China Further Increased Tax Support for R&D Investments in 2022
China further increased its tax support for R&D investments in 2022, expanding super deduction on R&D expenditure to technology-based small and medium-sized enterprises (TSMEs). in an effort to encourage innovation, promote industrial upgrade, and strengthen the core competitiveness of the country.
As China endeavors to shift from being a low-end mass manufacturer to a high-end producer, the government has doubled down on encouraging targeted investments in research and development (R&D) and technological innovation. The ongoing technology confrontation with the US is another factor at play, impacting a wide range of segments from access to chips and other key input technologies and products. This has resulted in China labeling its technology sector as a strategic one and for which government support has increased.
In 2022, China further increased its tax support for R&D investments.
According to the 2022 Government Work Report released on March 5 during the 2022 Two Sessions, it is declared that technology-based small and medium-sized enterprises (TSMEs) will be able to enjoy the super deduction policy on R&D expenditure, according to which 100 percent of the R&D expenses will be additionally deducted from the taxable income amount on the basis of actual deduction.
Previously, this policy was only applicable to manufacturing enterprises (except tobacco manufacturing). For other enterprises, including TSMEs that are not in the manufacturing sector, only 75 percent of the R&D expenses will be additionally deducted from the taxable income amount, on the basis of actual deduction.
On April 1, 2022, the Ministry of Finance together with the State Taxation Administration and the Ministry of Science and Technology released an announcement that provides more details on the implementation of this policy.
What is TSME?
A TSME falls under the scope of SMEs that conduct technology-based activities, which consists of scientific and technological personnel who are involved in R&D activities and obtain IP for creating high-tech products or services.
Different from the high and new technology enterprises (HNTE) qualification, the TSME status has special requirements on enterprises’ number of total employees, annual sales revenue amount, and total assets. On the other hand, the HNTE requires that the core technology of the enterprise’s key products (or services) is specially encouraged by the state and the ratio of income from high-tech related operations against total income is not lower than 60 percent in the current period, while TSME has no such requirements. In general, it is easier to apply for the TSME status for smaller businesses.
A TSME shall meet all the following requirements:
- Be registered in China (excluding Hong Kong, Macao, and Taiwan).
- The total number of its employees shall be no more than 500, and either its annual sales income or its total asset amount shall be no more than RMB 200 million (approx. US$30.8 million).
- The products and services provided by it are not included in the prohibited, restricted, or eliminated categories prescribed by the State.
- There is no occurrence of major safety or major quality accidents and serious violation of environmental law or serious dishonesty in scientific research in the previous year of filling and the present year, and it is not included in the list of enterprises with abnormal operations or the list of enterprises with serious dishonest behaviors in violations of the law.
- Its comprehensive evaluation score is not less than 60 points in terms of the evaluation indicators for TSMEs, with the score on scientific and technical staff indicator more than 0 point. The evaluation indicators for TSMEs, to be specific, include such categories as scientific and technical staff, R&D investment, as well as scientific and technological achievement, with a total score of 100.
Certain enterprises could be exempted from the scoring requirements, including:
- Enterprise that holds an HNTE certificate that has not expired yet.
- Enterprise that has won a state-level science and technology award within the past five years and ranked in the top three.
- Enterprise that has a recognized R&D body at provincial or ministerial level or above.
- Enterprise has taken the lead in the development of international standards, national standards, or industry standards within the past five years.
Enterprises may carry out self-evaluation in accordance with the Measures for Evaluating TSME (Guo Ke Fa Zheng  No.115), and shall, under the principle of voluntariness, fill in the enterprise information on the “National Information Service Platform for TSMEs” (http://www.innofund.gov.cn/, the TSME Service Platform).
The administrative departments of science and technology at the provincial level shall organize the relevant institutions to confirm the completeness of the contents of the TSMEs Information Form filled in by enterprises within five working days. Enterprises with complete information (that meet the stipulated conditions) shall be publicized on the Service Platform for 10 working days. Enterprises with no public objections shall then be included in the “National Information Database for TSMEs” (the TSME Database) and get a TSME Registration Number, which is valid from the publicity date till December 31 of the same year.
