The regulatory perspective

China's first regulation for foreign-invested research and development (R&D) centers was promulgated by the Ministry of Foreign Trade and Economic Cooperation in 2000, the Circular on Questions Relating to Foreign Investors Investing in and Establishing Research and Development Centers (R&D Circular), to encourage the investment and establishment of China-based R&D centers. Together with the R&D Circular, authorities including the General Administration of Customs and State Administration of Taxation further issued a series of state regulations for facilitating the purchase of R&D equipment, tax reliefs and other benefits to promote the policy.

Scope of R&D activities

The scope of activities qualifying the R&D center regime broadly covers the research and experimental development for natural sciences and related scientific and technological fields, as well as pilot experiments supporting such activities. These may include fundamental research, product application research, high technology research and research for public welfare.

The R&D Circular further sets out activities excluded from a qualified R&D center: (i) any research subject that is categorized as “prohibited projects” under the Foreign Investment Industrial Guidance Catalogue promulgated by the National Development and Reform Commission (NDRC) and Ministry of Commerce (MOFCOM); (ii) trading of technology that aren't results generated by the R&D center; and (iii) production activities other than pilot production for experimental purposes. Further, an R&D facility that purports to provide training, or one called a training center, may not apply for recognition as an R&D center according to current regulations.

Qualifying applicants

Foreign-invested R&D centers may take the form of a foreign-invested enterprise (FIE) including a wholly foreign-owned enterprise (WFOE) and joint venture (JV), as well as an internal department or branch office of an FIE. In each case, a China-based FIE must be set up to be recognized as an R&D center. Investors could either establish a center by either using a newly set-up FIE entity or by appointing a branch office or internal department of an existing entity. If investors go with the latter option to apply for recognition, separate accounting systems for the appointed R&D division must be adopted (as required by MOFCOM) and the involved entity must have expanded its business scope to include “R&D” or “development”.

R&D contributions

China currently has no exhaustive list for activities that support the recognition of an R&D center. Like most of the country's schemes for promoting foreign investment, regulations mainly focus on, and require applicants to submit details regarding, the feasibility study, investment intensity and availability of a qualified workforce.

1. The R&D center must have a clear focus of its target research and development fields and specific plans for projects. Notably, the authorities also implied a practice that the technology must be “advanced” when the applicant presents its feasibility study report for scrutiny. Applicants must have sufficient fixed premises, facilities, equipment and other conditions necessary for carrying out the contemplated scientific research.
2. The investment amount contributed to R&D activities must be at least US$2 million.
3. The R&D center must employ qualified management and professional research staff, of which 80% of those directly involved in R&D activities must fulfil educational criteria of at least having undergraduate degrees and diplomas.

Administrative procedures

The following sets out the key steps for establishing an R&D center under the current policies:

1. Forming the China entity for the R&D center

As the first step, foreign investors must apply for the incorporation of an FIE in accordance with the PRC Company Law, FIE regulations and the Foreign Investment Industrial Guidance Catalogue (or the Special Administrative Measures for Foreign Investment Access in Pilot Free Trade Zones (Negative List) if the project is within the Free Trade Zones (FTZs)). The FIE must obtain an Approval Certificate (or Filing Form in the FTZs) by MOFCOM and a Business License registered with the Administration for Industry and Commerce. For applications by an internal department or branch office of an existing FIE, the applicant must expand its business scope and file the revised business and updated bylaws/joint venture contracts with the original approving MOFCOM counterpart or, if it is under certain restricted industries, the provincial level MOFCOM.

2. Approval of environmental impact assessment

The applicant must prepare and submit an environmental impact assessment report and to the Ministry of Environmental Protection (MEP) for examination and approval. The report should include details of the construction design and planning, set up of laboratories, discharge and control of pollution, planning of environmental protection facilities, risk control and other factors as required by the MEP.

3. MOFCOM approval and recognition

Following the fulfilment of environmental criteria and the MEP's approval, the applicant must prepare an application report as well as a feasibility report to MOFCOM for establishing a foreign-invested R&D center. These documents must provide a detailed description of the planned R&D activities to be launched within China, scientific research facilities and workforce to be introduced for the project, the scientific research equipment to be used, as well as research funds and a financial analysis.

4. Application for tax relief and preferential treatment

A recognized R&D center is eligible for tax relief for certain imported R&D equipment as well as other preferential treatment according to the R&D Circular and certain local-level programs. Taking tax relief as an example, the applicant must further provide a list of equipment to be imported in line with its R&D investment plans for MOFCOM review and for prior filing to be confirmed by the customs authority.


