Tech transfer tax breaks may fail to entice MNCs

“The expanded scope of Announcement 82, which allows tax exemptions for not just IP rights transfers but non-exclusive licensing as well, doesn't go far enough to convince MNCs to keep their IP in China,” said Jinghua Liu, partner at Baker & McKenzie in Beijing.

Although there are measures to safeguard IP, the general mindset among foreign companies is that the country's IP rights protection has not yet reached a level they are completely comfortable with.

Announcement 82's expansion to non-exclusive licensing is largely aimed at fostering indigenous creation by encouraging local players and up-and-comers to share tech knowhow and IP as China seeks new ways to drive modern industry and economic growth.

It complements the Circular on Expanding the Implementation of Relevant Pilot Tax Policies of National Innovation Demonstration Zones on a Nationwide Basis (Circular 116), issued by the Ministry of Finance and SAT, which extended tech transfer tax breaks nationwide from certain pilot zones, and the Announcement on Issues Relevant to Enterprise Income Tax on Legal Person Partners of Venture Capital Firms Organized as Limited Partnerships (Announcement 81), which offered deductions to venture capital investors. These were all released on the same day, and apply only to tax-resident enterprises.

“Domestic companies have more to gain from many of these tax policies encouraging R&D or new technology because they require the research results or IP ownership to be in China,” Liu said.

Enterprise income tax

The 2008 PRC Enterprise Income Tax Law had restricted applications of tax exemptions on technology transfers even for licensors, allowing in practice only companies with exclusive licenses to qualify. Announcement 82 relaxes this and returns to the pre-2008 position when the threshold for qualifying for such tax exemptions was low, said of counsel Peng Tao at DLA Piper.

In recent years, China has issued various regulations that provide tax incentives and R&D super deductions to encourage innovation and high and new technology enterprises (HNTEs).

Qualified HNTEs in China only need to pay 15% enterprise income tax as opposed to the regular rate of 25%. “Many MNCs tried to take advantage of this but new policies restricted HNTEs to have their IP ownership in China, making it difficult,” said Liu.

Local tax developments play a large role in MNCs' global IP planning strategies as putting profits in a favorable jurisdiction minimizes tax burdens.

For Chinese MNCs with HNTE status, however, there is no need to store IP abroad as China's enterprise income tax for these companies is already relatively low, said Liu. (In comparison, the rate in Hong Kong is 16.5% and 17% in Singapore. Ireland offers 12.5%, but the offshoring efforts to move the IP to Ireland aren't worth getting that added 2.5%, Liu said.)

Transfer pricing

MNCs will need to closely watch China's moves to implement the Base Erosion and Profit Shifting (BEPS) program. The SAT has a dedicated team that focuses exclusively on BEPS and the final regulation will probably be promulgated at the end of the month or early next year, said DLA Piper's Tao.

“This is going to change the tax planning climate in China very significantly,” he said.

For instance, China will require the onshore subsidiary to provide information on the head office and worldwide operations in order to understand the company's transfer pricing policy and what would be reasonable from a PRC perspective. Tao expects the country will move away from the arms-length principle to the profit-split method, which directly allocates a certain percentage of revenue to China.

“This would trigger a whole new round of discussions,” he added.

By Katherine Jo