Hong Kong Tax Alert. Legislative bill detailing enhanced tax deductions for qualifying R&D activities introduced. 8 May Issue No.

Transcription

1 Hong Kong Tax Alert 8 May Issue No. 11 Legislative bill detailing enhanced tax deductions for qualifying R&D activities introduced On 20 April 2018, the Inland Revenue Amendment (No. 3) Bill (the Bill) was gazetted 1. The Bill seeks to implement the proposal announced by the Chief Executive in the 2017 Policy Address to provide for enhanced tax deductions for qualifying research and development (R&D) activities. Under the Bill, qualifying R&D expenditure on a qualifying R&D activity (i.e., Type B expenditure) will be eligible for enhanced tax deductions: the first HK$2 million being eligible for a 300% deduction and the remainder at 200%, without a cap on the total amount of the enhanced tax deductions that can be claimed. R&D expenditure, other than Type B expenditure (referred to collectively as Type A expenditure), on an R&D activity or a qualifying R&D activity, including capital expenditure on plant or machinery, will be eligible for a 100% tax deduction. In other words, the tax treatment for Type A expenditure under the Bill will be the same as that provided for under the current terms of section 16B of the Inland Revenue Ordinance (IRO). As regards subcontracted out R&D activities for qualifying R&D activities, in order to be eligible for the enhanced tax deductions, the payments must be made to a designated local research institute. For in-house R&D activities, the expenditure must be incurred for qualifying R&D activities undertaken and carried on by a taxpayer wholly within Hong Kong. The Bill also introduces a deeming provision whereby sums will be deemed to be profits chargeable to tax in Hong Kong if they are received for the use, or right to the use, outside Hong Kong of any intellectual property or know-how generated from R&D activities in respect of which a normal or enhanced deduction is allowable under section 16B. This alert explains the major provisions of the Bill. 1. The Bill can be downloaded from: 16/es pdf

2 Overview of the current regime R&D expenditure, normally incurred with a view to developing new products and improving existing production methods, is generally regarded as being capital in nature. As such, R&D expenditure is disallowable under section 17(1)(c) of the IRO. Nonetheless, section 16B(1) of the IRO specifically provides for a tax deduction for R&D expenditure related to the trade, profession or business of a taxpayer 2. Deductible R&D expenditure can be in the form of either: I. payments made to an approved research institute (a) for R&D related to the trade, profession or business of the taxpayer; or (b) the object of which is the undertaking of R&D related to the class of trade, profession or business to which the trade, profession or business of the taxpayer belongs (i.e., outsourced R&D activities); or II. expenditure on R&D related to the trade, profession or business of the taxpayer incurred by the taxpayer themselves (i.e., in-house R&D activities), including capital expenditure incurred on fixed assets, such as plant or machinery, other than that on land and buildings 3. Major provisions of the Bill Proposed new tax deduction regime for R&D expenditure The Bill proposes to revamp the current structure of section 16B of the IRO by referring the detailed operational provisions for both the normal and enhanced tax deductions for R&D expenditure under the new regime to a newly introduced schedule to the IRO, Schedule 45. For R&D expenditure of Type A on an R&D activity or a qualifying R&D activity, Schedule 45 proposes to retain the current 100% normal tax deduction rules of section 16B as noted above. Meaning of R&D expenditure The proposed definition of R&D expenditure is essentially the same as that referred to under the current terms of section 16B detailed above 4. The only notable exception is that under the new regime, a new term R&D institution will replace the current term approved research institute as regards out-sourced R&D activities. R&D institution is defined to mean: (i) a designated local research institute; and (ii) any university or college that is not a designated local research institute. Meaning of R&D activity The proposed definition of R&D activity is essentially the same as that applicable to the term R&D as currently defined in section 16B(4)(a) of the IRO. Under Schedule 45, R&D activity is defined as follows: a) an activity in the fields of natural or applied science for the extension of knowledge; b) 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; c) an original and planned investigations carried on with the prospect of gaining new scientific or technical knowledge and understanding; or d) 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. Meaning of qualifying R&D activity The proposed definition of a qualifying R&D activity is narrower in scope and only covers R&D activity as described in paragraphs (a), (c) or (d) above which is wholly undertaken and carried on in Hong Kong 5. For qualifying R&D expenditure of Type B on a qualifying R&D activity, Schedule 45 provides for a two-tiered enhanced tax deduction, i.e., a 300% tax deduction for the first HK$2 million of expenditure and a 200% deduction for the remainder, without a cap on the total amount of the enhanced tax deductions that can be claimed. Schedule 45 also contains transitional provisions whereby the new regime will take retrospective effect and apply to R&D expenditure incurred on or after 1 April Where the trade, profession or business is carried on partly in or partly out of Hong Kong, the amount of R&D expenditure eligible for a tax deduction may need to be apportioned. 3. Where such expenditure results in a relevant interest in a building or structure, taxpayers will be eligible to claim industrial building allowances under section 34 of the IRO on the expenditure. 4. Similar to the existing section 16B(5) of the IRO, the Bill specifies that R&D expenditure does not include a payment or expenditure incurred, for acquiring rights generated from an R&D activity. 5. The Bill also explicitly states that a qualifying R&D activity does not include: (a) any efficiency survey, feasibility study, management study, market research or sales promotion; (b) the application of any publicly available research findings or other knowledge to a plan or design, with an anticipated outcome and without any scientific or technological uncertainty; (c) an activity that does not seek to directly contribute to achieving an advance in science or technology by resolving scientific or technological uncertainty; or (d) any work to develop the non-scientific or non-technological aspect of a new or substantially improved material, device, product, process, system or service. 2

