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Enhanced Tax Deduction for Qualifying R&D Expenditure in Hong Kong
Date:  21 Jun 2018

Enhanced Tax Deduction for Qualifying R&D Expenditure in Hong Kong

On 2 May 2018, the Inland Revenue (Amendment) (No. 3) Bill 2018 (“the Bill”) was introduced into the Legislative Council. It provides enhanced tax deduction for expenditure incurred by enterprises on qualifying research and development (“R&D”) activities, in order to encourage more enterprises to conduct R&D activities in Hong Kong. Subject to the passage of the Bill by the Legislative Council, enterprises will be able to enjoy additional tax deduction for expenditure incurred on domestic R&D. The first $2 million spent on qualifying R&D will enjoy a 300% tax deduction and expenditure beyond that will enjoy a 200% deduction. There is no cap on the amount of enhanced tax deduction. 

Current Regime
Currently, under section 16B of the Inland Revenue Ordinance (“IRO”), R&D expenditure incurred by a taxpayer related to its trade, profession or business (including capital expenditure on plant or machinery but excluding capital expenditure on land or buildings or for acquiring rights generated from an R&D activity) qualifies for a 100% tax deduction in the year of assessment in which the expenditure is incurred, subject to certain conditions.  The R&D expenditure must be incurred in respect of R&D activities undertaken by the taxpayer itself or paid to an approved research institution.

The Proposed Enhanced R&D Tax Deduction Regime
The Bill proposes to amend and restructure section 16B of the IRO and a new schedule which sets out the operational details of the basic and enhanced tax deduction regimes for R&D activities is introduced, Schedule 45. These include the definitions, scope and rates of the basic tax deduction and the enhanced tax deduction. 

R&D expenditure is classified into two categories:

Schedule 45 Type A
(normal deduction)
Type B
(enhanced deduction)
Rates of deduction 100%
  • 300% for the first HK$2 million
  • 200% for the remainder (without limit)

R&D activities qualifying for deduction

An R&D activity is defined as:

(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.
A qualifying R&D activity is defined as:
  • falls within (a), (c) or (d); and
  • is wholly undertaken and carried on in Hong Kong; but
  • does not include
  1. any efficiency survey, feasibility study,management study, market research or sales promotion;
  2. 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;
  3. an activity that does not seek to directly contribute toachieving an advance in science or technology by resolving scientific or technological uncertainty; or
  4. any work to develop the non-scientific or non-technological aspect of a new or substantially improved material, device, product, process, system or service.

R&D expenditure qualifying for deduction

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. Type B expenditure is defined as R&D expenditureon a qualifying R&D activity in respect of:
  • a payment to a “designated local research institution” for out-sourced R&D activities;
  • an expenditure in relation to an employee (excluding a director) who is engaged directly and actively in a qualifying R&D activity; and
  • an expenditure on a consumable item that is used directly in a qualifying R&D activity.

Situation where no deduction is allowed

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 arrangementof which 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.

Deemed taxable trading receipts
Schedule 45 also proposes certain receipts (such as royalties received for the use or right to use outside Hong Kong of any intellectual property or know-how generated from any R&D activity for which the capital expenditure has been allowed as a deduction) will be treated as taxable income. 

All current deeming provisions under section 16B will be retained, i.e. where proceeds are earned from the sale of plant or machinery for, or rights generated from, an R&D activity for which the capital expenditure has been allowed as a deduction, such proceeds will be taxable (but limited to the amount of deduction previously allowed).  

Once the Bill is enacted, the new regime will take retrospective effect and apply to R&D expenditure incurred on or after 1 April 2018.

Clients who wish to explore details of the enhanced R&D tax deduction can contact Ms. Amie Cheung at amie.cheung@lccpa.com.hk