Hong Kong Court rules sub-licensing income is Hong Kong-sourced taxable income

The taxpayer was incorporated in Hong Kong by its UK parent company. The UK parent company owns certain trademarks and licensed them under a master license to the taxpayer for exploitation. Meanwhile the taxpayer entered into an agreement with a joint venture partner (JV Partner) and appointed the JV Partner as its agent to arrange sub-licensing of the trademarks for use in Japan. The royalty income from Japanese companies would be shared between the taxpayer and the JV Partner on a 40:60 basis.

Hong Kong taxation is on a territorial basis, whereby the source of sub-licensing income would generally be determined according to where the taxpayer obtained the rights and granted the sub-licensing rights. The CFI held that the taxpayer's 40% share of royalty income is Hong Kong-sourced and subject to Hong Kong profits tax, on the basis that: (i) the activities of the JV Partner in Japan are not carried out on behalf of the taxpayer and therefore cannot be attributed to the taxpayer in determining the source of its income; and (ii) the joint venture agreement and the sub-license agreements for Japan were signed by the taxpayer's director in Hong Kong.

The taxpayer also received an upfront payment for granting the JV Partner the right to participate in the management of the business of the design, manufacture, distribution and sale of certain products under the trademarks in Japan. Considering the facts of the case, the CFI held that the upfront payment arose in the ordinary conduct of the taxpayer's business to exploit its right under the master license instead of giving up any asset or transferring any risk. As such, the income does not constitute non-taxable capital receipts and therefore is taxable in Hong Kong as ordinary business income.

Contact Information

For additional information concerning this Alert, please contact:

Ernst & Young Tax Services Limited, Hong Kong

• Wilson Cheng
• Paul Ho, Financial Services

Ernst & Young LLP (United States), Hong Kong Tax Desk, New York

• Charlotte Wong

Ernst & Young LLP (United States), Asia Pacific Business Group, New York

• Gagan Malik
• Dhara Sampat

Ernst & Young LLP (United States), Asia Pacific Business Group, Chicago

• Pongpat Kitsanayothin

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor

For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.