3 Meaning of Type B expenditure Type B expenditure is defined as R&D expenditure on a qualifying R&D activity in respect of: I. a payment to a designated local research institution for out-sourced R&D activities; II. an expenditure in relation to an employee (excluding a director) who is engaged directly and actively in a qualifying R&D activity; and CIT empowered to designate an entity as a designated local research institution The Bill contains provisions that confer powers on the CIT to designate any university or college located in Hong Kong; or any other institute, association, organization or corporation located in Hong Kong that undertakes qualifying R&D activities in Hong Kong, as a designated local research institution. III. an expenditure on a consumable item that is used directly in a qualifying R&D activity. Royalties deemed taxable receipts where related R&D expenditure is tax deductible Meaning of Type A expenditure Type A expenditure is defined to mean R&D expenditure on an R&D activity or a qualifying R&D activity other than Type B expenditure. Safeguard measures to prevent abuse of the tax deduction for R&D expenditure In order to prevent abuse of the new regime, Schedule 45 explicitly specifies that no deduction will be allowed for R&D expenditure incurred by a person if: any rights generated from the R&D activities (other than certain outsourced R&D activities) will not be fully vested in the person; the R&D activities are undertaken for another person; the expenditure is, or is to be, met directly or indirectly by government grants or subsidies, whether in Hong Kong or elsewhere; the expenditure is incurred under an arrangement the main purpose, or one of the main purposes, of which is to obtain a deduction or a greater deduction to which the person would not otherwise be entitled. CIR may seek advice from CIT when processing claims The Bill contains provisions empowering the Commissioner of Inland Revenue (CIR) to seek advice from the Commissioner for Innovation and Technology (CIT) when processing section 16B claims or advance ruling applications. For the purposes of seeking such advice, the CIR may disclose to the CIT details of the taxpayer s R&D activities. The Bill proposes to add a new deeming section 15(1)(bb) to the IRO. Under section 15(1)(bb), the following sums, not otherwise chargeable to tax in Hong Kong, received by or accrued to a person on or after the date the Bill is enacted into law will be deemed taxable receipts of the person chargeable to tax in Hong Kong: for the use or right to use outside Hong Kong, any intellectual property or know-how generated from R&D activities in respect of which a tax deduction is allowable to the person under section 16B; or for imparting or undertaking to impart knowledge connected with the use outside Hong Kong of any such property or know-how. Sums deemed taxable where tax deductions have been allowed for related R&D expenditure Schedule 45 will retain all the deeming provisions currently contained in section 16B of the IRO. Such deeming provisions will deem the following sums as taxable receipts where tax deductions have been allowed for related R&D expenditure under section 16B: proceeds from the sale of plant or machinery, or insurance or compensation money received where the plant or machinery is destroyed, both capped at the amount of the total deductions previously allowed; and proceeds from the sale of any rights generated from the relevant R&D activities, capped at the amount of the total deductions previously allowed. Such an empowerment is made as the CIT is considered to have more expertise in determining what constitutes R&D activities in terms of whether such activities would lead to gaining new scientific or technical knowledge or resolving scientific or technological uncertainty etc. 3

