relevant year are to be regarded as trading receipts of the trade, profession or business of the eligible person for the relevant year; and
In computing the tax payable on the aforesaid trading receipts, the assessor will take into account the tax that has already been charged on the relevant concessionary portions at the concessionary tax rate.

Circumstances under which Tax Concessions will be withdrawn

The specified circumstances are as follows:

The eligible patent that is a patent is unconditionally revoked;
The eligible patent that is a patent application is abandoned, refused or withdrawn;
The eligible plant variety right that is a right is cancelled or no longer subsists;
The eligible plant variety right that is an application lapses, is declined or withdrawn, or no longer subsists; and
In relation to an eligible patent or an eligible plant variety right of which the date of filing is on or after the specified date, the conditions specified in section 19 of Schedule 17FD to the IRO have not been met.

Taxpayers’ Obligations

An eligible person should:

report its eligible IP income in the profits tax return and designated form for the year of assessment in which the income accrues;
notify the Commissioner in writing that it is chargeable to profits tax within 4 months after the end of the basis period of the year of assessment during which any of the circumstances specified in the section on “Circumstances under which Tax Concessions will be withdrawn” occurs in case no profits tax return has been issued to it for the year of assessment concerned; and
retain records of transactions, acts, or operations relating to the eligible IP income at least until the later of the expiry of 7 years after the completion of those transactions, acts or operations; or the expiry of 7 years after making the election under section 4 of Schedule 17FD to the IRO.

Concessionary Tax Rate and Two-tiered Profits Tax Rates

Pursuant to section 14(5) of the IRO, if an eligible person has made an election under section 4 of Schedule 17FD (i.e. election for the Tax Concessions), the eligible person would not qualify for the two-tiered profits tax rates.

Special Note for Taxpayers with Profits Tax Return for the Year of Assessment 2023/24 Filed Prior to the Enactment of the Amendment Ordinance

For taxpayers who have indicated their intent to claim the Tax Concessions by ticking the “Yes” box in the relevant section of their Profits Tax returns (i.e. Item 7.14 of BIR51 or Item 7.9 of BIR52) for the year of assessment 2023/24, they will be notified of the procedures for filing the designated form (IR1482) by mail.

For other taxpayers who would like to claim the Tax Concessions, they should submit IR1482 electronically upon filing of the Profits Tax returns.

More Information

Inland Revenue Ordinance

The Amendment Ordinance

OECD materials

Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance – Action 5: 2015 Final Report

Materials of the Intellectual Property Department

Materials of the Agriculture, Fisheries and Conservation Department

Plant variety rights