Embed Size (px)
Citation preview
China Tax & Investment News 1
China further expands the applicablescope for R&D super deduction
Issue No.CTIN201500912 Nov 2015
Executive summary
In June 2015, China State Council announced a decision on further expanding andrelaxing the criteria and scope of allowing super deduction for qualifying researchand development expenditures. On 3 November 2015, to implement the StateCouncil’s decision, the Ministry of Finance, the State Administration of Taxation andthe Ministry of Science and Technology jointly promulgated a circular, Caishui[2015] No.119 (Circular 119) to provide more details regarding the expandedscope of qualifying industries plus research and development expenditures, allowingback-claim application and simplified administrative approval procedures. Circular119 applies to China tax resident enterprises only and will be effective from 1January 2016. It brings positive messages to the market though leaving someuncertainties. This issue of China Tax and Investment News summarizes the keycontent of Circular 119 and highlights areas which require company executives’attention to ensure eligibility for the tax preference.
Background
As a general supporting tax policy encouraging research and development (R&D),under the Corporate Income Tax Law (CITL) context, China provides pre-tax superdeductions of 150% on qualifying R&D expenditures (RDE) actually incurred duringthe year (RDE super deduction regime)1. Alternatively, if related RDE wereincurred for developing intangible assets, the companies may amortize thecapitalized intangible assets based on 150% of the actual cost incurred. This R&Dincentive has been available in China ever since the CITL promulgated in 2008 andgradually, the regime has become more mature with a series of follow-onregulations providing implementation details.
China Tax &Investment News
Note:
1. Please refer to article 95 of the CITLIR.
China Tax & Investment News 2
In today’s world, innovation is almost like a lifestyle; it advances productivity, it provides sustainability. A lot ofcountries have been reforming their R&D incentive regimes to speed up innovation. The pace of this withineach country is unprecedented. For some, this means introducing completely new incentives; for others, itmeans making incentives more generous to encourage growth and development. In 2013, the China Ministryof Finance (MOF) and the SAT jointly released Circular 70 which detailed the expansion of the applicable scopefor China’s RDE super deduction regime2. In June 2015, the China State Council announced a decisionregarding another round of relaxation of RDE super deduction3. On 3 November 2015, to implement the StateCouncil’s decision, the MOF, the SAT and the Ministry of Science and Technology jointly promulgated a circular,Caishui [2015] No.119 (Circular 119) to provide specific implementation details.
Key messages and our observations
Circular 119 applies to China tax resident enterprises only and will become effective from 1 January 2016 andat the same time, replacing the prevailing Circular 1164 and Circular 70. It provides further details of theexpanded scope of qualified RDE, allows back-claim application and simplifies the administrative approvalprocedures.
The qualifying activities and covered industries - how to interpret two negative lists
According to Circular 119, “R&D activities” refer to activities with clearly defined purposes on a continuousbasis and systematically carried out in order to derive new science/technology knowledge, including
► applying new science/ technology knowledge in an innovative manner; or
► improving current technologies, products/services or techniques substantially
The qualifying applicable scope of the super deduction regime is primarily set in line with the above principle.Nonetheless, two negative lists are introduced to further refine the scope:
► Seven excluded types of industries – For eligible industries, rather than list those covered, Circular 119provides a negative list of those that are NOT covered:
1. The tobacco industry
2. Accommodation and catering industry
3. Wholesale and retail
4. The real estate industry
5. Leasing and commercial service industry
6. The entertainment industry
7. Other industries as specified by the MOF or the SAT
As we confirmed with the relevant in-charge SAT official, those not in the negative list are ALL eligibleindustries for the RDE super deduction regime. Clearly, not all activities conducted by a company engaging inan eligible industry are all eligible for the regime. The key assessment criterion should be whether thecompany has been engaging in qualifying R&D activities.
Note:
2. Caishui [2013] No.703. Certain Policies and Measures for Promoting Public Entrepreneurship and Innovation4. Guoshuifa [2008] No.116 issued by the SAT in 2008, providing the criterial and the detailed administrative
procedures of RDE super deduction, issued by the SAT in 2008.
