R&D tax breaks ease corporate burdens

It moves away from the traditional positive remuneration approach, which involved a tedious process of having to pour over a long eligibility list and often requiring the help of tax professionals. The new system is much simpler as it employs the negative list method, which excludes only six items: tobacco, hotel and restaurants, retail and distribution, real estate, leasing and entertainment.

While the old regime focused on what the specific R&D activity was and whether requirements were met, the government has flipped the system upside down, said Larry Sussman of O'Melveny & Myers. “Now as long as you aren't on the negative list, anything related to R&D is completely deductible,” he said.

Negotiations with tax authority

Sussman added that the Circular is a positive result of much lobbying and complaints: “This super deduction has always been a headache for most taxpayers as it frequently gets denied or not approved in various ways in practice.” He added he has dealt with a number of matters in Shanghai where claims are frequently rejected, as well as similar problems in Chengdu.

MWE China Law Offices' Hu also said disputes between the authority and taxpayers were common in all parts of China. “In most cases, both parties would not reach a consensus on whether certain items were eligible, which often discouraged companies from using the system.”

Practitioners have raised the question of how the new benefits will play out in practice as the tax break can seriously dent the revenue of local governments. Sussman said it is possible negotiation will continue to play a big role.

Hu, however, said: “the rules are very clear for the authorities to enforce so they don't have much room for excuses or objections.” The purpose of the Circular is to encourage enterprises to pour more money into R&D and the initiative comes from the top, he added.

Theoretically, parties can appeal a rejection and, if the higher level tax authority does not object to its subordinate's decision, they can take the matter to court. But no taxpayers dare do this in China, Hu said, as they want to maintain good relationships with the regulators.

Outsourcing and retroactive effect

Most clients will try to take advantage of the new provision that allows for the deduction of outsourced expenses, such as those for hiring a third party to do R&D and for consultancy fees, said Sussman. Companies seeking super deductions for these will have to show clearly how the outsourcing is directly related to the core research they are conducting in-house.

The Circular also provides a retroactive effect in allowing companies to go back three years to claim deductions.

It is important for firms to review all of these regulations and benefits that they can take advantage of, said Hu, adding that although compliance burdens have been reduced, failing to do things correctly may lead to a heavier workload in later stages.

The R&D tax boost timeline:

The Measures for the Administration of the Pre-tax Deduction of the Research and Development Expenses of Enterprises (Trial Implementation) (Circular 116), issued on December 10 2008, first defined what qualified as R&D activities and eligible deductions, and detailed the necessary application materials and filing procedures. It provided eight categories of claimable expenses directly related to R&D:

• Design fees for new products, expenses for creating procedures for new skills, books, information, translation fees
• Cost of materials, fuel and power
• Salaries, wages, bonuses and allowances for R&D employees
• Depreciation expenses or rental tools for equipment
• Amortization expenses of intangible assets like software, patents and non-patented tech
• Development and manufacturing costs of molds and process equipment exclusively used for testing and trials
• Costs for on-site testing of technology for prospecting and exploitation
• Costs for verification, assessment and inspection of R&D results

From January 2010, high-tech enterprises approved and registered in Beijing's Zhong Guan Cun Science and Technology Park were able to enjoy pre-tax super deduction for five more items:

• Basic pension fund, housing funding and insurance for medical, work-related injury, unemployment and maternity contributed by a company for its R&D employees
• Costs of operational maintenance, adjustment, testing and repair of tools and equipment
• Cost of samples, prototypes that are not fixed assets and expenses for general testing
• Cost of clinical tests of new drugs
• Certification costs for results

And, from January 1 2012 to December 31 2014, high-tech companies in several more pilot zones were eligible for the above.

The Circular on Policy Issues Relevant to the Pre-tax Super-deduction of Research and Development Expenses (Circular 70), issued on September 29 2013, then applied these additional deductible expenses nationwide. The benefits were no longer limited to high-tech and select regions. (See this article for a detailed background of these regulations.)

This puts into perspective how the Circular issued this month, which abolished such criteria to make all R&D-related expenses deductible and introduced a negative list, is a big step forward.

It is in line with the wider trend of China's approach of adopting negative lists to replace often complex procedures, as most recently seen in those for investment access and foreign exchange, to move toward a simpler and more transparent regulatory regime.

By Katherine Jo

China has issued new rules that simplify R&D accounting for companies and substantially increase the scope of deductible expenses, in an effort to encourage more research and innovation in the country.

These were part of the Circular on Improving the Policy of Pre-tax Super-deduction of Research and Development Expenses (Circular), jointly issued by the Ministry of Finance, State Administration of Taxation and Ministry of Science and Technology on November 2 2015.

