Tax deductibles of R&D expenditures in China

The “Law of Enterprise Income Tax” and its “Implementing Regulations” provide that the R&D expenditures incurred for the purpose to develop new technologies, new products and new crafts, can be subject to 50% more additional deduction after being deducted in full amount in light of actual situation.

According to the decision of the State Council, the State Administration of Taxation, the Ministry of Finance, and the Ministry of Science and Technology in Cai Shui [2015] No.119 (hereinafter “Document No. 119”) it was announced to extend the scope of R&D activities and expenditures which are subject to additional deduction policy, and raise some new management requirements. The new document will be effective since January 1, 2016.

(1) To relax the limit of industries enjoying additional deduction policy:
In 2008, Guo Shui Fa [2008] No.116 (hereinafter “Document No. 116”) provided that in order to enjoy additional tax deduction policies a firm should be engaged in key industries as listed in “Hi-tech Sectors with Primary State Support” and the “Guideline of the Latest Key Priority Developmental Areas in the High Technology Industry”.
Document No. 119 is applying the principle of a “negative list”: Except seven industries, all enterprises’ R&D activities may enjoy additional deduction policy. These include:

– Tobacco manufacturing;
– Accommodation and catering industry;
– Wholesales and Retail industries;
– Real Estate Industry;
– Leasing and Business service industry;
– Entertainment industry
– Other industries specified by the Ministry of Finance and the State Administration of Taxation.

(2) Creative design undertakings:
The development of multimedia, animation and game software; digital animation, design and production of digital anime and game design; building construction engineering design (green building evaluation criteria for Samsung); landscape architecture projects; industrial design, multimedia design, anime and its derivatives design, and model design.

(3) What can be declared as R&D expenses:
Comparing directly to Document No. 116, the new policy Document No. 119 includes an increase of labor costs for external R&D personnel, as well as in inspection fees for trial products. Other expenses directly related to R&D as long as they do not exceed 10% of total R&D expenses include technical books and data translation, expert advice fees, high-tech R&D insurance premiums, expenses for retrieval, analysis, evaluation, appraisal, assessment, acceptance, registration fees for patents, travel expenses, conference fees, etc..
At the same time the four categories: cost of depreciation; amortization of intangible assets; mold development and
manufacturing costs are able to enjoy accelerated depreciation as long as they are still connected with R&D relevant activities even if it is also used towards marketing, sales, or backoffice functions.

(4) Some limits to R&D activities conducted by external agencies lifted:
According to Document No. 119, R&D activities entrusted to non-affiliated companies, do not require providing details of expenditures of the project the same as this was stipulated under Document 116 in 2008. Instead of that, expenditures can be included in the R&D expenses of the enterprise at 80% of the actual amount incurred and be calculated for extra deduction
(However, if affiliated companies are entrusted with such projects, details are still required.)

(5) Deadlines for applicable extra deductions:
Document No. 119 allows the filing procedures with a retroactive effect (at most three years), for all those enterprises who conform to the extra deduction conditions.

(6) Changes in accounting requirements:
Document No. 116 requires that enterprises must carry out administration of special accounts for R&D expenditures.

The new Document No. 119 provides that enterprises shall treat R&D expenses in accordance with the requirements of national financial and accounting systems. Meanwhile they shall set up assistant accounts for those R&D expenses. According to our understanding, applying the new document, enterprises do not need to set up a separate special accounting book outside of their accounting system for R&D expenses, but they shall set up detailed sub-accounts under the R&D ledger. Therefore, to some extent, the burden of enterprises will be eased.

(7) To strengthen the follow-up management:
The tax authorities will carry out regular inspection, with the annual inspection rate being not less than 20%.

Our observations and suggestions
The No. 119 document expands the scope of R&D additional deduction policy. We anticipate that the filing procedure will also be further simplified. More enterprises will benefit from the policy.

But we want to draw the attention of our honored readers to the point that the tax compliance risk will also be increased due to the post administration of tax authorities. While actively striving for tax preference, enterprises shall collect expenditures and prepare documents, according to the relevant regulations, in order to meet the requirements of examination in the future.

As always, if you need: our professional consulting team and personnel in Shanghai and Taicang can offer you consulting service for both of the above mentioned policies and practices.
German, English, Chinese: Ms Katharina Siegrist, katharina.siegrist@ecovis.cn
English, Chinese: Ms Pingwen Hu, pingwen.hu@ecovis.cn