Being qualified as a TSME, in addition to the super R&D deduction policy, the losses of the enterprise occurred five years before the year in which they become qualified and have not been made up shall be allowed to be carried forward to subsequent years to be made up, and the maximum carry-forward period is up to 10 years. Besides, local governments may treat TSMEs as HNTE candidates and provide other incentives to support their growth.
Scope of super deduction on R&D expenditure expanded in 2022
When calculating the corporate income tax (CIT) taxable income, while the cost is usually 100 percent deductible, the expenses are subject to a deduction cap.
For example, for business entertainment expenses relating to production and business operations, only no more than 60 percent of the actual incurred amount can be deducted from taxable income and this amount cannot be more than 0.5 percent of the sales revenue of the current year.
Nevertheless, in an effort to encourage innovation, China sets no deduction cap for the expense actually incurred by an enterprise in R&D activities. Rather, an additional percentage of R&D expenses actually incurred can be deducted from the taxable income, on the basis of actual deduction. This is the so called “super deduction on R&D expenditure”.
With TSME being able to enjoy the 100 percent additional deduction of the R&D expenditure, in 2022, the super deduction policy on R&D expenditure shall be applied as follows:
- For TSMEs, starting from January 1, 2022, if the R&D expenses do not form intangible assets and are included in the current profits and losses, on the basis of actual deduction, an additional 100 percent of such R&D expenses could be deducted from the taxable income amount; if the R&D expenses have formed intangible assets, they can be amortized before CIT at 200 percent of the actual cost of intangible assets.
- For manufacturing enterprises (except tobacco manufacturing), starting from January 1, 2021, if the R&D expenses do not form intangible assets and are included in the current profits and losses, on the basis of actual deduction, an additional 100 percent of such R&D expenses could be deducted from the taxable income amount; if the R&D expenses have formed intangible assets, they can be amortized before CIT at 200 percent of the actual cost of intangible assets.
- For other enterprises (except tobacco manufacturing, lodging and catering, wholesale and retail, real estate, leasing and commercial services, and entertainment), during the period between January 1, 2018 and December 31, 2023, if the R&D expenses do not form intangible assets and are included into the current profits and losses, on the basis of actual deduction, an additional 75 percent of such R&D expenses could be deducted from the taxable income amount; if the R&D expenses have formed intangible assets, they can be amortized before CIT at 175 percent of the actual cost of intangible assets.
Manufacturing enterprises are enterprises whose main business is in the manufacturing industry and whose main business income accounts for more than 50 percent of the total income in the year of enjoying preferential treatment.
For expenses incurred in R&D activities entrusted by enterprises to external institutions or individuals within China, 80 percent of the actual amount shall be included in the entrusting party’s R&D expenses and allowed for the additional deduction, and the entrusting party shall not make further additional deduction.
For expenses incurred in R&D activities entrusted by enterprises to external institutions (exclude individuals) outside China, 80 percent of the actual expenses shall be itemized as the entrusting party’s commissioned overseas R&D expenses. The commissioned overseas R&D expenses, to the extent of two-thirds of the domestic R&D expenses, are eligible for the pre-tax additional deduction.
To be noted, R&D activities here refer to processes where an enterprise applies new science and technology knowledge creatively for the purpose of obtaining new science and technology knowledge or carried out systematic activities with specific goals continuously for substantive improvement of technologies, product (services), and processes. Non-creative activities, such as conventional upgrades of the enterprise’s products, are not regarded as eligible for the R&D super deduction policy. The State Taxation Administration also has detailed guidance on the scope of the R&D expenses.
Similar to other CIT preferential policies, to enjoy the R&D expenses super deduction policy, enterprises can enjoy the incentive when making tax payment (at the time of pre-payment or final settlement) by self-evaluating if they are qualified and retain relevant documents for future potential inspection of the tax bureau for 10 years. To be noted, R&D activities entrusted to overseas institutions are subject to additional documentation requirements.
Businesses in China may find its documentation requirements and application procedures burdensome if they are not familiar with the established tax system and eligibility criteria for accessing supportive measures. Seeking professional assistance might be the best choice. To learn more about how to get the most out of China’s preferential tax policies, please contact email@example.com.
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