The Inland Revenue (Amendment) (No. 2) Bill 2011 (the "Bill") was gazetted on 25 February 2011. Major changes proposed by the Bill include (i) providing tax deduction for capital expenditure incurred on the purchase of a copyright, registered design and registered trade mark; (ii) modifying existing provisions for deduction of capital expenditure incurred on the purchase of patent rights and rights to any know-how; and (iii) removing the requirement for "use in Hong Kong" condition.
It was announced in the 2010-11 Budget delivered on 24 February 2010 that the Hong Kong Government aims to promote the wider application of intellectual property rights by enterprises and encourage the development of creative industries in Hong Kong.
The Bill seeks to implement the 2010-11 Budget by proposing changes to the existing provisions on profits tax deduction and seeking to amend various sections of the Inland Revenue Ordinance (Cap. 112) (the "IRO"). The Bill will be introduced to the Legislative Council of Hong Kong on 9 March 2011.
Capital expenditure in relation to copyrights, registered designs and registered trade marks
Under the tax laws of Hong Kong, profits tax deduction is granted for an enterprise's revenue expenditure (i.e. outgoings and expenses incurred in the production of profits chargeable under Hong Kong profits tax). Common examples of revenue expenditure for which profits tax deduction is allowed in relation to the use of intellectual property rights include royalties and license fees.
Presently, funds used by enterprises for the purchase of intellectual property rights are not tax deductible, unless such capital expenditure was incurred on the purchase of patent rights and rights to "know-how" (as defined in the IRO to mean any industrial information or techniques likely to assist in the manufacture or processing of goods or materials).
The Bill seeks to amend the IRO by providing further types of capital expenditure for which profits tax deduction is granted. It was proposed that tax deductions shall also be allowed for the sums incurred by enterprises for the purchase of (i) copyrights; (ii) registered designs; and (iii) registered trade marks. The deductions will be spread over five years and be deducted in equal amounts, starting from the year of purchase, subject to adjustments if the relevant rights expired before the expiry of the said five-year period. Such deduction is allowable only if, at the end of the basis period of the deduction, the relevant intellectual property right has not been sold by the person who incurred the specified capital expenditure.
If the specified intellectual property right is used only partly to produce taxable profits, then the deduction allowable is that part of the specified capital expenditure that is proportionate to the extent of use of the right in producing the taxable profits.
In case the intellectual property rights are purchased or sold together with other assets for one consideration, the Commissioner may allocate a consideration for each individual asset. If the Commissioner is of the opinion that the consideration for the specified intellectual property right does not represent its true market value, it may determine the true market value.
If a tax deduction has been allowed to a person in respect of patent rights or rights to any know-how which are subsequently sold by the person, the proceeds of sale shall be treated as trading receipts to the extent of the amount of the deduction as previously allowed.
Where the specified intellectual property right is a copyright, registered design or registered trade mark and is subsequently sold, if there is an unallowed amount, such amount which exceeds the proceeds shall be deducted for the year of assessment in the basis period for which the sale occurs. If such proceeds exceed the unallowed amount, the excess (if not taxable under other provisions and do not exceed the deductions) shall be treated as a trading receipt. If there is no unallowed amount and the proceeds are not taxable otherwise and do not exceed the deduction, they are treated as a trading receipt.
Purchase from Associates
Presently, no tax deduction is allowable in relation to the purchase of patent rights or rights to know-how if the rights were purchased wholly or partly from an associate (as defined in the IRO to mean, among others, if the purchaser is a corporation: (i) any associated corporation; (ii) any person or such person's partner or relative who controls the purchaser; and (iii) any director or principal officer of the purchaser or any associated corporation, including any relative of such director or principal officer). The definition of an "associate" is widely interpreted.
The Bill does not seek to remove this restriction and extends this to apply to the proposed tax deductions in relation to the purchase of copyrights, registered designs and registered trademarks.
Legal expenses and valuation fees
Currently, although not expressly stated in the IRO, tax deductions for legal expenses and valuation fees incurred in connection with the purchase of patent rights and rights to know-how are allowed.
To eliminate any uncertainty, the Bill proposes to introduce a new section in the IRO to clearly provide that tax deduction is allowed for legal expenses and valuation fees incurred in connection with the purchase of patent rights and rights to know-how. This new section shall also apply to proposed changes relating to the purchase of copyrights, registered designs and registered trade marks.
Removing the "use in Hong Kong" condition
A "use in Hong Kong" condition is currently applicable to the tax deduction granted in relation to capital expenditure incurred on the purchase of patent rights and rights to know-how. The IRO provides that tax deduction would only be granted if the patent rights and rights to know-how are purchased for use in Hong Kong.
The Bill proposes to remove this "use in Hong Kong" condition so that tax deduction would be granted irrespective of whether the patent rights and rights to know-how will be used in Hong Kong. Tax deduction under the Bill would be granted so long as the rights are used by the taxpayers for production of profits chargeable under Hong Kong profits tax.
The removal of the "use in Hong Kong" condition shall also apply to the proposed tax deduction in relation to the purchase of copyrights, registered designs and registered trade marks.