Navigating tax deductions for intellectual property-related expenditures in Hong Kong

• Recurring royalties or licence fees are deductible under the general deduction rules to the extent that they are incurred in the production of the taxpayer’s assessable profits. On the other hand, upfront fees for obtaining licences are considered capital in nature and not deductible under both the general deduction rules and the specific deduction rules explained below.
• Capital expenditures relating to the registration or grant of IP rights, including trademarks, designs, patents and plant variety rights, are deductible to the extent that the rights are used in the production of the taxpayer’s assessable profits.
• Capital expenditures incurred on the purchase of patent rights and rights to know-how are fully deductible in the year of purchase, while those on the purchase of specified IP rights (i.e. copyrights, registered trademarks, registered designs, performer’s economic rights, protected layout design (topography) rights and protected plant variety rights) are deductible over five years, provided that the relevant conditions are met and the specific restrictions in point 4 below do not apply.
• No deduction is allowed for capital expenditures mentioned in point 3 above if any of the prescribed circumstances apply. Notably, two of the prescribed circumstances are:

(i) The rights are purchased wholly or partly from an associate (such as the taxpayer’s group company).

(ii) The rights are used wholly or principally outside Hong Kong by other persons.

Common issues faced by taxpayers and our recommendations

The existing tax deductions for IP-related expenditures are subject to stringent rules. Below are some common practical issues faced by businesses and our corresponding recommendations.

Upfront licence fees

Paying an upfront fee for the right to use an IP under a licence agreement is a common industry practice. In substance, upfront licence fees and annual royalties are similar, as both constitute payments for the right to use IP rather than for ownership. The main difference is that upfront fees are prepaid royalties, providing the licensor with immediate compensation and shifting risk to the licensee.

Nevertheless, these upfront fees are often regarded as capital in nature and disallowed as tax deductions on the basis that they are one-off, nonrecurring payments. The government has traditionally considered the disallowance of such fees to be equitable, as the recipient of the fees should likewise not be subject to tax in respect thereof. However, a recent Court of Appeal decision indicates that licensors may be taxed on these fees, since each party’s tax treatment depends on its own circumstances rather than mirroring that of the payer. This can result in mismatched outcomes when both parties are Hong Kong taxpayers.

In cross-border transactions, further complexity arises. If the fee is for the use of or the right to use an IP in Hong Kong, the Hong Kong payer not only cannot deduct the fee but must also withhold tax for the non-resident recipient. Depending on the parties’ bargaining power, the Hong Kong payer may bear the withholding tax cost, creating an additional financial burden.

In light of the above, we fully support allowing deductions for upfront fees incurred in acquiring licences of IP rights to facilitate various types of IP transactions in Hong Kong.

IP rights purchased from an associate

Companies conducting R&D activities in Hong Kong may acquire existing IP rights from their group companies for further development. However, under current rules, no deduction is allowed for capital expenditures incurred on the purchase of IP rights from associates.

While this anti-avoidance measure is intended to prevent abuse of tax deductions by associated companies, a blanket denial may be excessive. In our view, the concern can be addressed more proportionately, for example, by capping the transferee’s deduction at the transferor’s original cost where both parties are Hong Kong taxpayers. If the transferor is a non-Hong Kong taxpayer, the Commissioner of Inland Revenue is already empowered, under existing provisions, to adjust the consideration to reflect market value. Moreover, existing general anti-avoidance provisions provide sufficient safeguards against aggressive tax planning, making a blanket restriction unnecessary.

With these safeguards in place, we believe that the blanket restriction on the purchase of IP rights from associates could be lifted, thereby facilitating the intragroup transfer of IP rights and enabling Hong Kong businesses to harness global IP rights for local innovation.

IP rights used outside Hong Kong by other persons

It is common for Hong Kong taxpayers to have production bases outside Hong Kong and license their acquired IP rights to manufacturers for use abroad. Additionally, some Hong Kong taxpayers acquire film or programme rights and license them for broadcasting outside Hong Kong. If the IP rights are used wholly or principally outside Hong Kong by other persons, no deduction is allowed for the capital expenditures incurred on the purchase of such rights.

The policy intent of this restriction was to state beyond doubt that the acquisition costs of such IP rights are not eligible for tax deductions as they are not used for producing the taxpayer’s assessable profits, given Hong Kong’s source-based profits tax regime. This was based on the presumption that profits generated from the use of such IP outside Hong Kong were offshore sourced and non-taxable. However, with the introduction of the foreign-sourced income exemption regime in 2023, it is no longer possible for Hong Kong entities of multinational enterprise groups to make a non-taxable offshore claim in respect of royalty income derived from licences of acquired IP rights granted for use outside Hong Kong (unless the income is not received in Hong Kong). As a result, such taxpayers will face an unreasonably high effective tax rate since the IP acquisition costs remain non-deductible while the royalty income is taxable.

Although this issue was not specifically addressed in the 2025/26 budget proposal, we believe it is opportune time for the government to revisit this restriction to avoid undermining the economic viability of cross-border IP licensing arrangements.

Looking ahead

Modernizing deduction arrangements for IP-related expenditures would complement existing incentives and strengthen Hong Kong’s position as a global innovation hub. In comparison, Singapore’s IP acquisition deduction rules are less restrictive. Its Enterprise Innovation Scheme offers qualifying companies a 400 percent tax deduction on the first SGD400,000 of eligible IP costs, with an option for a cash payout. To maintain Hong Kong’s competitive edge, it is important to enhance our tax deduction framework for IP-related expenditures.

To ensure that these enhanced deductions are effective, it is important that conditions are not overly restrictive. We look forward to the government releasing further details and engaging with stakeholders to ensure the proposed measures are practical and aligned with industry needs.

This article was contributed by Charles Chan, Partner, Tax Services and National Tax Policy Services Leader, and Kathy Kun, Partner, National Tax Policy Services, PwC Hong Kong.