China Tax & Investment News 3
► Seven excluded types of activities - Circular 119 specifically excludes the following seven types ofactivities from the applicable scope of the RDE super deduction regime:
1. Routine upgrades of products/services;
2. Simple application of R&D results, such as direct application of public techniques, materials, devices,products, services, or knowledge, etc.;
3. Technical support to customers after commoditization;
4. Repeated or simple changes made to existing products, services, technologies, materials or processes;
5. Research on market, efficiency or management;
6. Regular quality control, test and analysis;
7. Research on social sciences, arts or humanities
The previous Circular 116 required that the R&D activities eligible for RDE super deduction shall fall within twoprescribed catalogues published by relevant central governmental authorities5. Circular 119 on the other handabolished the whole Circular 116 and list R&D activities that are not eligible.
Notwithstanding the above, we do not believe it could simply be interpreted as any activities not listed in theabove negative lists would automatically be treated as eligible for RDE super deduction regime. Rather, theaforesaid general definition of “R&D activities” should fundamentally be referred to as the standard benchmark. Therefore, it is possible that the SAT may issue further clarifications or implementation guidance for itssubordinates; until then, the local practice may vary and the implementations may heavily rely on respectiveeconomic development priorities in different areas. Concerned business executives are strongly advised toreview the current operations and proactively communicate with the tax authorities to understand theirpositions. Further, as per Circular 119, the local in-charge science and technology authorities6 will beconsulted if tax authorities have any questions on the eligibility of a taxpayer’s R&D activities. Opinion ofcompetent e science and technology authorities in-charge should therefore be observed as well.
Note:
5. As listed in Guokefahuo [2008] No.172 , “Key High & New Technologies Supported by the State” andNDRC/MOST/MIIT/MOC/SIPO Announcement [2011] No. 10 , the “the Catalogue of Industrial Guidance for High & NewTechnology Developmental Priorities”
6. City level and above
China Tax & Investment News 4
The eligible expenditures - the expanded scope
Circular 119 provides a full list of qualifying expenditures with detailed explanations. Table 1 below provides asummary to facilitate your understanding:
Table 1 (the yellow highlighted items are newly added under Circular 119)
Circular 119 generously expands the qualified RDE by adding certain types of expenditures such as servicefees for external R&D personnel, expert consultation fees, travel and meeting expenses, insurance premiumsfor R&D of high and new technology, etc.
Besides, previous documents such as Circular 116 and Circular 70 emphasized that the expenses of devicesand equipment “exclusively” used for R&D activities could be entitled to super deduction; Circular 119however removes the word “exclusively”, that means a broader scope of capital expenditure is allowed. It isalso worth-noting that the total amount of “Other relevant expenditures” shall be no more than 10% of thetotal qualifying RDE and some other expenditure such as employee welfare expenses, education expenses andlabor union fees are still not regarded as qualified RDE.
Qualifying expenditures Detailed explanationLabor cost ► Following expenditures for employees directly engaging in R&D activities:
salaries, standard pensions funds, standard medical insurance, unemploymentinsurance, work-related injury insurance, maternity insurance and housing funds
► Service fee for external R&D personnelDirect investment cost ► Materials, fuel and power directly consumed for R&D activities
► Development and manufacturing costs of equipment and moulds used for testingand experiments; costs of samples and prototypes that do not constitute fixedassets and expenses for general testing solutions
► Inspection fees for experimental products
► The expenditures for maintenance, adjustment, testing and rental cost on devicesand equipment for R&D
Depreciation expenses ► Depreciation expenses for devices and equipment for R&D
Amortization expenses ofintangible assets
► Intangible assets used for R&D, including :
► Software
► Patents
► Non-patented technologies (licensing, know-how, design and calculationmethod, etc.)
Designing fees for newproducts etc.
► Designing fees for new products
► Expenses for formulating procedures with new techniques
► Clinical trial costs for new pharmaceuticals
► On-site testing expenditures for exploration technology
Other costs directlyrelated to R&D activities(capped at 10% of thetotal qualifying RDE)
► Expenditures for technical books and information
► Translation fees
► Expert consultation fees
► Insurance premium for R&D of high and new technology
► Expenditures for research, analysis, review, verification, identification,evaluation, assessment and inspection of R&D results
► Application, registration and agency fees for intellectual property
► Travel and meeting expenses, etc.
Other expenses as prescribed by the MOF or the SAT
China Tax & Investment News 5
Important clarifications – treatment for out-sourcing R&D and group cost-sharing
Beside the above applicable scope of the industries, activities and expenditures, Circular 119 also providescertain important clarifications.
