Issue 9 - 9 December 2003

tax notes

　

Hong Kong Profits Tax treatment of

royalties paid to non Hong Kong residents



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 Hong Kong Inland Revenue Ordinance ("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) 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:

　

"(a)	sums, not otherwise chargeable to [Profits Tax], received by or accrued to a person from the exhibition or use in Hong Kong of cinematograph or television film or tape, any sound recording, or any advertising material connected with such film, tape or recording;
(b)	sums, not otherwise chargeable to [Profits Tax], received by or accrued to a person for the use of or right to use in Hong Kong a patent, design, trademark, copyright material or secret process or formula or other property of a similar nature, or for imparting or undertaking to impart knowledge directly or indirectly connected with the use in Hong Kong of any such patent, design, trademark, copyright, secret process or formula or other property;".

　

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

　

"(a)	100% of the sum in the case of a sum derived from an associate [in Hong Kong]:
	provided that this paragraph shall not apply in the case where the Commissioner [of Inland Revenue] is satisfied that no person carrying on a trade, profession or business in Hong Kong has at any time wholly or partly owned the [intellectual] property in respect of which the sum is paid; or
(b)	the following percentages of the sum in any other case including any case of the description mentioned in the proviso to paragraph (a) above,
	(i)	for any sum received by or accrued to that person before 1 April 2003, 10% [of the sum paid];
	(ii)	for any sum received by or accrued to the person on or after 1 April 2003, 30% [of the sum paid]."

　

　

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, then a tax saving could be achieved by paying royalties to the offshore associate which would only pay Profits Tax on 30% of the royalties paid (formerly 10%) 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 rate of 30% of royalties paid (formerly 10%).

　

　

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 the appropriate rate of 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.

　

　

Provisional Profits Tax

As with all other Profits Tax assessments, assessments on royalties will contain a demand for provisional tax for the subsequent year. For the Year of Assessment 2003/04, the preferential rate used to calculate the assessable income of the non resident recipient has increased from 10% to 30% of the amount paid.  Under the IRO, the IRD has the power to assess provisional Profits Tax for 2003/04 on royalties by reference to the new deemed rate of 30% where it is applicable.  However, the IRD's website states that for the purposes of assessing provisional Profits Tax for 2003/04, the IRD will continue to calculate the liability by reference to assessable income based on the 10% rather than the 30%, calculation. This transitional arrangement is entirely at the IRD's discretion.

 

 

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.

 

The deemed preferential rate used to calculate the assessable income in respect of royalty payments has increased from 10% to 30% effective 1 April 2003, following the changes to the IRO arising from the Financial Secretary's 2003 Budget Speech, which were enacted in July 2003. Hong Kong payers of royalties should ensure that they notify the non resident recipients of the increase in the assessable profits to 30% of the royalties paid.

 

The rate of Profits Tax for companies was increased from 16% in 2002/03 to 17.5% for 2003/04. Coupled with the increase in the deemed assessable profits under the preferential rate this means a significant increase in the effective rate of withholding tax as seen below:

 

2002/03           10% x 16%      =          1.6%

 

2003/04           30% x 17.5%   =          5.25%

 

Hong Kong payers of royalties should therefore ensure that they have retained sufficient funds to meet these increased liabilities.

If you wish to discuss the above please notify your usual Grant Thornton contact or contact:

Paul Chow

T +852 2218 3188

E paul.chow@gthk.com.hk

　

David Southwood

T +852 2218 3103

E david.southwood@gthk.com.hk

　

Tom Corkhill

T +852 2218 3167

E tom.corkhill@gthk.com.hk

　

Brenda Cheung

T +852 2218 3136

E brenda.cheung@gthk.com.hk

　

Gary James

T +852 2218 3137

E gary.james@gthk.com.hk

　

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.

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