“The new scheme eases the compliance burden, as R&D companies no longer need to apply for preferential tax treatment,” said Lawrence Hu of MWE China Law Offices.

Under the old rules, companies had to compile a specialized report to book all relevant expenses to show and get approval from the tax authority. Now they just need to identify the phases in their current accounts and file for deductions, he said.

Negative List

The Circular offers a significantly expanded scope of deductible expenses related to R&D.

It moves away from the traditional positive remuneration approach, which involved a tedious process of having to pour over a long eligibility list and often requiring the help of tax professionals. The new system is much simpler as it employs the negative list method, which excludes only six items: tobacco, hotel and restaurants, retail and distribution, real estate, leasing and entertainment.

While the old regime focused on what the specific R&D activity was and whether requirements were met, the government has flipped the system upside down, said Larry Sussman of O'Melveny & Myers. “Now as long as you aren't on the negative list, anything related to R&D is completely deductible,” he said.

Negotiations with tax authority

Sussman added that the Circular is a positive result of much lobbying and complaints: “This super deduction has always been a headache for most taxpayers as it frequently gets denied or not approved in various ways in practice.” He added he has dealt with a number of matters in Shanghai where claims are frequently rejected, as well as similar problems in Chengdu.

MWE China Law Offices' Hu also said disputes between the authority and taxpayers were common in all parts of China. “In most cases, both parties would not reach a consensus on whether certain items were eligible, which often discouraged companies from using the system.”

Practitioners have raised the question of how the new benefits will play out in practice as the tax break can seriously dent the revenue of local governments. Sussman said it is possible negotiation will continue to play a big role.

Hu, however, said: “the rules are very clear for the authorities to enforce so they don't have much room for excuses or objections.” The purpose of the Circular is to encourage enterprises to pour more money into R&D and the initiative comes from the top, he added.

Theoretically, parties can appeal a rejection and, if the higher level tax authority does not object to its subordinate's decision, they can take the matter to court. But no taxpayers dare do this in China, Hu said, as they want to maintain good relationships with the regulators.

Outsourcing and retroactive effect

Most clients will try to take advantage of the new provision that allows for the deduction of outsourced expenses, such as those for hiring a third party to do R&D and for consultancy fees, said Sussman. Companies seeking super deductions for these will have to show clearly how the outsourcing is directly related to the core research they are conducting in-house.

The Circular also provides a retroactive effect in allowing companies to go back three years to claim deductions.

It is important for firms to review all of these regulations and benefits that they can take advantage of, said Hu, adding that although compliance burdens have been reduced, failing to do things correctly may lead to a heavier workload in later stages.

The R&D tax boost timeline:

The Measures for the Administration of the Pre-tax Deduction of the Research and Development Expenses of Enterprises (Trial Implementation) (Circular 116), issued on December 10 2008, first defined what qualified as R&D activities and eligible deductions, and detailed the necessary application materials and filing procedures. It provided eight categories of claimable expenses directly related to R&D:

• Design fees for new products, expenses for creating procedures for new skills, books, information, translation fees
• Cost of materials, fuel and power
• Salaries, wages, bonuses and allowances for R&D employees
• Depreciation expenses or rental tools for equipment
• Amortization expenses of intangible assets like software, patents and non-patented tech
• Development and manufacturing costs of molds and process equipment exclusively used for testing and trials
• Costs for on-site testing of technology for prospecting and exploitation
• Costs for verification, assessment and inspection of R&D results

From January 2010, high-tech enterprises approved and registered in Beijing's Zhong Guan Cun Science and Technology Park were able to enjoy pre-tax super deduction for five more items:

• Basic pension fund, housing funding and insurance for medical, work-related injury, unemployment and maternity contributed by a company for its R&D employees
• Costs of operational maintenance, adjustment, testing and repair of tools and equipment
• Cost of samples, prototypes that are not fixed assets and expenses for general testing
• Cost of clinical tests of new drugs
• Certification costs for results

And, from January 1 2012 to December 31 2014, high-tech companies in several more pilot zones were eligible for the above.

The Circular on Policy Issues Relevant to the Pre-tax Super-deduction of Research and Development Expenses (Circular 70), issued on September 29 2013, then applied these additional deductible expenses nationwide. The benefits were no longer limited to high-tech and select regions. (See this article for a detailed background of these regulations.)

This puts into perspective how the Circular issued this month, which abolished such criteria to make all R&D-related expenses deductible and introduced a negative list, is a big step forward.

It is in line with the wider trend of China's approach of adopting negative lists to replace often complex procedures, as most recently seen in those for investment access and foreign exchange, to move toward a simpler and more transparent regulatory regime.

By Katherine Jo