Although outsourcing R&D could be eligible (capped at 80% of the actual outsourcing cost) for the RDE superdeduction regime, Circular 119 clearly stipulates that overseas outsourcing expenditures are NOT eligible. Onthe other hand, under the guidelines stated in Circular 116, super deduction claims for outsourcing R&D shallbe supported by the breakdown of incurred expenditures. In practice, third-party service providers would notbe willing to provide their expenditures breakdown due to confidentiality. Circular 119 relaxed thisrequirement and clarifies that expenditure breakdown is not necessary unless the outsourcing is conductedbetween related parties.
Circular 119 allows cost sharing on R&D expenditures within an enterprise group under certain circumstances.On that, Circular 119 emphasized that the expenditure allocated shall match the benefits received. TheCircular does not elaborate, but at a calculated guess, relevant transfer pricing principle might be referred.Further, although Circular 119 does not specify, considering the target of the super deduction regime is toencourage R&D activities WITHIN China; the rule itself only applies to China tax residents only and overseasoutsourcing expenditure is not allowed, cross-border cost sharing would unlikely be eligible for the RDE superdeduction regime.
Table 2 (below) provides a detailed summary of those important clarifications for your reference:
Table 2
Items Definition Tax treatment Notes
OutsourcingR&D
► An enterprise outsources tothird parties (institutions orindividuals) for carrying outR&D activities on its behalf
► Consignor: eligible forsuper deduction basedon 80% of the actualR&D expenses incurred
► Consignee:NOT eligible
► Overseas outsourcing:NOT eligible
► The actual R&D expensesincurred shall bedetermined according tothe arm’s length principle
► For R&D activities involvingrelated parties, theconsignee shall provideexpenditure breakdown tothe consignor
Cooperativedevelopment
► Enterprises work incollaboration with each otherfor the development of R&Dprojects
► Enterprises are entitled to super deduction based on theR&D expenses actually borne respectively
Group costsharing
► R&D projects requiringcentralized development inthe group due to therequirements of advancetechnology and heavyinvestment
► Benefitting members shall properly allocate R&Dexpenses actually incurred and claim super deductionrespectively
► The expenditure allocation shall match the benefitsreceived
Creativedesign
► Creative design activities7 ► The relevant expenses incurred are qualified for superdeduction
Note:
7. Creative design activities refer to development and designing on multimedia software and digital game; architecturaldesigning (meet certain condition) and landscape architectural design and planning; designingIndustrial/multimedia/digital animation and comic as well as derivative products
China Tax & Investment News 6
Other key administrative matters – relaxed or stricter
► Administrative procedures and post-event tax audit - Circular 119 does not specify the tax administrativeprocedures for RDE super deduction claims. Nevertheless, according to a SAT rule Guoshuifa [2004]No.82, RDE super deduction shall follow a record filing procedure, rather than an administrativeapproval procedure. Generally speaking, the record filing scheme may reduce both taxpayers’ and taxadministrators’ workload, since time-consuming approval procedures are no longer needed. However,taxpayers (especially listed companies) may not be willing to compromise the certainty of a taxtreatment in exchange for a simplified procedure. Further, record-filing does not mean tax authoritieswould relax supervision on RDE super deduction claims. Instead, it may represent that the focus of taxauthorities is now shifted to post-event supervision and inspection. Circular 119 requires tax authoritiesto carry out follow-on inspections on a regular basis. It specifies that the annual audit shall cover no lessthan 20% of the total R&D projects that have enjoyed RDE super deduction.
Furthermore, changing from “approval” to “record filing” does not mean reporting and communicationsare no longer required. To avoid surprise, taxpayers may indeed want to take a more proactiveapproach in communicating with tax authorities and evaluate their position from time to time based ondiscussions carried out with tax officials.
► Back-claim application - Circular 119 allows companies to claim back missing super deduction forqualifying R&D expenses incurred after 1 January 2016, the maximum period is up to three years.
► Accounting requirement - Pursuant to the details previously listed in Circular 116, companies wererequired to set up specialized accounts and record R&D expenditures separately for RDE superdeduction purposes. Based on Circular 119, companies may now set up subsidiary ledgers based onrespective R&D projects under existing accounting records which may reduce the burden on businesses.However, it is still required that RDE shall be separately recorded from the general operatingexpenditures; otherwise, tax authorities are allowed to make appropriate adjustments.
► Follow-up verification – Circular 119 indicates that in case a tax authority has concerns on the superdeduction eligibility of a company’s R&D projects, it could directly request verification from a localcompetent science and technology authority (city level and above). Nevertheless, it also clarifies that forR&D projects undertaken by companies which belong to provincial/ministry level (or above) and forcross-year R&D projects which have already been verified, no verification will be required.
