Deduction on R&D Expenditures

Deduction on R&D Expenditures | Bestar

Hong Kong R&D Tax Deductions Explained

Hong Kong offers an enhanced tax deduction regime for Research and Development (R&D) expenditures to encourage innovation and technological advancement. The system, which has been in effect since April 1, 2018, categorizes R&D expenditures into two types, each with its own deduction rate.

Enhanced Tax Deduction Rates

The tax deduction for R&D expenditures in Hong Kong is categorized as follows:

• Type B expenditure: This is eligible for an enhanced deduction. The rates are:

  
  

  • 300% for the first HK$2 million of qualifying R&D expenditure.

  • 200% for any remaining amount of qualifying R&D expenditure exceeding HK$2 million.

  • There is no cap on the total amount that can be deducted at the 200% rate.

    
    

• Type A expenditure: This is eligible for a standard 100% tax deduction. This applies to R&D expenditures that do not meet the criteria for Type B.

What Constitutes Qualifying R&D Expenditure?

To qualify for the enhanced (Type B) deduction, the R&D activities and the associated expenditures must meet specific criteria as outlined by the Inland Revenue Department (IRD).

Qualifying R&D Activities A "qualifying R&D activity" must be wholly undertaken and carried on in Hong Kong and is defined as:

• An activity in the fields of natural or applied science to extend knowledge.

  
  

• An original and planned investigation carried on with the prospect of gaining new scientific or technical knowledge and understanding.

  
  

• The application of research findings or other knowledge to a plan or design for producing new or substantially improved materials, devices, products, processes, systems, or services before they are commercially produced or used.

  
  

The R&D activity must be more than just a minor or incremental upgrade and must involve an advancement in science or technology.

Qualifying R&D Expenditures (Type B) Type B expenditures are generally related to R&D activities carried out in-house or outsourced to a specific type of institution. These include:

• Payments to a "designated local research institution" (DLRI): This is for outsourced qualifying R&D activities. The list of DLRIs is determined by the Commissioner for Innovation and Technology.

  
  

• In-house expenditures: This includes costs related to:

  
  

  • Employees: Expenditures on employees (excluding directors) who are directly and actively engaged in a qualifying R&D activity.

  • Consumable items: Expenditures on consumable items that are used directly in a qualifying R&D activity.

    
    

R&D Expenditures (Type A) Expenditures that do not fall under the definition of Type B are considered Type A and can still be 100% deductible if other conditions are met. Examples include:

• Expenditures for machinery and equipment used for R&D.

  
  

• Expenditures on R&D activities carried out outside of Hong Kong.

  
  

• Other R&D expenditures like consultancy fees paid for expert advice.

  
  

Important Considerations for Claiming the Deduction

• The enhanced deduction applies to qualifying expenditures incurred on or after April 1, 2018.

  
  

• To claim the enhanced deduction, a company must ensure that the rights to any intellectual property generated from the R&D activity are fully vested in the taxpayer.

  
  

• The deduction will not be allowed if the R&D activity is undertaken for another person or if the expenditure is subsidized by the government or another party.

  
  

• Even if an R&D project is not successfully completed, the associated activities may still be considered "qualifying" for the purpose of the deduction. The key is the intention to achieve an advancement in science or technology.

  
  

• Taxpayers may apply for an advance ruling from the IRD to confirm whether their activities qualify for the deduction.

  
  

How Bestar can Help

Claiming R&D tax deductions in Hong Kong can be complex, and engaging with professionals—such as Bestar—can significantly help businesses navigate the process and maximize their benefits. Here's a breakdown of how Bestar can assist:

1. Identifying and Defining Qualifying R&D Activities

The first and most critical step is to determine if your activities meet the Inland Revenue Department's (IRD) definition of "qualifying R&D." This is often not as straightforward as it seems.

• Expert Interpretation: Bestar can help you interpret the IRD's guidelines (e.g., Departmental Interpretation and Practice Notes No. 55) and apply them to your specific business activities. This involves analyzing whether your projects involve "advancement in science or technology" and go beyond minor or incremental improvements.

  
  

• Structured Methodology: We can help you establish a clear methodology for documenting and categorizing your R&D projects. This ensures that you have the necessary evidence to support your claims in the event of an IRD audit.

2. Maximizing Deductible Expenditures

Once the activities are identified, the next challenge is to correctly categorize and calculate the eligible expenses.

• Expenditure Classification: Bestar can help you distinguish between Type A (100% deduction) and Type B (enhanced 300%/200% deduction) expenditures. This is particularly important for professional fees, as the deduction rate depends on the service provider (e.g., a Designated Local Research Institution vs. an external consultant).

  
  

• Cost Allocation: We can assist in a detailed review of your financial records to properly allocate expenses. This includes identifying direct and indirect costs, and correctly apportioning employee salaries and consumable costs to R&D activities. This is especially important for staff who may not be 100% dedicated to R&D.

3. Documentation and Compliance

Maintaining a robust and comprehensive audit trail is essential for a successful claim.

• Record-Keeping: Bestar can advise on the specific documentation required by the IRD, such as project plans, timesheets for R&D staff, invoices for consumables, and contracts with service providers.

  
  

• Claim Preparation: We can prepare and file the necessary tax forms, including the supplementary form for R&D expenditures, ensuring all information is accurate and compliant with the latest regulations.

4. Strategic Planning and Risk Management

Beyond a single year's claim, professional advice is crucial for long-term R&D planning.

• Intellectual Property (IP) Strategy: A key requirement for the deduction is that the intellectual property generated from the R&D must be fully vested in the taxpayer. Bestar can help structure your agreements and contracts to ensure this condition is met.

  
  

• Cross-Border R&D: For multinational corporations, managing R&D across different jurisdictions is a significant challenge. Bestar can help structure arrangements to maximize tax benefits while complying with both Hong Kong and foreign tax laws. This includes advising on transfer pricing arrangements for R&D services.

  
  

• Audit Defense: In the event of an IRD inquiry or audit, Bestar can represent your company and provide expert defense, drawing on their in-depth knowledge of tax laws and the R&D regime.

5. Accessing Other Government Incentives

In addition to tax deductions, the Hong Kong government offers various funding schemes to support R&D and innovation through the Innovation and Technology Fund (ITF). Bestar can help you:

• Identify Relevant Schemes: We can assess your business activities and help you identify other potential government grants or subsidies, such as the Enterprise Support Scheme (ESS) or the R&D Cash Rebate Scheme (CRS).

  
  

• Navigate Application Processes: We can assist with the complex application processes for these schemes, increasing your chances of success.

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