China Raises Pre-Tax Additional Deductions for R&D Expenses of Manufacturing Firms

On April 7, 2021, China’s Ministry of Finance (MOF) and State Taxation Administration (STA) jointly released the Announcement on Further Improving the Policy for Pre-Tax Additional Deductions for R&D Expenses (MOF STA Announcement [2021] No.13). The announcement, with retrospective effect from January 1, 2021, increases the ratio of additional deduction on manufacturing firms’ R&D expenses from 75 percent to 100 percent.

According to the announcement, for R&D expenses actually incurred by manufacturing firms:

• If they have not formed intangible assets, nor have they not been included into the current profits and losses, such expenses can be additionally deducted before tax at 100 percent of the actual deductions.
• If they have formed intangible assets, they can be amortized before tax at 200 percent of the actual cost of intangible assets.

For example, if an enterprise spent RMB 1 million (approx. US$153,000) of R&D expenses and such expenses did not form intangible asset and was not included in the current period’s profit or loss, a total of RMB 2 million (approx. US$305,000) is allowed to be deducted from the enterprise’ taxable income. If the RMB 1 million expenditure formed intangible assets, the pre-tax amortization can be made based on the costs of RMB 2 million.

As the higher pre-tax deductions mean lower corporate income tax (CIT) to be paid by manufacturing firms, this policy is designed to boost enterprises’ R&D input, incentivize business innovation, and advance industrial upgrading.

This policy is expected to reduce corporate taxes by another RMB 80 billion (approx. US$12 billion) this year, on top of the RMB 360 billion (approx. US$55 billion) tax cuts last year. Wang Jianfan, Director of the Tax Administration Department of the MOF, said “this policy is the largest in this year’s structural tax cuts.”

Entitlement to additional deduction on a semi-annual basis

In general, enterprises are entitled to enjoy the additional deductions of R&D expenses when completing their annual financial CIT settlement by May 30, the second year.

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However, under the new policy, manufacturing firms can opt to benefit from the additional deduction of R&D expenses on a semi-annual basis.

The Announcement [2021] No.13 stipulates that when an enterprise declares the CIT for the third quarter (pre-paid quarterly) or for the month of September (pre-paid monthly) of the current year, it can choose to deduct the additional deductions of the R&D expenses incurred in the first half of the current year.

This reform allows enterprises to benefit from the tax incentive in advance when prepaying the CIT, thereby further encouraging enterprises to increase their R&D spending.

Eligibility criteria for manufacturing firms

To enjoy this preferential policy, an eligible firm must have manufacturing as their main business and the main business revenue must account for more than 50 percent of its total revenue.

In addition, it must fall under the scope of the manufacturing industry determined by the Industrial Classification for National Economic Activities (GB/T 4574-2017) or any updated scope released by the relevant government department.

Scope of deductible R&D expenses

According to the Cai Shui [2015] No.119, the scope of deductible R&D expenses includes:

• Staff and labor expenses (of personnel engaging in R&D activities directly)
• Directs costs
• Depreciation of instruments and equipment used for R&D activities
• Amortization of intangible assets
• Design fees
• Other relevant expenses

Furthermore, from January 1, 2018, the commissioned overseas R&D expenses may also be eligible for the pre-tax additional deductions. According to the Cai Shui [2018] No.64, for expenses of R&D activities carried out by commissioned overseas parties, 80 percent of the actual amount of such expenses may be itemized as the enterprise’s commissioned overseas R&D expenses. The commissioned overseas R&D expenses, to the extent of two-thirds of the domestic R&D expenses that meet the given conditions, may be eligible for the pre-CIT additional deduction in accordance with applicable rules.

According to Hannah Feng, Partner and Head of Dezan Shira & Associates’ Corporate Accounting Service and Tax Team in North China, “the key challenge to claim the pre-tax additional deductions for R&D expenses is to capture the eligible R&D expenses from your ERP system, as the accounting and tax rules on recognizing the R&D expenses are different. For instance, the staff expenses of personnel engaging in R&D activities may be coded in the ERP system as ‘salary costs’ instead of ‘R&D expenses’. Tax team members in an organization should always seek external advisors’ advice in preparing the R&D claims or explore the technology solution to improve the efficiency and reduce errors on manual adjustments.”

Promoting R&D and advance manufacturing

China has been rolling out tax privileges for R&D activities in manufacturing industry to promote the deep integration of traditional manufacturing and information technology and advance the country’s industrial upgrading.

In recent years, the ratios of the additional deduction for R&D expenses of manufacturing firms have been raised from 50 percent and 75 percent to the current 100 percent. Besides, the government also introduced a relaxed policy for the refund of end-of-period value-added tax (VAT) credit for certain advanced manufacturing taxpayers.

China Briefing has been closely watching government support policies for R&D activities of enterprises. Our parent company, Dezan Shira & Associates, has an experienced team of tax accountants, lawyers, and ex-tax officials who can help your business on a wide spectrum of tax service areas. For more information and assistance, please email us at China@dezshira.com.

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