In order to promote Hong Kong as an international research & development (R&D) hub and attract more R&D activities to be performed in Hong Kong, the Hong Kong government has recently enacted new tax regulations which provide tax incentives to qualifying R&D expenditures incurred on or after 1 April 2018.
The new regulations classify R&D expenditure into two broad categories (Category A and Category B) which are tax deductible subject to meeting certain conditions as follows:
• Category A expenditure is entitled to a basic 100% tax deduction.
• Category B expenditure is entitled to super-deduction treatment where an enhanced two-tiered tax deduction, i.e. 300% for the first HK$2million and 200% for any remaining amounts, is available.
Where Category A expenditure is incurred for an R&D activity performed outside or partly outside Hong Kong, the deduction for the expenditure is subject to apportionment. By contrast, Category B expenditure will qualify for super-deduction treatment only if the relevant R&D activity is wholly carried out in Hong Kong.
Qualifying R&D expenditure
In order for expenditure on a qualifying R&D activity to be tax deductible, it must be incurred in relation to the taxpayer's business and must be:
• an expenditure in relation to (a) an employee engaged directly and actively in a qualifying R&D activity or (b) a consumable item that is used directly in a qualifying R&D activity; or
• paid to a designated local research institution; or
• paid to a designated local research institution which has, as an object, the undertaking of a qualifying R&D activity related to the class of business to which the taxpayer's business belongs, where the payment is used for pursuing that object.
Qualifying R&D activity
The term "Qualifying R&D activity" is defined under the new regulations. The critical element to qualify for Category B expenditure is that the R&D activity is wholly undertaken in Hong Kong and meets one of the following conditions:
• an activity in the fields of natural or applied science to extend knowledge; or
• any original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding; or
• the application of any research finding 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.
The Hong Kong Inland Revenue Department ("IRD") will release a Departmental Interpretation and Practice Notes ("DIPN") shortly to elaborate on and clarify the provisions of the new regulations and the level of proof required from taxpayers to enable the IRD to assess any super-deduction/enhanced tax deduction claim. It is hoped that the DIPN will set out a reasonable degree of flexibility in terms of documentation requirements and will fulfil the Hong Kong government's intention of encouraging R&D activities in Hong Kong. To ensure that eligible taxpayers are in a position to claim the new R&D tax incentives, it will be vital that they have the systems and processes in place to correctly identify projects and classify their R&D expenditure.
The tax deductibility of some common R&D expenditures under the new regulations are as follows:
|R&D expenditures||Tax deductibility|
|Payment to a group company for subcontracted R&D activities||Non-deductible generally|
|Staff costs for in-house R&D staff with activities performed in Hong Kong||300%/200% deductible|
|Payment to a designated local research institution for qualifying R&D activities in Hong Kong||300%/200% deductible|
|Staff costs for in-house R&D staff with activities performed in Hong Kong and China||100% deductible (subject to apportionment)|
|Capital expenditures on acquisition of plant and machinery for an R&D activity||100% deductible|
|Purchase consideration for a property which is used as a laboratory for an R&D activity||Non-deductible (but eligible for industrial building allowances)|
Contributed by: Masson de Morfontaine, Anthony Hung