Pre-Tax Super Deduction of R&D Expenses in 2023 – An Explainer
The Chinese government has indefinitely extended the policy enabling a pre-tax super deduction of R&D expenses, allowing companies to deduct 200 percent of their China R&D expenses to reduce their tax burden and increase capital flow. There are nonetheless certain parameters for the R&D activities eligible for the super deduction, as well as the types of companies that can apply it. We explain which activities and businesses are eligible for the super deduction, and how to apply for it in 2023.
China’s tax authorities recently announced that the preferential policy of pre-tax super deduction of R&D expenses (“super deduction”) would become a permanent policy for all eligible companies. In order to assist companies with applying for this policy, China’s State Tax Administration (STA) has released a series of explainers for its implementation in 2023 in the months since the announcement.
The preferential tax policy aims to encourage companies to increase their R&D investments and support scientific and technological innovation and form part of China’s wider efforts to foster sci-tech development through various support policies and tax incentives. Note that the super deduction policy is not available to companies operating in industries on the negative list.
Companies can apply the super deduction for R&D expenses as soon as September and October 2023 for the expenses incurred in the first three quarters of the year.
In advance of this upcoming deadline, we provide an overview of how the policy works, which companies are eligible, and how to apply the super deduction when filing and paying the provisional corporate income tax (CIT) in the fall.
At an executive meeting on March 24, 2023, China’s State Council extended a raft of preferential tax policies and free cuts, including the pre-tax deduction on R&D expenses for certain eligible companies.
In the March meeting, the State Council decided to remove the expiration date for the policy entirely, effectively making it a permanent policy.
On March 26, 2023, the STA and Ministry of Finance (MOF) jointly released the Announcement on Further Improving the Pre-tax Super Deduction Policy for R&D Expenses (STA MOF Announcement  No. 7) (the “Announcement No. 7”), confirming that the revamped policy would be implemented retroactively from January 1, 2023, with no end date, and outlining the basic procedures and eligibility requirements.
The pre-tax super deduction of R&D expenses was first implemented in 2008 and has since continued to relax the scope of activity that is included in the policy and increased the ratio of the deduction for more types of companies.
For instance, in the fourth quarter of 2022, the government increased the deduction ratio from 75 percent to 100 percent for all types of companies. The ratio increase from 75 percent to 100 percent was initially rolled out exclusively for manufacturing enterprises in 2021 and has been steadily expanded to more and more companies ever since.
Pre-tax super deduction of R&D expenses – FAQs
What is the super deduction of R&D expenses?
The pre-tax super deduction of R&D expenses is a preferential tax policy that allows certain eligible companies to double their pre-tax deduction of R&D expenses as well as pre-tax amortization of R&D expenses, depending on whether they have led to the formation of tangible or intangible assets. The aim of this is to reduce the CIT burden of companies and save companies’ cash flows to encourage more investment in R&D.
Specifically, Announcement No. 7 states that if the R&D expenses that have been incurred in the process of conducting R&D activities do not form intangible assets and are included in the profits and losses of the current period, on the basis of deduction according to the regulations, an additional 100 percent of the actual amount will be deducted before tax. This in effect means that companies can deduct a total of 200 percent of their R&D expenses before tax, resulting in lower corporate income tax (CIT) payable for a given tax year.
An example provided in a Q&A by the STA states that, if a company incurs RMB 10 million in R&D expenses in the year 2023, and these expenses do not result in intangible assets and are recorded as current expenses, then the company can deduct 100 percent of the expenses incurred in addition to the pre-tax deduction of RMB 10 million that is already granted by law. The total deduction before tax would therefore amount to RMB 20 million.
Meanwhile, where intangible assets are formed, R&D expenses that lead to the creation of intangible assets, which are also known as “capitalized R&D expenses”, can be amortized before tax at 200 percent of their cost. According to the explainers, there is no time limit placed on when the intangible assets are formed, which means that the intangible assets can be created in one year and be amortized before tax at 200 percent of the cost in the following year.