Alan Zhou and Robert Sun, Global Law Office, Shanghai

The commercial/IP perspective

To encourage the growth of domestic innovation and the cultivation of local talents, China has introduced various incentives in relation to R&D. The incentives available to qualified R&D entities include reduced enterprise income tax rates, exemptions from customs duties for equipment imports, additional tax deductions for expenditures incurred in relation to the activities and tax exemptions for profits derived from qualified technology transfers. These incentives, along with the available pool of local talent and the relatively lower costs, have encouraged many domestic companies as well as multinationals to set up global, regional or country-specific R&D facilities in China over the past decade or so.

Notwithstanding these advantages, it is critical for companies with R&D operations to ensure that the investments made with respect to R&D activities, intellectual property (IP) portfolios and long-term technology strategy are properly protected.

Human resources

Human talent is the lifeblood of any R&D organization. Ensuring that a robust human resources structure is in place to govern the rights and obligations of individual employees is therefore critical. Employers may assert rights over service inventions created up to a year after the departure of an employee inventor, which is likely to have an impact on the company with respect to employees that are joining or leaving the organization. Companies may consider conducting due diligence with respect to incoming inventor employees to ensure that no liabilities relating to any past inventions, non-competition, non-solicitation or confidentiality covenants are carried over when they join. It is also worth ensuring that employment contracts, invention assignment agreements, company manuals and other relevant documents have incorporated all pertinent provisions concerning the rights and obligations of the entity and the inventor employees with respect to such issues.

Service inventions

The “products” created by the R&D centers are primarily innovations invented by the employees as part of their R&D activities, generally referred to as “service inventions”. To ensure that a company can achieve the desired rate of return from its investments in the R&D and to protect the IP rights underlying these service inventions, it would be prudent to establish a comprehensive scheme for regulating the development, protection and exploitation of such inventions. It is also important to establish an equitable inventor reward and remuneration program with clear guidelines accompanied by a justifiable valuation scheme that takes into account the operational costs (salaries, operation of the facility, materials, etc.) incurred by the company, as well as the economic benefits derived from each invention and each individual inventor's contribution to that invention.

Intellectual property

IP is a key asset of any company and should be properly developed, maintained and protected. The company's internal controls with respect to IP protection should be reviewed to determine whether adequate protective measures have been instituted. These controls should include conducting an IP audit to determine the existing IP assets and to identify the strengths and weaknesses of the company's IP portfolio; formulating an IP development and procurement strategy to track market trends in the industry, identify patents which would pose a threat to the company's R&D and business operations and determine potential areas of innovation for future R&D projects and which inventions should be patented or procured from third parties.

The company should also have guidelines on how the IP may be utilized as part of the business strategy. These should include, but not be limited to, standard negotiation terms for technology licenses and transfers to third parties, with rules and approval processes for deviations on these terms. An IP enforcement strategy that takes into account the company's business strategy as well as its IP position from both defensive and offensive perspectives should be set in place.

Confidentiality and trade secrets

Unlike patents and other registrable IP, trade secrets tend to be invisible but important elements of the company's IP portfolio. In order for corporate information to be protected as a trade secret, the information must not be known to the public, be capable of deriving economic benefits and of practical use to the company and be protected internally as trade secrets via reasonable confidentiality measures.

To ensure that its trade secrets are properly protected, the company should institute a system that:

• classifies trade secrets based on the level of sensitivity;
• incorporates technical and other measures to secure them against unauthorized access; and
• restricts access to key trusted employees on a strict need-to-know basis.

It would also be prudent to track and record what confidential information has been disclosed and to whom, with acknowledgement forms signed by recipients.

Pushing forward with innovation

As of 2014, almost 1600 FIEs have set up R&D departments or organizations in China, taking advantage of the more than 700 million college graduates that China churns out per year. The majority of these R&D facilities appear to be wholly foreign-owned enterprises, because there does not appear to be any significant advantage in setting up joint ventures. However, there may be certain intangible advantages to having domestic participation, for example, if the local partner has sufficient clout such that it is able to ensure access to special government subsidies, qualify for certain incentives earmarked for domestic innovation or provide advantages when bidding for government procurement projects, etc.

According to the statistics issued by the Ministry of Science and Technology, the total investments in R&D in China was projected to reach Rmb1.34 trillion, with enterprise expenditures making up more than 76% of this amount. In 2014, R&D made up 2.1% of China's GDP, and the total number of full-time R&D personnel in China was projected to reach 3.8 million man-years, ranking highest in the world. The government incentives and business advantages offered by China have made it one of the most attractive destinations for R&D investment. China has become a key global center for innovation, and that is not expected to change anytime soon.


Grace Chen, Covington & Burling, Beijing