Issue 9.1 - October 2008
Tax notes

Where a Hong Kong taxpayer pays royalties to an offshore person or company for the use of intellectual property in Hong Kong, those royalties are deemed to be assessable to Profits Tax in the hands of the non resident recipient.

Moreover the Hong Kong payer has a duty to withhold the relevant tax from the royalties paid and pay the tax to the Hong Kong Inland Revenue Department (IRD).

The IRD imposes a duty on the Hong Kong payer of royalties to a non resident recipient to withhold Profits Tax from the royalties paid and to lodge a Profits Tax Return with the IRD on behalf of the non resident recipient giving details of the royalties paid and the assessable profits arising there from. Once the Profits Tax Return has been filed, the IRD will issue an assessment to the payer of the royalties (on behalf of the non resident person) who will then pay the tax withheld to the IRD.

Deemed assessable income
Section 15 (1) of the Inland Revenue Ordinance (IRO) deems certain sums to be receipts arising in or derived from Hong Kong from a trade, profession or business carried on in Hong Kong and which are therefore subject to Hong Kong Profits Tax, including:

Section 15(1)(ba) IRO was enacted with effect from 25 June 2004 and effectively extends the scope of Section 15(1)(b) IRO by bringing amounts for the use of, or right to use, the relevant types of property outside Hong Kong into charge if those amounts are claimed as deductible expenses for Profits Tax purposes by the Hong Kong payer of the royalties.

Section 21A(1) IRO then extends Section 15(1) IRO by stating that where a payment to a non resident person falls within the deeming provisions in Sections 15(1)(a), (b) or (ba) IRO as set out above, the amount of the assessable income on which the non resident is liable to tax shall be calculated as follows.

The preferential deemed amount used to calculate the assessable income under Section 21A(1)(b) IRO was increased from 10% to 30% effective 1 April 2003.

Anti-avoidance
One of the reasons for the enactment of Section 21A(1) IRO is to prevent avoidance of Profits Tax through the payment of royalties at the lower rates of withholding tax.

In particular, payment of Profits Tax on the full amount of the royalties under Section 21A(1)(a) IRO is aimed at preventing situations where a Hong Kong company develops a trademark or other intellectual property in-house in Hong Kong and then enters into a sale and leaseback agreement with a subsidiary or associated company resident offshore. If it were not for the provisions of Section 21A(1)(a) IRO, a tax saving could be achieved by paying royalties to the offshore associate which would pay Profits Tax on only 30% of the royalties paid whilst the Hong Kong company received a 100% deduction for the payment for Profits Tax purposes.

However where a Hong Kong company has not owned the intellectual property which is the subject of the royalties then, even if these royalties are paid to an offshore associate, the assessable income of the offshore recipient will be calculated by reference to the deemed amount of 30% of royalties paid.

Assessment and payment of tax withheld
Under Section 20B IRO a Hong Kong entity which pays royalties to an offshore entity is required to withhold Profits Tax from the royalties paid to the non Hong Kong resident recipient. The Hong Kong payer must apply for a Profits Tax Return on behalf of the non Hong Kong recipient, complete the return and submit this to the IRD. The IRD will then issue an assessment to the Hong Kong payer as an agent for the non Hong Kong resident recipient of the royalties, and the Hong Kong payer must then settle the resultant tax liabilities.

The effective rates of withholding tax for 2008/09 for payments to corporate recipients are:

  Standard Rate = 16.5%
  Deemed Rate (30%x16.5%) = 4.95%

The effective rates of withholding tax for 2008/09 for payments to non corporate recipients are:

  Standard Rate = 15.0%
  Deemed Rate (30%x15%) = 4.5%

Hong Kong payers of royalties to non Hong Kong residents should withhold sufficient funds from the payments to meet these liabilities.

Provisional Profits Tax
As with all other Profits Tax assessments, assessments on royalties will contain a demand for provisional tax for the subsequent year. Where appropriate a request for a holdover of all or part of the Provisional Profits Tax can be lodged with the IRD. Such a request must be made at least 28 days before the due date for payment. 

Summary
Hong Kong taxpayers who make payments to non Hong Kong residents for the use of intellectual property have an obligation to withhold tax from those royalties, and to provide the IRD with the relevant information to enable this tax to be collected by assessment.

Hong Kong payers of royalties should ensure that they properly identify the appropriate rate of Profits Tax and notify the non resident recipients of the liability to Profits Tax on the royalties payable and ensure that the correct amount is withheld from payment in the non resident and reported to the IRD.
　

Contact Information

Paul Chow
T  +852 2218 3188
E  paul.chow@gthk.com.hk

Gary James
T  +852 2218 3137
E  gary.james@gthk.com.hk

David Southwood
T  +852 2218 3103
E  david.southwood@gthk.com.hk

Brenda Cheung
T  +852 2218 3136
E  brenda.cheung@gthk.com.hk

Mary Ho
T  +852 2218 3040
E  mary.ho@gthk.com.hk

Daisy Ip
T  +852 2218 3168
E  daisy.ip@gthk.com.hk

Winnie Tsui
T  +852 2218 3280
E  winnie.wy.tsui@gthk.com.hk

About Tax notes
Tax notes are issued in summary form exclusively for the information of clients and staff of Grant Thornton and should not be used or relied upon as a substitute for detailed advice. Accordingly Grant Thornton accepts no responsibility for any loss that occurs to any party who acts on the information contained herein without further consultation with ourselves.

Published by Grant Thornton

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