For instance, if a company researches and develops intangible assets in September 2022, and the cost of intangible assets allowed for additional deduction is RMB 15 million if it is amortized over 10 years, it can be amortized before tax at 200 percent of the cost of intangible assets in 2023, which means that a total of RMB 3 million can be amortized before tax.
Who is eligible for the super deduction?
To be eligible for the super deduction, companies must meet both of these requirements at the same time:
- Be a resident enterprise with sound accounting, audits, and collections, which is able to accurately collect R&D expenses; and
- Must not be in one of the industries on the negative list, which include tobacco manufacturing, accommodation and catering, wholesale and retail, real estate, leasing and business services, and entertainment industries.
Companies that meet the two above requirements can apply the super deduction policy, regardless of whether they have reported profits or losses in the year they apply the policy.
Note that if a company is currently experiencing losses, then the application of the super deduction policy will result in an increase in losses, as under the policy, 200 percent of the total R&D expenses will be included in the balance sheet.
This increase in losses will be carried forward to the following five or 10 years to offset future profits, depending on the type of enterprises, which will reduce the taxable income in the following year, resulting in a further reduction to the overall tax burden and help to save the company’s cash flow.
Which R&D activities are eligible for the super deduction?
The scope of R&D activities that are eligible for the super deduction is still implemented in accordance with the 2015 Notice on Improving the Pre-tax Super Deduction Policy for R&D Expenses (Cai Shui  No. 119) (“Announcement No. 119”).
Announcement No. 119 states that, in order for the R&D expenses to be eligible for the super deduction, they must have been spent on “systematic activities with clear objectives that companies continue to carry out to acquire new scientific and technological knowledge, creatively apply new scientific and technological knowledge, or substantially improve technologies, products (or services), and processes.”
Announcement No. 119 clarifies that expenditure on the following activities is not eligible for super deduction:
- Routine upgrade of enterprise products and services;
- The direct application of a scientific research result, such as the direct adoption of publicly available new processes, materials, devices, products, services or knowledge, and so on;
- The technical support activities that companies provide to customers after the commercialization of a product or service;
- Duplication or simple changes to existing products, services, technologies, materials, or processes;
- Market research, efficiency research, or management research;
- Routine quality control, test analysis, repair, and maintenance, or when these activities act as part of an industrial or service process; and
- Research in the social sciences, arts, or humanities.
Moreover, in addition to R&D activities by an enterprise itself, the R&D expenses incurred through commission, cooperation, centralized R&D, and other forms can also enjoy the additional deduction policy.
What is the permitted scope of R&D expenses?
The permitted scope of R&D expenses includes:
- Personnel costs, such as wages and salaries, basic pension insurance premiums, basic medical insurance premiums, unemployment insurance premiums, work-related injury insurance premiums, maternity insurance premiums, and housing provident funds for personnel directly engaged in R&D activities, as well as labor costs for external R&D personnel.
- Direct input costs, including (but not limited to) materials and fuel and power costs directly consumed by R&D activities.
- Depreciation expenses, such as those for instruments and equipment used in research and development activities.
- Amortization of intangible assets, such as software, patent rights, and non-patented technologies (including licenses, know-how, designs, calculation methods, and so on) used in research and development activities.
- New product design fees, new process specification formulation fees, clinical trial fees for new drug development, field trial fees for exploration and development technologies; and
- Other expenses directly related to R&D activities, including (but not limited to) technical books and materials fees, data translation fees, expert consultation fees, high-tech R&D insurance premiums, and so on. The total amount of such expenses shall not exceed 10 percent of the total R&D expenditure that is eligible for super deduction.
Announcement No. 119 includes detailed explanations of the scope of each expense category. For example, it specifies that employee welfare, supplementary pension insurance, and supplementary medical insurance do not belong to personnel expenses, and thus should be treated as “other expenses”.
How can companies apply for the super deduction?
For the tax filing documents discussed below, there could be local variances from city to city. Companies should use the documents that have been released by the tax authority in the jurisdiction in which they pay CIT. Below, we have provided the forms and documents released by Shanghai’s tax authority as an example.
