A tougher road ahead

The tax incentive has attracted tens of thousands of companies to apply for HNTE certification, including both domestic companies and Chinese subsidiaries of foreign enterprises. By the end of 2008, 15,541 companies had been granted HNTE status. Because an HNTE certificate must be renewed every three years, companies certified in 2008 will have to apply for renewal of their HNTE certificate in 2011.

Toughened scrutiny of HNTE certification

As the first round of HNTE certificate renewal occurs in 2011, not all HNTE certification authorities at the provincial level are equipped with the rules and regulations needed for the task. For example, the Shanghai High and New Technology Enterprise Certification Office (上海市高新技术企业认定办公室), a local certification office with one of the heaviest workloads, appears to have not yet decided whether it will use the same grading system for renewal as it did to evaluate first time applicants.

Despite the uncertainties surrounding the renewal process, it appears that HNTEs will face bigger hurdles in seeking renewal than they did in seeking certification the first time. The local certification offices recently have been criticised by scholars and observers for issuing too many HNTE certificates. The certification offices' past liberal approach to HNTE certification may be due to their unfamiliarity with the relevant rules and regulations, to local governments' interest in having more HNTEs in their territories, and to their own efforts to attract more companies to apply for HNTE status.

Recently, all signs indicate that the time for being easily granted HNTE certificates may be over. In an article published by New Century Weekly (新世纪周刊), an official from the Ministry of Science and Technology, who spoke on the condition of anonymity, claimed at least half of the HNTEs obtained their HNTE status through fraud or misrepresentation. Such a high-profile claim by a government official is unusual in China and may signal the central government's revised approach in toughening up the approval process for HNTE certificates. In addition, the certification authorities at the provincial level may also prefer to be more stringent in granting HNTE certificates. In 2009 the National Audit Office issued an audit report as to 116 certified HNTEs in various parts of the country finding that 73% of them did not actually meet HNTE requirements. The National Audit Office has indicated that it may conduct a similar round of audits in 2010.

Several issues concerning HNTE certification

Ownership of intellectual property rights

A company applying for HNTE certification can earn points in the intellectual property rights category by either owning or having an exclusive global licence to use intellectual property. Many HNTEs, especially those controlled by foreign companies, have earned those points by relying on a licence to use intellectual property owned by their foreign parent company. Nonetheless, the local certification authorities have expressed their preference towards ownership rights to licence rights. The authorities appear to believe that ownership, more than an exclusive global licence, indicates that the tax savings that accompany HNTE status have benefited or will benefit the applicant in the areas of technology research and commercialisation.

This preference does not necessarily require a foreign company with a Chinese subsidiary seeking HNTE certification to transfer ownership rights of its intellectual property to the subsidiary. Rather, the foreign parent company should help the subsidiary obtain intellectual property rights of its own in China, such as patent rights. As filing patent applications first in China benefits the applicant for any invention or utility model completed in China due to the PRC Patent Law's (中华人民共和国专利法) requirement for a national security review before the invention or utility model can become the subject of a foreign patent application, the foreign companies may wish to encourage their Chinese subsidiaries to file for Chinese patents on their own inventions before deciding on foreign filing strategies.

Intellectual property protected in China

For the purpose of evaluating the intellectual property of a company applying for an HNTE certificate, certification authorities usually only recognise those rights that are protected by Chinese laws. In addition, the Guidelines provide that the certification authorities may verify information concerning intellectual property rights by checking with the relevant government agencies, such as the State Intellectual Property Office (Sipo). Since these government agencies do not keep records about most foreign intellectual property rights, the part of the licensing arrangement involving only foreign intellectual property rights most likely cannot be verified by the certification authorities. Therefore, an applicant for HNTE certification needs to show that its core technology is protected by intellectual property rights that are enforceable in China and identifiable in the databases of the relevant government agencies.

Acquiring ownership of intellectual property rights

Under the relevant Chinese laws, there are essentially three ways for an enterprise to acquire ownership of intellectual property rights: as a transferee in a transfer of intellectual property rights, as a researcher or developer of technology, and as a commissioning party in a commissioning arrangement. All three methods not only allow the enterprise to acquire intellectual property rights, they may also allow the enterprise to devote part of its spending to research and development, which is also required under the Administrative Measures.

In practice, spending by Chinese subsidiaries over a certain threshold may have to be approved by their foreign parent companies. Because such spending may potentially increase the Chinese subsidiaries' market competitiveness, lower their tax burden, and help them provide better products or services, foreign parent companies should encourage their Chinese subsidiaries to pursue ownership of intellectual property rights and not insist on resorting to exclusive global licences for the purpose of HNTE certification.

Licenser's partial retention of patent rights

In some cases, a Chinese subsidiary is able to obtain exclusive global licence over the rights to exploit certain intellectual property from its foreign parent company. However this comes with a caveat: the licence only covers a limited number of ways to exploit the intellectual property, not all of them. For example, the parent company may grant an exclusive global licence to its Chinese subsidiary to manufacture a certain patented product, but not to sell it.

Because such a division of intellectual property rights between licenser and licensee is not explicitly prohibited by the state or local HNTE regulations, it is difficult to know for certain whether it would hinder a company's efforts to receive an HNTE certificate or renewal. However, given the recent tougher climate for HNTE certification, it is possible that the certification authorities would insist on the licenser completely relinquishing its control of the intellectual property. A licence agreement with explicit limitations on the licensee's right to exploit the licensed intellectual property thus may not pass the certification authorities' scrutiny.

If it is necessary for a foreign parent (licenser) or third party to exploit particular intellectual property rights, the Chinese exclusive global licensee may enter into a sublicence agreement with the foreign parent or third party. A sublicence agreement between the Chinese licensee and a third party would enable the third party to exploit the intellectual property rights to the extent contemplated by the foreign parent and the Chinese licensee. However, a sublicence granted back to the foreign parent may be viewed as an end run around the requirement for worldwide exclusive licence and thus face the danger of being rejected by the certification authorities.

Commercialisation of technologies

An HNTE applicant is also required to show that it has put certain technologies to commercial use. Under the Guidelines, the technologies for the purpose of commercialisation do not necessarily have to be protected by intellectual property rights that the applicant owns or holds an exclusive global licence to. The applicant can put a technology to commercialise use as long as it has the legitimate right of exploitation.

Certification authorities are likely to evaluate an applicant's level of technology commercialisation by checking 1) whether the applicant has introduced any new products or services in connection with a technology in the past three years; (2) whether a competent third party is able to certify that a technology has been commercialised; or (3) whether the applicant has benefitted commercially from the transfer or licence of a technology to another party.

A final note

Almost three years into the tax benefits for HNTEs, the review of applications for HNTE certificates appears to be getting more strict. Although it is hard to predict how certification authorities will process applications, a company seeking an HNTE certificate may wish to prepare itself for the review process by paying attention to key issues such as intellectual property rights and technology commercialisation.

Fang Qi, Fangda Partners, Beijing