The Financial Secretary (FS) referred to the following tax measures and developments that Hong Kong has recently implemented, or which are currently being considered, with a view of promoting Hong Kong’s economic development and enhancing its co-operation on international tax matters.
Patent box tax incentive
A bill introducing a patent box tax incentive in Hong Kong would be introduced into the Legislative Council in the first half of 2024. The proposed incentive would allow eligible intellectual property (IP) income derived from eligible IP assets that are patents or patent-like to be taxed at a concessionary tax rate of 5% in Hong Kong.
Under the proposed incentive, the following onshore-sourced income derived from the eligible IP assets would be taxed at 5% instead of 16.5%:
- Income derived from an eligible IP asset in respect of the exhibition or use of, or a right to exhibit or use (whether in or outside of Hong Kong) the asset; or the imparting of, or undertaking to impart, knowledge directly or indirectly connected with the use (whether in or outside of Hong Kong) of the asset, i.e., covering most royalties or licensing income;
- Income arising from the sale of an eligible IP asset (apparently only applies to eligible IP assets that are revenue in nature given that onshore income derived from the sale of eligible IP assets that are capital in nature would be non-taxable capital gains in Hong Kong under section 14 of the Inland Revenue Ordinance (IRO); and
- Where the sales price of a product or service includes an amount which is attributable to an eligible IP asset – such portion of the income from those sales that, on a just and reasonable basis, is attributable to the value of the asset (e.g., that ascertained based on the transfer pricing principles and methodologies).
A local registration requirement for the eligible IP assets, where applicable, has been proposed to encourage and promote more local filings in Hong Kong such that the relevant inventions would comply with the relevant requirements in the region.
In addition, the calculation of the extent of the eligible IP income that will be subject to the concessionary tax rate would need to be ascertained based on the “nexus approach”, thereby requiring detailed record of the relevant research and development (R&D) expenditure or acquisition costs in relation to the creation of the eligible IP assets.
The proposed incentive would be an important policy tool for encouraging the industrial and R&D sectors, creative industries and IP users to engage in more IP creation and exploitation for manufacturing and or trading activities to meet their strategic needs of upgrading products and services and moving up the value chain.
Tax concessions for eligible single-family offices passed into law
Under the legislation, effective from 1 April 2022, family owned investment holding vehicles (FIHVs) and familyowned special purpose entities (FSPEs) held by FIHVs that are managed by an eligible single-family office will be tax exempt in respect of their profits derived from transactions in certain financial assets as specified in Schedule 16C of the IRO. Subject to the 5% threshold, the tax exemption will extend to cover income incidental to such qualifying transactions.
This regime for the tax concessions for eligible single-family offices has recently been peer-reviewed by the Organisation for Economic Co-operation and Development (OECD) as being not a harmful tax practice. Furthermore, unlike the corresponding regimes in Singapore, the Hong Kong regime has no expiry date. Additionally, any in-scope offshore income under the Foreign-sourced Income Exemption (FSIE) regime of Hong Kong generated by the FIHVs/FSPEs that is incidental to or in the course of their earning the tax-exempt income will not be subject to tax under the FSIE regime. All these factors would thus ensure the sustainability of the tax concessions offered in Hong Kong, thereby making the city’s regime attractive and competitive.
Furthermore, the FS also indicated that the preferential tax regimes for funds and single-family offices outlined above will be reviewed, with the desirability of increasing the types of qualifying transactions and enhancing flexibility in handling incidental transactions to attract more similar entities to establish a presence in Hong Kong.
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Read morePublic consultation on the implementation of BEPS 2.0 – Pillar Two in Hong Kong
In October 2021, to tackle base erosion and profit shifting (BEPS) risks arising from the digitalization of the economy, the Organization for Economic Co-operation and Development (OECD)/Group of Twenty (G20) announced a landmark international agreement for a two-pillar solution to reform international taxation rules starting from 2023, (commonly referred to as “BEPS 2.0”). Agreed by Hong Kong as well as over 135 other jurisdictions, the BEPS 2.0 framework represents one of the most ambitious international tax reform projects ever developed.
As part of BEPS 2.0, Pillar Two proposes global minimum tax mechanisms with the objective of subjecting multinational enterprise (MNE) groups whose annual revenue exceeds €750 million to a minimum effective tax rate (ETR) of 15% on their profits in every jurisdiction where they operate. The Global Anti-Base Erosion (GloBE) rules – which comprise the Income Inclusion Rule (IIR) and the Undertaxed Profits Rule (UTPR) – are the primary mechanisms through which Pillar Two seeks to achieve this objective and consist of defensive tax measures that jurisdictions can adopt to collect additional tax (called “top-up tax”) on MNE groups doing business in low-tax jurisdictions.
The consultation paper issued last December indicated that Hong Kong would enact legislation to translate the GloBE rules into domestic tax laws, effective from 1 January 2025. In addition, to preserve its taxing rights over economic activities undertaken in Hong Kong by in-scope MNE groups, the consultation paper also indicated that a Hong Kong Minimum Top-up Tax (HKMTT) will be introduced in 2025.
Under the proposed HKMTT, any low-taxed profits of Hong Kong constituent entities of in-scope MNE groups will be subject to a top-up tax such that their effective tax rate (ETR) in Hong Kong will meet the required minimum of 15% under the GloBE rules.
The HKMTT is intended to qualify as a Qualified Domestic Minimum Top-up Tax Safe Harbor (QDMTT Safe Harbor). As such, once the in-scope MNE groups have paid the top-up tax under the HKMTT in Hong Kong in respect of the low-taxed profits of their Hong Kong constituent entities, their top-up tax liabilities under the GloBE rules will be deemed to be zero.
This would save them the need to make two complicated calculations of their ETR under both the HKMTT and the GloBE rules, which would otherwise be required if the HKMTT only qualifies as a QDMTT but not also a QDMTT Safe Harbor. In the former situation, the top-up tax paid under the HKMTT as a QDMTT will be creditable against any top-up tax liabilities of the in-scope MNE groups under the GloBE rules.
However, the top-up tax payable under the HKMTT could be higher than that payable under the GloBE rules. This is because where a constituent entity is not 100% owned, the top-up tax payable under the IIR (with the UTPR as a backstop) would be less than the full top-up tax after taking into account the percentage of ownership interest that an ultimate parent entity has in the constituent entity concerned whereas the HKMTT would not.
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Read moreSummary
This could be regarded as a more down-to-earth budget focusing on dispelling many of the negative sentiments that some have expressed about the economic outlook of Hong Kong as an international trading and financial center. We hope this budget instills confidence in people, allowing Hong Kong to seize opportunities and achieve high-quality development.
