China: New Regulations on Super Deduction for R&D Expenses

published on august 21, 2018 / reading time: approx. 2 minutes

According to the previous regulations, the Research and Development（"R&D"）expenses are entitled to a 50% super deduction for Chinese Corporate Income Tax ("CIT") purpose, while the small and medium-sized technology enterprises can enjoy a higher super deduction rate of 75 %. However, the two regulations for R&D expenses super deduction are not applicable to overseas R&D expenses. Recently, China has launched two new tax benefits for R&D expenses super deduction, which aim to promote R&D investment and technological innovation.

New Tax Reductions

At the executive meeting in July this year, the State Council proposed several tax reduction policies. Among them, the most concerned is that the scope of enterprises which can enjoy 75% super deduction for R&D expenses is expanded from small and medium-sized technology enterprises to all enterprises. It is expected that this policy would only apply to enterprises that are eligible for R&D expenses super deduction, i.e. the 6+1 restricted industries such as the tobacco manufacturing industry would not be included. The policy is expected to be valid from 2018 till the end of 2020. According to preliminary estimates, the benefit will reduce the annual tax amounting to RMB 65 billion.

Background and Explanations

Prior to 2018, overseas R&D expenses could not enjoy the super deduction. The Circular Caishui [2018] No. 64 issued in June this year broadens the super deduction to R&D expenses incurred overseas. The new regulation came into force with retroactive effect on January 1, 2018. It is stipulated in the Circular that for the R&D expenses arisen from overseas contract R&D activities, 80 % of the actual amount incurred could be booked as overseas R&D expenses for contract activities. The principal enterprise may super-deduct its overseas R&D expenses for contract activities before CIT to the extent that such expenses do not excess two third of the enterprise’s qualified domestic R&D expenses. It is worth noting that for the above-mentioned super deduction for overseas R&D expenses, it’s required that the principal should file the contract R&D agreement with the competent Science and Technology Administrative Department in advance. If the both contract parties are related parties, the trustee shall provide the principal with details of the expenses of the R&D projects. Therefore, if the group intends to apply for super deduction for intercompany R&D expenses, the following conditions must be met:

The R&D results are attributed to the Chinese entity;
The trustee shall disclose the details of R&D expenses to the Chinese tax authorities.

Considering the limit of super deduction for overseas R&D expenses, if a group hopes that its Chinese subsidiaries can fully enjoy the R&D super deduction policy, it may need to adjust the allocation of R&D functions within the group.

In addition, the regulation also clarify that R&D expenses paid to overseas parties should be determined in accordance with the arm’s length principle. Taking the series of anti-tax avoidance regulations introduced by China in recent years into account, R&D expenses should be determined based on the benefit-received principle under the premise of fully considering the functions, risks and assets of all parties.

Prospects

The above two measures not only increase the intensity of super deductions, but also provide the same tax preferential treatment to overseas and domestic R&D expenses. The measures are believed to be conducive to market vitality and investment in R&D activities, especially for enterprises with high R&D expenses or overseas R&D centers.