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Hong Kong Publishes Departmental Interpretation and Practice Notes on Deductions for Environmental Protection Installation and R&D Expenditure

The Hong Kong Inland Revenue Department has published a revised version of Departmental Interpretation and Practice Notes (DIPN) No. 5 and a new DIPN No. 55.

DIPN No. 5 covers deductions for expenditure on technical education, building refurbishment, prescribed fixed assets, and environmental protection facilities. It has been revised in respect of changes made in 2018 for the deduction of capital expenditure in relation to environmental protection facilities. This includes that from the year of assessment 2018/19 (year starting 1 April 2018), capital expenditure incurred for procuring environmental protection installations may be deducted in full in one year of assessment instead of over five years of assessment. For this purpose, environmental protection installations include:

  • Any of the following installations:
    • solar water heating installations;
    • solar photovoltaic installations;
    • wind turbine installations;
    • offshore wind farm installations;
    • landfill gas installations;
    • anaerobic digestion installations;
    • thermal waste treatment installations;
    • wave power installations;
    • hydroelectric installations;
    • bio-fuel installations;
    • biomass combined-heat-and-power installations;
    • geothermal installations; and
  • Energy efficient building installations (EEBIs) registered under the Hong Kong Energy Efficiency Registration Scheme for Buildings administered by the Electrical and Mechanical Services Department.

EEBIs include four types of central building services installations, including lighting installations, air-conditioning installations, electrical installations, and lift and escalator installations.

DIPN No. 55 covers the new enhanced deduction for research and development (R&D) expenditure incurred on or after 1 April 2018 in respect of qualifying R&D activities, which is provided under section 16B of the Inland Revenue Ordinance. With the enhanced deduction, the first HKD 2 million spent on a qualifying R&D activity will enjoy a 300% deduction and expenditure beyond that will enjoy a 200% deduction, with no cap on the amount of enhanced tax deduction.

Qualifying expenditure for the enhanced deduction is referred to as "Type B" expenditure and generally includes payments made to a designated local research institution and in-house qualifying expenditures for a qualifying R&D activity carried out in Hong Kong. R&D expenditure not qualifying as Type B expenditure is referred to as Type A expenditure and is generally eligible for a 100% deduction.

Along with the introduction of the new enhanced deduction, provisions are included for the treatment of the proceeds from the sale of plant or machinery for, and rights generated from, an R&D activity as trading receipts. This includes provision for the alignment of taxation with value creation, including that the following sums, not otherwise chargeable to profits tax, received by or accrued to a person should be deemed to be trading receipts arising in or derived from Hong Kong from a trade, profession or business carried on in Hong Kong:

  • sums for the use, or the right to the use, outside Hong Kong of any intellectual property or know-how generated from any R&D activity in respect of which a deduction is allowable under section 16B in ascertaining profits of the person under profits tax; or
  • sums for imparting or undertaking to impart knowledge directly or indirectly connected with the use outside Hong Kong of any such property or know-how.

It is also provided that income should be taxed at the place where the value is created and returns from intangibles should accrue to the entities that carry out the DEMPE functions. As such, if an intellectual property or know-how is created or developed through an R&D activity of an enterprise carrying on a trade or business in Hong Kong, the royalties derived from licensing such intellectual property or know-how should be regarded as Hong Kong sourced income and hence should be subject to Hong Kong profits tax.

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