Hong Kong: Upfront lump sum and annual royalties received from UK company taxable in Hong Kong

Court of First Instance decision concerning upfront lump sum and annual royalties received from UK company

Court of First Instance decision concerning upfront lump sum and annual royalties

The Court of First Instance on 19 October 2023 held that the upfront lump sum and annual royalties derived by a Hong Kong company under a licensing and sub-licensing arrangement of trademarks with a UK company were taxable in Hong Kong.

The case is: Patrick Cox Asia Limited v Commissioner of Inland Revenue


The taxpayer licensed trademarks from its parent and sub-licensed them to Japanese companies at the behest of a UK company, which made an upfront payment to the taxpayer for (1) obtaining the right to participate in the business of selling certain products under the trademarks in Japan, and (2) sharing the profits derived from such business (with the UK company receiving 60% of the royalties from the Japanese companies while the taxpayer received 40% of the royalties). 

The court held that the upfront payment and the 40% royalties derived by the taxpayer were taxable in Hong Kong because:

  • The taxpayer carried on one single business (i.e., the business of licensing the trademarks, whether in Japan or other locations), and some parts of its business operations (i.e., licensing operations regarding trademarks registered outside Japan) were conducted in Hong Kong.
  • The upfront payment and the 40% royalties were Hong Kong-sourced from Hong Kong because both the master license with the UK company and the sub-licenses with the Japanese companies were executed in Hong Kong. The fact that the trademarks were registered in Japan and only exploitable in Japan was irrelevant because the taxpayer’s licensing activities in Hong Kong, and not the business activities in Japan, produced the taxpayer’s profits.
  • The upfront payment was revenue (and not capital) in nature because the taxpayer did not transfer (1) any of its economic and contractual rights regarding the trademarks, or (2) 60% of the economic benefit it would otherwise have derived under the master license to the UK company. The fact that the payment may be capital in nature in the hands of the payee is irrelevant.

KPMG observation

The court’s holding that the source of royalty income from licensing and sub-licensing of intellectual property (IP) is the place(s) where the licensing and sub-licensing agreements are effected rather than the place of use of the IP is different from the international norm under income tax treaties which generally provide that the place of residence of the royalty payer (which generally is also the place of use of the IP) is regarded as the source state of the royalties.

Under the existing foreign-sourced income exemption (FSIE) in Hong Kong, a similar non-taxable claim on offshore royalty income received in Hong Kong by a Hong Kong entity within a multinational group will be available for royalties derived from a patent, or an IP similar to patent only, and subject to the fulfilment of the newly introduced nexus requirement. However, under the expanded FSIE regime (i.e., expanded to cover foreign-sourced gains from disposal of all types of assets), effective from 1 January 2024, an upfront payment received under a licensing or sub-licensing arrangement, even if foreign-sourced and capital in nature, may nevertheless be taxable if it represents an income from sale of a covered asset (which is widely defined to include any movable property and immovable property, and effectively means all assets in the laws of Hong Kong).

For more information contact a KPMG tax professional:

David Ling | davidxling@kpmg.com


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