4 Commentary While we welcome the introduction of the Bill as a means of spurring innovation and technology in Hong Kong, the government may need to give further thought to certain provisions of the Bill. Firstly, the proposed enhanced tax deductions would only apply to qualifying R&D expenditure incurred on qualifying R&D activities wholly undertaken and carried on in Hong Kong. The government reasoned that such a condition be imposed in order to encourage enterprises to invest more in R&D in Hong Kong and groom local R&D talent. However, Hong Kong may currently lack sufficient talent with the necessary skills and expertise to conduct certain types of R&D activities. Enterprises may often find it necessary to undertake part of their in-house R&D activities outside Hong Kong. Under the new regime, such enterprises would not be able to benefit from the enhanced tax deductions for in-house R&D activities undertaken outside Hong Kong. As regards subcontracted out R&D activities, the Inland Revenue Department s (IRD) current interpretation of section 16B is that only those subcontracted out to an approved research institute would be granted a tax deduction. In other words, regardless of whether the R&D activities are subcontracted out to be undertaken inside or outside Hong Kong, including those undertaken under costsharing arrangements in a group context, no tax deduction would be granted under section 16B where the service provider is not an approved research institute. Despite various submissions made by certain professional and business organizations requesting that the government amend, or the IRD relax its current interpretation of section 16B as regards subcontracted out R&D activities, the Bill has not addressed the concerns raised. As a result, subcontracted out R&D activities, other than those to a designated local research institute, or a university or college, will not qualify for either the normal or the enhanced tax deductions under the new regime. Given the importance of cost-sharing arrangements for R&D activities in a group context, the government may need to further consider whether any tax relief can be granted for such arrangements. We hope that the government will take the above into consideration when finalizing the Bill. Clients who have any views or comments on the Bill can contact their tax professionals so that we can convey their thoughts to the government in an appropriate manner. 4

5 EY Contacts Hong Kong office Agnes Chan, Managing Partner, Hong Kong & Macau 22/F, CITIC Tower, 1 Tim Mei Avenue, Central, Hong Kong Tel: / Fax: EY Asia-Pacific Business Tax Services Leader Tracy Ho tracy.ho@hk.ey.com EY Greater China Business Tax Services Leader Chee Weng Lee chee-weng.lee@hk.ey.com Hong Kong Business Tax Services partners, Ernst & Young Tax Services Limited Agnes Chan agnes.chan@hk.ey.com Owen Chan owen.chan@hk.ey.com Wilson Cheng wilson.cheng@hk.ey.com May Leung may.leung@hk.ey.com Grace Tang grace.tang@hk.ey.com Karina Wong karina.wong@hk.ey.com Jo An Yee jo-an.yee@hk.ey.com EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com Ernst & Young Tax Services Limited. All Rights Reserved. APAC No ED None. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. ey.com/china Follow us on WeChat Scan the QR code and stay up to date with the latest EY news.