Intellectual Property: Making a Move to Hong Kong

In the last year we have seen a number of international groups structuring the ownership of new intellectual property (IPR) holdings into Hong Kong companies, or indeed,   re-registering their IPR into Hong Kong  companies, and away from the old favourite jurisdictions of Holland, Luxembourg, Cyprus and Ireland.

All these latter countries happen to be in the EU and their VAT systems have moved adversely against IPR taxation since the substantial VAT changes within the EU, effective from 1 January 2010.

But first some background on Hong Kong, which is still incorporating companies at a rate of over 100,000 per year, despite the financial crisis.

The Hong Kong tax system has a number of commendable features including:

• Maximum effective profits tax rate of 16.5 per cent. In reality many businesses pay a lower effective tax rate than this or pay no tax if an ‘offshore profits’ claim is made.
• Maximum effective Salaries Tax rate of 15 per cent. In reality most individuals pay a lower effective tax rate than this.
• Tax-free capital gains.
• Tax-free dividend income.
• Tax-free offshore source income.
• No withholding tax on dividends and interest.
• No withholding of tax on salaries.
• Minimal capital duty on authorised share capital increases or reorganisations.
•  No exchange controls.
• No VAT
• No arm’s length pricing requirements, although benchmarking for a suitable ‘cost plus’ profit margin is advisable.
• Tax-free interest on income for businesses since 22 June 1998, if interest is received from a Hong Kong financial institution and the deposits is not collateral for another loan.
• Simple formula for annual tax reporting requirements for businesses and employees.
• Advance tax rulings are available to clarify treatment of any uncertain tax areas including offshore taxation or tax-free status claims.
• Withholding on royalties is typically a maximum of  4.95 per cent although this is often reduced by a double tax treaty.  Hong Kong has the best double tax treaty with the PRC.

The reason Hong Kong is now a jurisdiction of choice is because of the sudden upsurge in the number of modern Double Tax Treaties signed since 1 January 2010, and the fact there is no VAT in Hong Kong.

Double Tax Agreements with Hong Kong

During 2010, Hong Kong has trebled the number of jurisdictions with which it has signed comprehensive Double Tax Agreements (DTAs). It had previously only signed agreements with The People’s Republic of China, Belgium, Luxembourg, Thailand and Vietnam.

Countries/regions that Hong Kong has now signed tax agreements with are as follows: Burnei, The Netherlands, Indonesia, Belgium Thailand, Mainland China, Mexico, Luxembourg, Vietnam, Austria Czech Republic, Ireland, Italy, Kuwait, Japan, France, UAE, Switzerland and the UK.

These are mostly expected to come into force from 1 April 2011. 

A full list is available on the HK Government website.

Analysis

A Hong Kong company owning or purchasing IPR can now deduct 100 per cent of the costs of that purchase against its Hong Kong source taxable profits. In effect the Hong Kong tax liability of the company will be controllable by a variety of legitimate techniques. There is no VAT in Hong Kong; indeed Hong Kong entities can recover VAT incurred by their businesses in many EU and other countries.

Value Added Tax / Indirect Tax Issues

The European VAT system recently changed substantially with respect to services that are rendered in a business-to-business situation. As of January 1, 2010, such services are in principle subject to VAT in the country where the recipient of the services is situated. Royalties that are charged by an EU conduit or holding  company to European companies are thus in principle subject to VAT in the countries where these European companies are situated.

If these companies qualify as entrepreneurs for VAT purposes, the EU company can apply the reverse charge mechanism, meaning that the EU company can charge the royalties without VAT and that the European companies must report the royalties in their local VAT returns. Usually, these companies should be able to claim back the VAT, in which case the VAT liability will on balance be nil. For many groups, however, this could result in irrecoverable VAT at the operating company level if they provide exempt services. Irrecoverable VAT is tax deductible in the country concerned thus reducing the effective VAT cost.

If the recipients do not qualify as entrepreneurs for VAT purposes, any EU conduit company must charge EU VAT and this VAT cannot be claimed back. However; these services will not then be subject to the ‘reverse charge’ mechanism in each operating company, in the EU. In essence VAT will arise adding to the tax costs of any royalty conduit ie, in the Netherlands, Luxemburg etc. It is for this reason that IP holding companies are now being located in non EU jurisdictions, especially if there is likely otherwise to be irrecoverable VAT on royalties.

Transfer Pricing

Based on international transfer pricing practices, a royalty conduit company must receive an arm’s length remuneration for the services rendered. The arm’s length profit margin must be determined for each specific case based on the facts and circumstances, and transfer pricing/ benchmarking studies can be undertaken to demonstrate the arm’s length pricing/ royalty rates.

For example, discussions with tax authorities  indicate that conduit  companies must be remunerated on the basis of the actual functions carried out. Basically, if the conduit company plays an active role in the financing or licensing activities of the group and bears the risks that are associated with this, one would expect this company to receive a certain margin over the interest or royalty paid. However, if the conduit company merely has an administrative function (eg, if the company only handles the royalty charges, but has no employees, is not involved in the decision making process and does not bear any real risks, etc), the remuneration could be even as low as the operational costs plus a certain profit margin (of eg, two – five per cent).

 AzureTax Limited have access into Royalty databases  and are experienced in benchmarking and drafting of transfer pricing documentation.

Conclusion

There are a number of interesting opportunities for multinational groups to explore, using Hong Kong companies as holding companies, for treasury purposes and for holding IPR or for using Hong Kong as a conduit for paying royalties tax efficiently. And this has all come into place since 1 January 2010.

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