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Super deduction of R&D expenses will become a permanent benefit for eligible companies

The preferential policy of pre-tax super deduction of R&D expenses will become a permanent benefit for eligible companies. According to an announcement from the Chinese authorities, the program will be extended indefinitely and will allow certain entities to deduct 200% of their Research & Development (R&D) cost.

In the months since the announcement, China’s State Tax Administration (STA) released a series of documents explaining how this policy will be implemented in 2023 and how eligible companies will be able to reduce their tax burden and increase capital flow.

The goal of this policy, which is part of a larger government initiative to foster science and tech development, is to support scientific and technological innovation. Companies that operate in industries on the negative list cannot access this tax benefit.

Beginning in September and October 2023, companies can request the super deduction for R&D expenses incurred in the first three quarters of the year.

The pre-tax super deduction of R&D expenses was first implemented in 2008 and has since continued to relax the scope of activity that is included in the policy and increased the ratio of the deduction for more types of companies.

In the fourth quarter of 2022, the government increased the deduction ratio from 75% to 100% for all types of companies. The ratio increase was initially rolled out exclusively for manufacturing enterprises in 2021 and later expanded to more sectors.

In an example offered by the STA, if a company incurs RMB 10 million in R&D expenses in 2023, and these expenses do not result in intangible assets and are recorded as current expenses, then the company can deduct 100 percent of the expenses incurred in addition to the pre-tax deduction of RMB 10 million that is already granted by law. The total deduction before tax would therefore amount to RMB 20 million.

R&D costs that lead to the creation of intangible assets, known as “capitalized R&D expenses”, can be amortized before tax at 200%. There is no time limit placed on when the intangible assets are formed, which means that the intangible assets can be created in one year and be amortized before tax at 200 percent of the cost in the following year.

Eligible companies must be a resident enterprise with sound accounting, audits, and collections, which is able to accurately collect R&D expenses; and must not be in one of the industries on the negative list, including tobacco manufacturing, accommodation and catering, wholesale and retail, real estate, leasing and business services, and entertainment industries.

Companies that meet these conditions can apply the super deduction policy, regardless of whether they have reported profits or losses in that year.

If a company is currently experiencing losses, then the application of the super deduction policy will result in an increase in losses, as under the policy, 200% of the total R&D expenses will be included in the balance sheet.

This increase in losses will be carried forward to the following five or 10 years to offset future profits, depending on the type of enterprise. This will reduce the taxable income, resulting in a further reduction to the overall tax burden and help the company’s cash flow.

To meet eligibility, R&D expenses must have been spent on “systematic activities with clear objectives that companies continue to carry out to acquire new scientific and technological knowledge, creatively apply new scientific and technological knowledge, or substantially improve technologies, products (or services), and processes.”

Activities such as routine upgrade of products and services, technical support, duplication or changes of existing products, market research, quality control, repair, and maintenance, among other, are not eligible for super deduction.

In addition to R&D activities by an enterprise itself, the R&D expenses incurred through commission, cooperation, centralized R&D, and other forms can also enjoy the additional deduction policy.

It varies depending on the jurisdiction how a company applies for the super deduction. Firms should use the directives that have been released by the tax authority in the jurisdiction in which they pay CIT (corporate Income tax).

To benefit from the R&D super deduction, companies must set up an auxiliary account specifically for the R&D expenses that are eligible, in accordance with each project. The company must then accurately collect and calculate the R&D expenses eligible for super deduction in the annual balance. If a company carries out multiple R&D activities in a given tax year, it must collect the R&D expenses according to the different projects.

Companies should calculate R&D expenses and production and operation expenses separately to determine the various expenses accurately and reasonably.

Enterprises must calculate the super deduction by themselves based on the actual R&D expenses incurred and fill out the preferential conditions in the corresponding line of the tax return.

Companies must also retain relevant materials for future reference but are not required to file them beforehand or receive prior approval.

The way to file the super deduction will depend on whether the company chooses to apply the super deduction during the provisional CIT payment period (in September or October) or the annual CIT filing period (between January and May), and whether they fill in the form manually or digitally.

For filings during the provisional CIT payment period, companies can register manually, write the name and discount amount of relevant preferential items under the “Deduction: tax-exempt income, deduction of income, super deduction”.

If filing digitally through the local e-tax website, a company can directly select the name of the corresponding preferential item in the drop-down menu and fill in the preferential amount.

In addition to declaring the super deduction in the relevant tax forms, companies must also fill in the Detailed Form of Research and Development Expenses Plus Deduction Preferences, which should then be kept for future reference.

If a company has utilized the super deduction during the September/October period, it must include the R&D expenses from the first three quarters that have been deducted, along with the R&D expenses of the final quarter when submitting their annual CIT filing in the first five months of the following year. By doing so, the company can fully benefit from the preferential policy and apply the super deduction to their R&D expenses for the entire year.

Enterprises should maintain updated records of their R&D expenses. This tax policy can contribute to lightening a company’s tax burden; however, the process can be difficult. Working with a local tax expert could help avoid mistakes and the misinterpretation of the regulations.

To learn more about our services in China, contact our Head of Business Advisory - Ms. Kristina Koehler-Coluccia at 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.


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