R&D super reduction zone – to be implemented on the 1st January 2016
Circular 119 was released on the 21st October. It significantly changes R&D deduction regulation by focusing on pre-additional deductions of R7D expenses. Most local and foreign firms will be positively impacted, expect for those that belong to industrial sectors or that practice activities falling in the scope of the negative list. Foreign firms and multinationals may now wonder on which basis a project will be deemed to meet R&D super deduction requirements.
Scope of eligibility for R&D expenses:
For non-intangibles, 50% tax deduction from the taxable income of the year is applicable. For intangibles, a pre-tax amortization must be calculated from 150% of the cost of the intangible assets.
Key improvements for foreign investors and multinationals:
Circular 119 enlarges the scope of eligibility of R&D deductible expenses thereby providing numerous business opportunities for investors.
Processes are now simpler:
- Additional accounts can now be used to capture relevant R&D expenses
- Loosening of registration requirements
- Retroactive 3 year tax benefit claim is now possible.
- The sharing method for the R&D expenses can be determined by the group centralizing high investments form different firms.
- In jointly developed projects, the relevant parties are now able to compute additional deduction respectively for the R&D expenses they made.
- Breakdown of expenses/invoices are no longer required from external parties for payments made to them.
The Negative List
Key implications for foreign investors and multinationals:
Resident firms must conduct proper accounting and are subject to verification from the tax authorities if the R&D expenses aren’t correctly computed. The prefectural level of authorities may intervene in the case of a disagreement. Investors and multinationals must bear in mind that they will be subject to regular checks and follow ups from the authorities. Indeed, 20% of the firms concerned will be audited on a regular basis.
R&D expenses must therefore comply with the Chinese financial requirements:
- Deductible R&D expenses must appear in subsidiary ledgers
- Deductible R&D expenses must be accurately computed and imputed in the current year
- Multiple deductible R&D expenses must be based on respective R&D projects
- R&D expenses must be separated from manufacturing and business expenses
A written agreement is no longer required between members of a corporate group for R&D expenses. However, it once was and previous versions can still be asked by the relevant tax authorities. Investors and multinationals must therefore carefully assess transfer pricing regulations when claiming R&D benefits within a corporate group. In addition, external R&D expenses to the group aren’t eligible for tax benefits. Only 80% of the amount will be allowed for additional deductions based on the arm’s length transactions principle.
New uncertainties for foreign investors and multinationals:
Three main areas of R&D expense deductibility remain unclear:
|R&D expenses links||Expenses linked to external parties||Costs linked to R&D activities|
|They must relate to activities but it is unclear whether they still must contribute to an actual development of technologies or processes.||No specifications were made on intellectual property ownership.||They are capped at 10% of total eligible R&D but nothing is said on the nature of those 10%.|
These innovative measures are essential to the development of foreign trade and investment in China since they embody the innovation capacity of the country. They will surely help China meet its new 6.8% growth target in a more effective and sustainable way. However, the negative list may slow down this trend since some industries remain excluded .Food innovation or new manufacturing technologies can therefore still be subject to normal taxation which is highly controversial. This reduces business opportunities although the impact should not be too visible on the economy since those incentive policies meet the international standards. Foreign investors and multinationals should now carefully assess those new measures in terms of innovation and growth prospects.