Introduction
The concept of "smart economy" has led multinational corporations (MNCs) to view technology as a core asset. Recognizing this trend, many jurisdictions are offering various incentives to encourage technology innovation, investment and the creation of intellectual property (IP). Establishing a global IP centre that can operate across borders can help MNCs to not only recruit top talent, but also to increase their innovation capabilities and expand product exposures.
When selecting an optimal location for an IP centre, key considerations include:
- Robust legal protection
- Attractive tax benefits
- Availability of talent
- Costs and other commercial factors such as geopolitics, the local economy and law enforcement
Popular IP Centres
Traditionally, MNCs often used offshore entities incorporated in jurisdictions like the Cayman Islands or British Virgin Islands to hold the group's IP. However, an increasing number of MNCs are shifting their IP centres from these offshore jurisdictions to onshore jurisdictions, driven by economic substance requirements as well as attractive government incentives offered by other (onshore) jurisdictions.
Popular onshore IP centre destinations used to be in Europe, such as Switzerland, due to its well-connected IP treaty network and robust law enforcement to protect IP rights. However, in recent years, certain jurisdictions in Asia — in particular, Hong Kong SAR and Singapore — are gaining popularity as IP centres due to their increasing focus on technology innovation, as well as robust IP law enforcement, favourable tax treatments and access to a large pool of highly skilled tech talent within Asia.
Additionally, the geographic proximity to major Asian markets and innovation ecosystems makes them attractive locations for companies looking to centralize their IP management and drive global growth.
Hong Kong SAR
In Asia, Singapore and Hong Kong SAR have increasingly emerged as attractive IP hubs. In this regard, Hong Kong SAR has recently introduced a new tax regime — the patent box — which further incentivises MNCs to locate their IP centres in Hong Kong SAR. As such, we will focus on Hong Kong SAR in this article.
Impact of Patent Box Tax Regime on IP Income
The newly introduced patent box regime offers a favourable 5 percent tax rate on a portion of the taxpayer's Hong Kong SAR-sourced taxable profits derived from the use or sale of eligible IP. This represents a significant reduction from the standard 16.5 percent profit tax rate, making Hong Kong SAR an even more attractive destination for companies to develop, hold and commercialize their IPs.
Furthermore, the patent box regime has been designed with flexibility to encourage innovation. It recognizes that many Hong Kong SAR entities collaborate with R&D partners, both locally and globally, in the R&D process. As such, the regime allows companies to count offshore R&D expenses incurred by unrelated parties (as well as onshore R&D expenses incurred by related parties if the related party is also a Hong Kong SAR tax resident) toward the calculation of the eligible R&D expenditure. This would therefore increase the portion of the taxpayer's profits eligible for the preferential tax rate. It is worth noting that for R&D activities outsourced to non-Hong Kong SAR affiliates, those R&D expenses incurred would not qualify as eligible R&D expenditure within the definition of the patent box regime.
Overall, the introduction of the patent box regime has cemented Hong Kong SAR's position as an increasingly attractive IP hub in Asia. Local businesses and professionals have a positive view about the enhanced tax incentives, which are expected to further stimulate innovation, investment and the development of Hong Kong SAR as a leading regional IP centre.
China
In this regard, we have already seen an increasing number of China domestic corporates looking to expand overseas and increase the economic substance and operating functions of their Hong Kong SAR subsidiaries/affiliates.
In particular, many China corporates have started to license or transfer their IPs to Hong Kong SAR and use the China entity to perform contract R&D services for the overseas (Hong Kong SAR) principal. Such license or transfer of IPs as well as ongoing contract R&D services would give rise to various China tax implications, including corporate income tax (CIT), value-added tax (VAT) and transfer pricing (TP), all which should be thoroughly considered as part of the overall planning of any potential restructuring of the operating structure. We further discuss the tax considerations below.
From a CIT perspective, royalty income, income derived from the transfer of IP and R&D service income will be regarded as part of the China entity's taxable income and subject to the standard CIT rate of 25 percent, unless such income is subject to CIT exemption (e.g., for certain royalty income and income derived from the transfer of IP) and/or the entity is eligible for other preferential tax rates (e.g., 15 percent if the entity qualifies as a high and new technology enterprise (HNTE)).
Nevertheless, it is worth noting that the aforementioned income may have an adverse impact on the eligibility of a preferential tax rate. This could be the case if the ratio of R&D expenses over sales revenue is reduced to be lower than the minimum threshold for qualifying as an HNTE because the denominator, being the sales revenue, is increased due to the receipt of the aforementioned income. Transferring the IPs out of the China entity may also have an adverse impact on the eligibility of HNTE qualification, as owning IPs that have a core function in supporting the main products and/or services of the company from a technology perspective is also one of the requirements for qualifying as an HNTE.
According to the prevailing VAT regulations in China, royalty income, income derived from the transfer of IP and R&D service income of a China entity would generally be subject to VAT at 6 percent plus surcharges on the VAT payable. Nevertheless, zero-rated VAT or VAT exemption may be available to the taxpayer depending on the nature of the income and the location where the IP will be used.
For example, R&D services sold to overseas entities and wholly consumed outside China can apply for zero-rated VAT treatment, and registered IP transfer/ licensing with relevant authorities (e.g., Ministry of Science and Technology) can apply for VAT exemption treatment, etc. As such, to the extent the abovementioned zero-rated or VAT exemption treatment could be available, the licensing/IP transfer/R&D service agreement should include a detailed description of the covered service and clearly state the location where the IP will/can be used to help substantiate the application of the zero-rated or VAT exemption treatment.
When conducting cross-border IP and/or R&D-related activities between related parties, companies must ensure that their TP practices align with the arm's length principle. This requires pricing intangible assets, IPs and R&D cost allocations based on what independent parties would agree to under similar circumstances. Relevant factors include the nature of the R&D, each party's contributions and risks, ownership and use of resulting IP, and the pricing of shared services. Thorough documentation is essential to demonstrate that the intercompany arrangements comply with relevant local tax laws.
Our Comments
When selecting the appropriate jurisdiction for holding IPs, MNCs should comprehensively consider all relevant factors and driving forces including commercial feasibility, legal protection of the IP rights, availability of talent pool, operating costs and, last but not least, the tax issues and costs arising from cross-border transactions as well as the tax benefits (preferential tax treatment) that the jurisdiction can offer.
Originally published by 12 August, 2024
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.