Accounting and management
According to Announcement No. 119, in order to enjoy the R&D super deduction, companies must set up an auxiliary account specifically for the R&D expenses that are eligible for the super deduction, in accordance with each R&D project. The company must then accurately collect and calculate the R&D expenses that are eligible for super deduction in the annual balance. If a company carries out multiple R&D activities in a given tax year, it must collect the R&D expenses that are eligible for the super deduction according to the different R&D projects.
In 2021, local tax authorities released a revised version of the guide for managing the auxiliary R&D expenditure account.
Moreover, companies should also calculate R&D expenses and production and operation expenses separately in order to accurately and reasonably determine the various expenses. If the separation between the different types of expenses is unclear, then no additional deduction is implemented.
Calculating R&D expenses for super deduction
Companies must calculate the super deduction by themselves based on the actual R&D expenses incurred and fill out the conditions for the preferential treatment in the corresponding line of the tax return.
Companies must also retain relevant materials for future reference but are not required to file them beforehand or receive prior approval.
The enterprise shall calculate the super deduction amount by itself based on the actual R&D expenses incurred, and fill in the preferential conditions in the corresponding line of the tax return.
Time frame for declaration
Companies can choose whether to apply the super deduction of R&D expenses in September or October, during the period for the filing and payment of provisional CIT, or in the first five months of the following year when handling the annual CIT filing.
The super deduction will be applied for the R&D expenses incurred in the first three quarters of the year if the companies choose to file the deduction during the period for the payment of provisional CIT. The prepayment period is either in September, if the company handles CIT payments on a monthly basis, or in October if it handles them on a quarterly basis.
Otherwise, the company can choose to apply the super deduction for the R&D expenses incurred over the whole year by applying it during the annual CIT filing, which is conducted between January and May of the following year.
Companies that choose the first option can still apply the super deduction for R&D expenses incurred over the whole year by filing the expenses incurred in the first three quarters (which have already been deducted) along with the expenses of the last quarter in the annual CIT filing.
Filing the super deduction
The way to file the super deduction will depend on whether the company chooses to apply the super deduction during the provisional CIT payment period (in September or October) or the annual CIT filing period (between January and May), and whether they fill in the form manually or digitally.
For companies that file the super deduction during the provisional CIT payment period, they can:
- If filling manually, write the name and discount amount of relevant preferential items under the “Deduction: tax-exempt income, deduction of income, super deduction” (line 7) of the People’s Republic of China Enterprise Income Tax Monthly (Quarterly) Prepayment Tax Return (Type A, A200000).
- If filing digitally through the local e-tax website, directly select the name of the corresponding preferential item in the drop-down menu, and fill in the preferential amount (refer to the Catalog of Corporate Income Tax Declaration Items to choose the correct item).
In addition to declaring the super deduction in the relevant tax forms, companies must also fill in the Detailed Form of Research and Development Expenses Plus Deduction Preferences (A107012), which should then be kept for future reference.
If a company has utilized the super deduction during the September/October period, it must include the R&D expenses from the first three quarters that have been deducted, along with the R&D expenses of the final quarter when submitting their annual CIT filing in the first five months of the following year. By doing so, the company can fully benefit from the preferential policy and apply the super deduction to their R&D expenses for the entire year.
The option to apply the super deduction for the R&D expenses of the first three quarters in September or October is given to companies in order to increase the capital flow throughout the year. It is important that companies keep an accurate record of the R&D expenses and are accurate and truthful when applying for the super deduction in their tax filings.
To avoid the risk of errors or misinterpretations of regulations getting in the way of enjoying the preferential policy, it is advisable to work with local tax experts. For help with assessing eligibility for the super deduction policy, accounting, application, and monthly, quarterly, or annual CIT filing, contact our tax experts by emailing firstname.lastname@example.org.
China Briefing is written and produced by Dezan Shira & Associates. The practice assists foreign investors into China and has done so since 1992 through offices in Beijing, Tianjin, Dalian, Qingdao, Shanghai, Hangzhou, Ningbo, Suzhou, Guangzhou, Dongguan, Zhongshan, Shenzhen, and Hong Kong. Please contact the firm for assistance in China at email@example.com.
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