The Inland Revenue Department (“IRD”) released practice note DIPN 55 to set out the IRD’s interpretation of the R&D tax concession, the practical application of the concession and documentation requirements.

Commencing from the year of assessment 2018/19 (expenditure incurred from 1 April 2018), qualifying R&D activities are eligible for either:

• Type A expenditure: 100% tax deduction; or
• Type B expenditure: 300% tax deduction for the first HK$2 million and 200% for the remainder
  (without limit). 

Key features of tax deduction regime:

Registration of patents is not a prerequisite for an activity to be regarded as an R&D activity.

Must an R&D activity be wholly undertaken and carried on in Hong Kong?

DIPN 55 clarifies that the R&D activity is not required to be wholly carried on in Hong Kong, but only local Hong Kong expenditure may qualify for the enhanced deductions.

Qualifying R&D expenditure

• payments to designated local research institutions (DLRI) (a list can be found at www.itc.gov.hk/en/dlri/index.htm)

• staffing costs
  • on employees of the enterprise itself (i.e. an employer and employee relationship subsists) engaged directly and actively in a qualifying R&D activity.
  • borne by an enterprise relate to secondees or expatriates sponsored by the enterprise.

• directors’ remuneration is excluded
  (apportionment can be allowed where a person occupies a dual role in being both a director and an employee directly and actively engaged in a qualifying R&D activity.)

• direct consumables e.g. a laboratory chemical used in a qualifying R&D activity, electronic components that are integrated into a larger assembly in such a way that they are effectively transformed into part of a larger prototype. Software is not with consumable items.

• expenditures incurred under Cost Contribution Arrangements (“CCA”) may be eligible provided they meet various conditions such as:
  • enterprises derive proportionate benefits from the R&D activities under the CCA
  • each participant actively participates in the R&D project
  • there are co-ownership of rights amongst CCA participants
  • payments to external contractors (other than DLRIs) are not eligible for the enhanced R&D deduction.

Rights fully vested in the enterprise

• rights includes patented rights, unregistered know-how and work-in-progress intangibles.
• co-ownership of rights isacceptable
• use SPV to hold IPs is acceptable if the SPV acts as a nominee for the enterprise performing an R&D activity.

 
DIPN 55 clarifies both the nature of qualifying activities and associated R&D expenditure under the enhanced deduction regime.  Determining whether a prospective project would be considered as an R&D activity or a qualifying R&D activity must be assessed on a case by case basis.  Proper documentation in respect of such activities will be critical to facilitate successful R&D claims.
 
Clients who wish to explore more details can contact Ms. Amie Cheung at amie.cheung@lccpa.com.hk