Conclusions
It is obvious that the implementation of Circular 119 will bring benefits to taxpayers who engaged in R&Dactivities. As Circular 119 will take effect from 1 January 2016, taxpayers are highly recommended toconduct thorough review of their current R&D activities and the relevant expenditure recording system toensure eligibility for this tax preference. Last but not least, do not forget DOCUMENT, DOCUMENT, andDOCUMENT and keep track of all transactions and paperwork. Although Circular 119 does not specify thedocumentation requirement on taxpayers to support claiming RDE super deductions, companies shoulddocument as much as possible as taxpayers are now burdened to prove themselves for the qualificationsand assume any responsibilities if found to be failed. Please do talk to your EY tax advisers if you have anyqueries or concerns.
China Tax & Investment News 7
Contact usFor more information, please contact your usual EY contact or one of the following of EY’s China tax leaders.
• Walter Tong+86 21 2228 [email protected]
• Martin Ngai (Beijing)+86 10 5815 [email protected]
• Fisher Tian (Tianjin)+86 22 5819 [email protected]
Office Tax Leaders
• Samuel Yan (Dalian/Shenyang)+86 10 5815 [email protected]
Service Line Tax Leaders
• Andrew Choy (International Tax& Transfer Pricing)+86 10 5815 [email protected]
• Paul Wen (People AdvisoryServices)+852 2629 [email protected]
• Samuel Yan (Global Compliance & Reporting)+86 10 5815 [email protected]
• Becky Lai (Tax Policy)+852 2629 [email protected]
• David Chan (Transaction Tax)+852 2629 [email protected]
• Jane Hui+852 2629 [email protected]
Author – China Tax Center
Greater China Tax Leader
• Lucy Wang (Qingdao)+86 10 5815 [email protected]
• Vickie Tan (Shanghai)+86 21 2228 [email protected]
• Audrie Xia (Suzhou)+86 21 2228 [email protected]
• Raymond Zhu (Wuhan)+86 21 2228 [email protected]
• Jean Li (Xiamen)+86 755 2238 [email protected]
• Rio Chan (Guangzhou/Changsha)+86 20 2881 [email protected]
• Chuan Shi (Chengdu)+86 21 2228 [email protected]
• Clement Yuen (Shenzhen)+86 755 2502 [email protected]
• Joanne Su (Xi’an)+86 10 5815 [email protected]
• Patricia Xia (Hangzhou)+86 21 2228 [email protected]
• Andrew Chen (Nanjing)+86 21 2228 [email protected]
• Tracy Ho (Hong Kong)+852 2846 [email protected]
• Heidi Liu (Taipei)+886 2275 [email protected]
• Kenneth Leung (Indirect Tax)+86 10 5815 [email protected]
Sector Leaders
• Henry Chan (Financial Services)+86 10 5815 [email protected]
• Alan Lan (Energy & Resources)+86 10 5815 [email protected]
• Martin Ngai (Technology, Media,Telecommunications)+86 10 5815 [email protected]
• Vickie Tan (Life Science)+86 21 2228 [email protected]
• Gary Chan (Real Estate)+86 10 5815 [email protected]
• Audrie Xia (ConsumerProducts)+86 21 2228 [email protected]
• Walter Tong (Automotive &Transportation)+86 21 2228 [email protected]
• Raymond Zhu (Government&Public Sector)+86 21 2228 [email protected]
China Tax & Investment News 8
About EYEY is a global leader in assurance, tax, transaction and advisoryservices. The insights and quality services we deliver help build trustand confidence in the capital markets and in economies the worldover. We develop outstanding leaders who team to deliver on ourpromises to all of our stakeholders. In so doing, we play a criticalrole in building a better working world for our people, for our clientsand for our communities.
EY refers to the global organization and may refer to one or more ofthe member firms of Ernst & Young Global Limited, each of which isa separate legal entity. Ernst & Young Global Limited, a UK companylimited by guarantee, does not provide services to clients. For moreinformation about our organization, please visit ey.com.
© 2015 Ernst & Young (China) Advisory LimitedAll Rights Reserved.
APAC no. 03002524ED None.
This material has been prepared for general informational purposes only andis not intended to be relied upon as accounting, tax, or other professionaladvice. Please refer to your advisors for specific advice.
ey.com/china
EY | Assurance | Tax | Transactions | Advisory
