Cheng & Cheng Taxation Reveals how Super Tax Deduction on R&D Activities in Hong Kong

HONG KONG SAR – Media OutReach – 13 December 2021 – Taxation can be an effective tool for
influencing corporate behaviour. Cheng & Cheng Taxation Services Limited
(“Cheng & Cheng’s Taxation”) regards it is the reason why many
jurisdictions are devoting huge amounts of resources in an effort to attract research
and development (R&D) centres. In this, Hong Kong is no exception.

A ‘super tax
deduction’ on certain R&D activities was introduced in Hong Kong with
effect from the year of assessment 2018/19. This was a breakthrough in Hong
Kong’s taxation system as it was the first time that the Inland Revenue
Department (IRD) had allowed deductions of 300%/200% on certain
operating expenditure. The first
HK$2 million spent on qualifying R&D expenses is eligible for a 300% tax
deduction
. For amounts over HK$2 million, a 200% tax deduction will be
granted.

There are
two important tax considerations relating to R&D expenses in Hong Kong:

  • Requirements for Hong Kong’s super tax
    deduction on R&D activities
  • Tax risk on R&D expenses paid by
    a Hong Kong corporation to overseas entities

A three-minute video relating to each consideration
to facilitate your understanding of the issues. Please refer to this link (Link) to access to the videos.

Cantonese
Version : Link

Mandarin
Version : Link

Requirements for Hong Kong’s super tax deduction on R&D activities

Carrying
out the R&D activities in Hong Kong is compulsory for qualification for the
super tax deduction
.

Hong Kong
Science Park and Cyberport are popular incubators for start-ups in Hong Kong,
particularly for those with significant R&D functions, as they offer
appealing incentives and funding for start-ups. The super tax deduction is a
further incentive introduced by the Hong Kong government for corporations carrying
out R&D activities in Hong Kong.

Below is a
summary of some of the basic requirements for the super tax deduction:

Requirement 1:

The R&D
activities must be carried out either by the taxpayers themselves, or must be outsourced
to designated local research institutions. Outsourcing of R&D activities to
group companies or external parties that are not designated local research institutions
are generally not eligible for the super tax deduction, except under proper cost-recharge arrangements. A list
of designated local research institutions can be found on the Hong Kong government
website. (Link)

Requirement 2:

For R&D
activities carried out by the taxpayers themselves, only consumables and staff
costs directly related to the R&D activities qualify for the super tax deduction.
These expenses have to be exclusively and directly related to the R&D
activities in order to qualify for the super tax deduction. (Link
for illustration of Qualifying R&D Expenses)

Tax
risk on R&D expenses paid by a Hong Kong corporation to overseas entities

At first, R&D payments made to overseas group companies were not tax deductible
in Hong Kong under the IRO’s original Section 16B. The recent amendments under Departmental
Interpretation and Practice Notes (DIPN) 55 have now slightly relaxed the
situation, but it is still difficult.

R&D
expenses are subject to specific tax deduction rules in Hong Kong. The
underlying reason is that R&D is treated as a capital expenditure by the IRD,
since R&D activities tend to bring fundamental change and significant
advancements to the products or services of a company. Capital expenditure is
generally not tax deductible in Hong Kong.

Section 16B
of the IRO is the legal provision that governs tax deductions for R&D
expenses. It is too complex to go through all details of Section 16B here, but Cheng
& Cheng’s Taxation will highlight the current situation of cross-border
R&D cost recharge arrangements, which are common for multinational corporations.

Regardless
of the super tax deduction, R&D payments made in the past to overseas group
companies were not tax deductible in most circumstances under Section 16B. Now,
under DIPN 55, R&D fees paid to overseas group companies could qualify for the
100% normal tax deduction if both the following conditions are met:

  • Not
    more than 20% of the total R&D costs of the Hong Kong company are
    subcontracted to overseas group companies; and
  • The
    R&D costs paid to overseas companies should not be more than HK$2 million.

Despite the
relaxation in DIPN 55, it is still difficult for multinational corporations
with significant R&D functions outside Hong Kong to pursue tax deductions for
R&D costs. Multinational corporations should plan their R&D cost contribution
and subcontracting arrangements carefully.

Tax
advisory consulting

Multinational
corporations should consult their tax advisors to ensure thorough cross-border tax
planning is in place to maximise the tax benefits.

There are
pros and cons to incurring R&D costs in Hong Kong from a tax perspective.
Multinational corporations should consult their tax advisors to ensure their
current R&D arrangements are eligible for the maximum tax deduction, with a
view to improving their group’s overall tax efficiency.

For more
details of Hong Kong and Mainland China tax news, please visit our website at https://henrykwongtax.com.

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