Tax Tips (16) – New Tax Rule is Harmful to Intellectual Property Activities in Hong Kong

Many people may have forgotten about the “Summit on New Directions for Taxation” held in October last year.  In his speech for the event, the Financial Secretary Mr. Paul Chan said that “the most important aspect of today’s Summit is the discussion on how taxation (policy) can play a role in the economic development (of Hong Kong) in multiple directions”, and praised that “our tax system is simple, provides certainty, and it is implemented consistently”.  The Financial Secretary also mentioned that the Tax Policy Unit set up in April 2017 is working at full speed, demonstrating the determination of the Government to actively pursue economic growth and development of industries through tax policies.

The Government has indeed done a lot of work on taxation in the past year.  Some are for the implementation of the BEPS Minimum Standard (such as the transfer pricing regulations), and some relate to the expansion of industries, such as the super-deduction on research and development expenditure.  This issue of Tax Tips discusses Section 15F Sums derived from intellectual property by non-Hong Kong resident associates (“15F”) of the Inland Revenue Ordinance (“IRO”) hidden in the transfer pricing regulations under Inland Revenue (Amendment) (No. 6) Ordinance 2018.  15F was passed by the Legislative Council and is effective from 1 April 2019 onwards.

What Does 15F Say

In simple terms, when a person (say a Hong Kong company, “HK Co”) performs any of the development, enhancement, maintenance, protection or exploitation (collectively as “DEMPE”) activities in Hong Kong for any intellectual property (“IP”), that person would be regarded as having contributed to the value creation of the IP.  If a non-Hong Kong associated person (say “X Co”) receives a sum for the exhibition, use or imparting of the IP or the rights of the IP inside or outside Hong Kong, a sum associated with value contributed by HK Co (the “relevant sum”), if not already subject to Hong Kong profits tax, would be deemed as Hong Kong sourced income of HK Co and subject to profits tax.    

The original text of 15F* can be found here for Reader’s easy reference.  

According to 15F, no matter HK Co is the owner of the IP or not, provided that HK Co has performed any of the DEMPE activities for an IP to contribute value to it, including carrying out the relevant functions, providing assets, or taking up the relevant risks, and the offshore associate (X Co) receives “a sum” from the IP and has not paid any Hong Kong profits tax on any part of the sum, 15F empowers the Hong Kong Inland Revenue Department (“IRD”) to deem the relevant sum as income of HK Co and taxed accordingly.    

Readers may already have questions in mind about 15F, some of which may be covered below:

  1. What is the meaning of “a sum”?  Is it restricted to mean an identifiable sum received by X Co for the use of the IP?  If the IP is a brand, and X Co uses the brand to sell goods, is the sales revenue “a sum”?
  2. Would DEMPE activities performed by HK Co before 1 April 2019 be included in the analysis?
  3. How would the IRD determine the “relevant sum” if the IP is used by various subsidiaries or joint ventures of X Co in different countries, and HK Co is unable to obtain the detailed information of the income of these companies?  Even if HK Co is able to provide the information, how would the IRD assess the value contributed by these companies in order to accurately calculate the “relevant sum”?
  4. Under the IRO, is HK Co legally bound to provide information of X Co and the various subsidiaries or joint ventures in different countries to prove whether these companies have each received “a sum” and the amounts?  
  5. If HK Co is the owner of the IP and transferred the IP to X Co at an arm’s length price, why would HK Co not be exempt from 15F?
  6. Income of X Co and the various subsidiaries or joint ventures in different countries derived from the IP may have been subject to tax in the relevant countries; if part or all of the income is deemed to be taxable income of HK Co and subject to Hong Kong profits tax, the issue of double taxation would arise.  As the double taxation is not arising from a transaction between two jurisdictions but it stems only from the deeming provisions of the IRO, the issue cannot be resolved on a bilateral basis even if Hong Kong and the other side(s) has a Double Tax Arrangement (“DTA”) signed. How would the IRD deal with this issue?  Would HK Co be required to provide evidence of tax payment by the various offshore companies in order to avoid an assessment under 15F?
  7. How would the statutory auditors ascertain the tax provision of the X Co Group (including HK Co, all together referred to as “X Group”)?  If there is a multinational group interested to acquire X Group, how would the buyer assess the tax exposure of X Group under 15F?

The above may only be some of the questions created by 15F.

Facebook’s Data Centre

Last month, Facebook announced that it will invest US$1 billion to build its 15th data centre, the first in Asia, in Singapore.  Tax consideration is not mentioned in the media reports covering this news. It can be imagined that some kind of DEMPE activities must be carried out in the data centre, creating certain IP to be used in different parts of the world.  If Facebook were to select Hong Kong as the location for the data centre, would they be worried about the threat of 15F?

Would multinational groups or other tech giants be scared away from Hong Kong because of 15F when they select the location to invest in Asia to carry out DEMPE activities related to IP?  It is entirely possible that multinational groups, in any industry, may choose to avoid Hong Kong because of tax risks and uncertainties created by 15F!

Voice Against 15F

When the Inland Revenue (Amendment) (No. 6) Bill 2017 (“the Bill”) was gazetted last year, many professional organisations made submissions to the Bills Committee voicing out concerns on 15F, some even requested that 15F be removed.  The Government responded that there are companies that transfer legal ownership of IPs to associates in low-tax jurisdictions where no DEMPE activities are performed but earn the IP income.  In order to align taxation with value-creation, which is the objective of BEPS, the Government is introducing 15F to combat such profits shifting activities. The Government claimed that DTA partners are adopting a similar approach to transfer pricing, and genuine commercial transactions would not be affected.

Lastly, in order to pass the Bill (and 15F), the Government has said that various issues will be clarified in a Departmental Interpretation and Practice Notes (“DIPN”) to be issued, and deferred the commencement date of 15F to 1 April 2019 to allow more lead time to taxpayers.   

Tax Tips

The scope of 15F is very wide and it is not a specific anti-avoidance provision.  15F would apply even if the taxpayer is not engaged in any tax avoidance. Under the shadow of 15F, the statement that “our tax system is simple, provides certainty, and it is implemented consistently” would no longer be true.  15F discourages companies to conduct IP-related activities in Hong Kong, which is in direct contradiction to the Government policy of encouraging research and development activities in Hong Kong.

If the law is flawed, DIPN would not make it flawless.  Therefore, the best approach to 15F is to ask the Government to repeal it or amend it substantially such that it only applies in limited circumstances.  The Author would raise the demand through the appropriate professional organisation. In the meantime, Readers may also raise the issue via appropriate means.    

If the Government refuses to amend 15F, the only way to eliminate tax risk is not to carry out any DEMPE activities in Hong Kong, which is basically an impossible task.  Companies should thus wait for the DIPN before deciding the action to take.


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(This is an English translation of the Chinese article published in the Hong Kong Economic Journal Forum on 9 October 2018: Forum 16)


* Full text of 15F (!en-zh-Hant-HK?INDEX_CS=N&xpid=ID_1532314900253_001) was updated on 13 July 2018, copyright belongs to the Hong Kong SAR Government ( )

Facebook Singapore data center:

Submissions to Legco re Bill 6:

IRD’s response to public concerns on 15F: