Technology innovation has become in the past few years a major priority for the Chinese government, whose goal is to transition the country from the manufacturer of the world to a producer of high-end technology. As part of this initiative, China’s State Council recently announced the renewal of a range of supportive tax and fee policies, including the tax deduction for R&D expenses.
The Ministry of Finance and the State Taxation Administration published announcements for the implementation of these policies. Upon the extension, the temporary expansion of the super deduction of research and development (R&D) expenses to general enterprises has become a long-term policy.
The continuing trade tensions with the United States have also played an important role in China’s intention to support a wide range of segments from chips and other key input technologies and products. This has resulted in the technology sector becoming a strategic focus for the government.
At the same time, authorities are encouraging targeted investments in R&D and technological innovation.
One of the most important incentives to encourage innovation in China is the High and new technology enterprises (HNTEs) treatment, which reduces a qualified taxpayer’s applicable corporate income tax (CIT) rate from the standard 25 percent to 15 percent.
Besides the lower CIT rate, the losses of qualified HNTE that occur five years prior to the year in which they become qualified and have not been made up – shall be allowed to be carried forward to subsequent years to be made up, to a maximum of 10 years. For normal enterprises, the maximum carry-forward period is only five years.
HNTEs can enjoy a one-off pre-tax deduction for equipment and instruments (fixed assets other than houses and buildings) newly purchased during the period from October 1, 2022, to December 31, 2022, and such deduction is allowed to be 100 percent weighted.
To qualify for HNTE status, a company must meet all the following criteria:
Be registered in China (not including Hong Kong, Macao, and Taiwan) for at least one year.
Owns the intellectual property (IP) right for the core technology of its key products or services through independent R&D, transfer, donation, merger, and acquisition, etc.
The core technology of the enterprise’s key products (services) falls within the scope of the areas outlined in the Regions of Advanced Technologies Strongly Supported by the State, which covers more than 200 categories of technologies, products, and services in eight large technological areas.
The enterprise’s technical personnel engaging in R&D and relevant technological innovation activities constitute more than 10 percent of the total number of employees in the current year.
In the last three financial years (the actual operational period for newly established ones), R&D expenditure should account for a certain percentage of the enterprise’s total sales revenue in the same period:
No less than five percent if the latest annual sales revenue is below RMB 50 million (inclusive, approx. US$7.7 million);
No less than four percent if the latest annual sales revenue is below between RMB 50 million (approx. US$7.7 million) and RMB 200 million (inclusive, approx. US$30.8 million)
No less than three percent if the latest annual sales income is upwards of RMB 200 million (approx. US$30.8 million).
R&D expenditure within China is not less than 60 percent of the total R&D expenses.
The ratio of income from high-tech related operations against total income is not lower than 60 percent in the current period.
The enterprise’s innovation capacity evaluation satisfies the corresponding requirements.
The enterprise has no record of major safety or quality incidents or serious environmental violations during the year preceding the application.
Companies need to submit all necessary documents during the application process and pass several assessments to be certified as HNTEs.
The application is processed by the HNTE accreditation authority, formed by the provincial-level science and technology administration and management authority, together with the provincial level finance and tax authorities. The HNTE accreditation authority is led by the Leading Team for Administration of Accreditation of HNTE Nationwide (National HNTE Leading Team).
If everything is in order, the process takes approximately 60 working days. The qualifications of an accredited HNTE are valid for three years from the date of issuance of the HNTE Certificate.
Once the accreditation is granted, a company must present information on its IP, technical personnel, R&D expenses, operating income, etc. of the preceding year through the Network for Administration of Accreditation of HNTE before May 31 every year.
Upon examination by the authorities, and the company complies with the accreditation criteria, there shall be no change to its HNTE qualification. Failure to report a major change in relation to the accreditation criteria or failing to submit annual reports on development status for two years cumulatively will cause the revocation of the HNTE qualification.
If an accredited HNTE is found to be non-compliant, authorities may request a re-examination. When non-compliance is confirmed, the HNTE qualification will be cancelled, and the tax authorities will recover tax incentives claimed by the enterprise for the year from which it becomes delinquent.
Companies based in Beijing can benefit from 2021, from lower qualifications and simplified procedures for HNTE status and submit documents online. The National HNTE Leading Team Office will approve the application soon after the application has undergone expert assessment and review by the HNTE accreditation authority.
A Technology-based small- and medium-sized enterprise (TSME) falls under the scope of SMEs that conduct technology-based activities, which consists of scientific and technological personnel involved in R&D activities and obtain IP for creating high-tech products or services.
As TSME, the losses of the enterprise occurred five years before the year in which they become qualified and have not been made up shall be allowed to be carried forward to subsequent years to be made up, and the maximum carry-forward period is up to 10 years.
Local governments may treat TSMEs as HNTE candidates and provide other incentives to support their growth.
TSMEs can enjoy super deduction on their R&D expenses. Starting from January 1, 2022, if the R&D expenses of TSMEs do not form intangible assets and are included in the current profits and losses, on the basis of actual deduction, an additional 100 percent of such R&D expenses could be deducted from the taxable income amount; if the R&D expenses have formed intangible assets, they can be amortized before CIT at 200 percent of the actual cost of intangible assets.
TSME status requires a certain number of total employees, annual sales revenue amount, and total assets. While HNTE requires that the core technology of the enterprise’s key products (or services) is encouraged by the state and the ratio of income from high-tech related operations against total income is not lower than 60 percent in the current period, TSME has no such requirements. In general, it is easier to apply for the TSME status for smaller businesses.
A TSME shall meet all the following requirements:
Be registered in China (excluding Hong Kong, Macao, and Taiwan).
The total number of its employees shall be no more than 500, and either its annual sales income or its total asset amount shall be no more than RMB 200 million (approx. US$30.8 million).
The products and services provided by it are not included in the prohibited, restricted, or eliminated categories prescribed by the State.
There is no occurrence of major safety or major quality accidents and serious violation of environmental law or serious dishonesty in scientific research in the previous year of filling and the present year, and it is not included in the list of enterprises with abnormal operations or the list of enterprises with serious dishonest behaviors in violations of the law.
Its comprehensive evaluation score is not less than 60 points in terms of the evaluation indicators for TSMEs, with the score on scientific and technical staff indicator more than 0 point.
The evaluation indicators for TSMEs, to be specific, include such categories as scientific and technical staff, R&D investment, as well as scientific and technological achievement, with a total score of 100.
Certain enterprises could be exempted from the scoring requirements, including:
Enterprise that holds an HNTE certificate that has not expired yet.
Enterprise that has won a state-level science and technology award within the past five years and ranked in the top three.
Enterprise that has a recognized R&D body at provincial or ministerial level or above.
Enterprise has taken the lead in the development of international standards, national standards, or industry standards within the past five years.
As part of the application process, companies may carry out a self-evaluation in accordance with the Measures for Evaluating TSME and fill in the enterprise information on the “National Information Service Platform for TSMEs” (http://www.innofund.gov.cn/, the TSME Service Platform).
A confirmation can be expected within five working days. Enterprises with complete information shall be publicized on the Service Platform for 10 working days, and if there is no public objection, they can be included in the “National Information Database for TSMEs” and get a TSME Registration Number, valid from the publicity date till December 31 of the same year.
Any changes to the company’s name or criteria should be entered on the TSME Service Platform within three months.
In addition to HNTE and TSME, Advanced technology service enterprises (ATSEs) status is another innovation tax policy in China to encourage the provision of information technology outsourcing (ITO), business process outsourcing (BPO), or knowledge process outsourcing (KPO) services to overseas entities.
The ATSE incentive reduces the CIT rate for a qualified ATSE from the standard 25 percent to 15 percent, like HNTE.
ATSEs are subject to zero value added tax (VAT) rate for the provision of certain offshore services, which means they can be exempted from the corresponding VAT payment where the simple tax computation method is applicable, or they can enjoy the tax exemption, credit, and refund method where VAT general tax computation method is applicable.
To be qualified as an ATSE, an enterprise must fulfill all the following requirements:
Be registered in China (excluding Hong Kong, Macao, and Taiwan).
Be engaged in one or more categories of advanced technology service businesses listed in the Scopes of Recognized Advanced Technology Service Businesses (for Trial Implementation, hereinafter, the Scope) and adopt advanced technologies or has strong research and development capabilities.
More than 50 percent of its staff hold a college degree or above.
More than 50 percent of its total revenue in the current year comes from the revenue generated from the advanced technology service businesses listed in the Scope.
Revenue generated from offshore service outsourcing business is not less than 35 percent of total revenue in the current year.
“Revenue generated from offshore service outsourcing business” refers to the revenue generated by an enterprise from overseas entities by providing the ITO, BPO, KPO services specified in the Scope for the overseas entities by the enterprise itself or by other enterprises directly subcontracted by the enterprise under the entrustment contract signed between the enterprise and the overseas entities.
Companies interested in ATSE status must present their application at the department of science and technology at the provincial level and submit the necessary documents. The process takes about 60 working days, and the certification is valid for three years.
To encourage innovation, China permits the super deduction of the enterprise’s R&D expenses, besides the lower CIT rates and loss carry-forward policy.
R&D expenses benefit from the following preferential policies:
For manufacturing enterprises (except tobacco), if the R&D expenses do not form intangible assets and are included in the current profits and losses, on the basis of actual deduction, an additional 100 percent of such R&D expenses could be deducted from the taxable income amount; if the R&D expenses have formed intangible assets, they can be amortized before CIT at 200 percent of the actual cost of intangible assets.
For TSMEs, if the R&D expenses do not form intangible assets and are included in the current profits and losses, on the basis of actual deduction, an additional 100 percent of such R&D expenses could be deducted from the taxable income amount; if the R&D expenses have formed intangible assets, they can be amortized before CIT at 200 percent of the actual cost of intangible assets.
For other enterprises (except tobacco, lodging and catering, wholesale and retail, real estate, leasing and commercial services, and entertainment), starting from January 1, 2023, if the R&D expenses do not form intangible assets and are included in the current profits and losses, on the basis of actual deduction, an additional 100 percent of such R&D expenses could be deducted from the taxable income amount; if the R&D expenses have formed intangible assets, they can be amortized before CIT at 200 percent of the actual cost of intangible assets.
The temporary expansion would now be extended and improved to become a long-term policy, which proves the Chinese government’s commitment to support tech innovation.
For expenses incurred in R&D activities entrusted by enterprises to external institutions or individuals within China, 80 percent of the actual amount shall be included in the entrusting party’s R&D expenses and allowed for the additional deduction, and the entrusting party shall not make further additional deductions.
For expenses incurred in R&D activities entrusted by enterprises to external institutions (exclude individuals) outside China, 80 percent of the actual expenses shall be itemized as the entrusting party’s commissioned overseas R&D expenses. The commissioned overseas R&D expenses, to the extent of two-thirds of the domestic R&D expenses, are eligible for the pre-tax additional deduction.
To enjoy the R&D expenses super deduction policy, enterprises must self-evaluate and retain relevant documents for potential inspection of the tax bureau for 10 years. R&D activities entrusted to overseas institutions are subject to additional documentation requirements.
These incentives can reduce a company’s tax burden substantially. However, documentation requirements and application procedures can be difficult. Professional assistance might be the best option for firms not familiar with the Chinese tax system.
To learn more about our services in China, contact our Head of Business Advisory - Ms. Kristina Koehler-Coluccia at firstname.lastname@example.org.
DISCLAIMER: All information in this article is verified to the best of our ability and is assumed to be correct at time of release; however, Woodburn Accountants & Advisors does not accept responsibility for any losses arising from reliance on the information provided within. The information provided is for general guidance and does not replace specialized advice.