Hong Kong Tax Alert: 10 October 2013
R&D activities undertaken by a subsidiary under detailed guidance and supervision of a parent
In the 2013 annual meeting between the HKICPA and the IRD held earlier this year, a follow-up question on what amounted to “activities undertaken by the person themselves” was raised by the HKICPA. The scenario posed by the HKICPA is depicted in the following diagram.
The question asked was: whether in this circumstance the activities of the local R&D staff employed by mainland China subsidiary could be regarded as activities undertaken by HK Company, thereby qualifying the relevant amount paid by HK Company to mainland China subsidiary as “in-house” R&D expenditure eligible for a tax deduction under section 16B(1)(b) of the IRO?
In reply, the IRD stated that because HK Company and mainland China subsidiary were two separate legal entities, R&D activities undertaken by mainland China subsidiary could not be regarded as undertaken by HK Company itself. As such, HK Company would not be entitled to claim the amount paid to mainland China subsidiary as “in-house” R&D expenditure deductible under section 16B(1)(b) of the IRO.
R&D activities performed under group cost sharing arrangements
It has become common practice for multi-national companies to pool their resources and carry out R&D activities under a cost sharing arrangement (CSA). In general, a CSA is an arrangement by which the participants agree to share the cost of developing one or more intangibles (the “cost shared intangibles”) that will be separately exploited by each of the participants.
By participating in a CSA, each participant obtains a separate interest in the relevant cost shared intangibles. Consequently, each participant may separately exploit the cost shared intangibles in a manner consistent with that interest, without owing compensation to the other participants.
In its 2013 annual meeting with the IRD, the HKICPA also raised a question in relation to R&D expenditure incurred under a CSA arrangement. The scenario posed involved a group CSA arrangement under which a Hong Kong company sent its employees to the group’s R&D centre to conduct R&D activities where they were joined by employees of other companies in the group. A portion of the cost of the group’s R&D centre would be allocated to the Hong Kong company.
In the scenario proposed, the cost allocated to the Hong Kong company was HK$1 million, while the actual staff costs in respect of those employees who were sent by the Hong Kong company to the R&D centre was HK$300,000. The question raised was that in such circumstances what amount the Hong Kong company can claim as deductible.
In reply, the IRD stated that the Hong Kong company could only claim a tax deduction of HK$300,000 under section 16B(1)(b) because this was the amount that the Hong Kong company had incurred for its own R&D activities. The IRD added that expenses incurred by other group companies and recharged to the Hong Kong company could not be regarded as “in-house” R&D expenditure incurred by the Hong Kong company itself.