For the purpose of encouraging the R&D activities, tax preferential policy for R&D expense additional deduction has been issued years ago. This policy briefly is that R&D expense incurred for conducting R&D activities can be deducted before corporate income tax with an additional amount which is a certain percentage of the actual expense incurred. In this way, more expenses can be deducted and the tax payer can pay less tax. For many SMEs, cash flow is always a critical issue especially under the current slow-down economic condition caused by convid-19. If the tax preferential policy can be enjoyed, capital could be saved.
Today, we would like to explain the preferential policy about R&D expense. What kind of companies can enjoy the policy? How to enjoy the policy?
1. What is the favorable policy is?
According to law of Corporate Income Tax and the detailed implementation rules, R&D expense which actually incurred for the development of new techniques, new products or new technology and have not yet been capitalized as intangible assets, can be additionally deducted by 50%. In 2018, according to a tax document issued (Caishui (2018)99), for the period from 1 January 2018 to 31 December 2020, the rate is 75%.
If you apply for enjoying the policy as a medium and small size science and technology enterprise, the period for 75% is from 1 January 2017 to 31 December 2019. (Caishui (2017)34).
If you outsource R&D work to an oversea contractor, partial R&D expense charge by the contractor can be additionally deducted. According to the tax document (Caishui (2018)64), 80% of the expense charged by overseas contractor can be regarded as overseas contractor’s R&D expense for enjoying the policy and the limit for additional deduction is the two thirds of R&D expense incurred in China.
However, please note that not all R&D projects and R&D expense in the mind of the enterprise are accepted by tax rules for additional deduction.
Regarding the R&D activities, the definition from a tax document issued (Caishui(2015)119) is on-going systematic activities with explicit purposes of obtaining science and technology new knowledge, creative appliance of science and technology new knowledge or practical improvement on technology, products(services), techniques. The tax document listed several activities which are not allowed for the preferential policy. For example, routine upgrading for the products/service, direct appliance of certain public announced scientific R&D result or technical support activity offered to customers after the commercialization are not regarded as R&D activities for additional deduction.
Regarding the R&D expense, the tax documents (Caishui(2015)119; State tax bureau announcement (2015)97) list out the item of expense allowed for additional deduction and the deduction limit. Briefly, R&D expense for additional deduction can include labor cost, direct expense such as materials, fuel, power and other expense relating to experiment or test, depreciation and amortization on equipment or patent, designing and others. The expense which does not fall in the scope is not allowed for additional deduction, even if it relates to R&D projects.
2. Who can enjoy the policy?
Many people ever thought that only the enterprise entitled high-tech or medium or small size science and technology enterprise can make additional deduction on R&D expense. Actually this is a misunderstanding. The title of high-tech or medium or small size science and technology enterprise tile is not a must condition for enjoying the policy. Even you are not a high-tech or medium or small size science and technology enterprise, if the tax requirements are satisfied, you can still enjoy the policy. On the contrary, as a high-tech or medium or small size science and technology enterprise, for applying the deduction policy, the specific requirements on R&D activities and expense mentioned above shall still be fulfilled.
Then is it correct that all enterprises which conduct R&D activities can enjoy the policy？The answer is no. Restriction and requirement has been set.
According to tax document (Caishui(2015)119, State tax bureau announcement (2015)97), the following industries cannot enjoy the policy:
1) Tobacco manufacturing
2) Accommodation and catering
3) Wholesale and retailing
4) Real estate
5) Leasing and commercial service
7) Other industries stipulated by the Ministry of Finance and State Tax Authority
Tax rules also set up requirements on the enterprise. The following enterprise cannot enjoy the policy:
1) The enterprise without a complete accounting system
2) Tax payment amount is identified by tax authority
3) Non-resident enterprise
Enterprise which does not fall in the restricted industries or disallowed list of enterprises still are not permitted to enjoy the policy if process of collecting and booking R&D expenses is not complied with tax rules:
1) sub-ledger shall be set up for R&D expense by R&D projects
2) R&D expense and manufacturing expense shall be separately booked. No separation, no additional deduction
3．How to enjoy the policy?
Before 2018, for enjoying preferential policy, prior approval shall be obtained from tax authority by filing relevant documents about R&D projects with tax authority. From 2018, according to a tax document issued (State Tax Bureau Announcement (2018)23), the tax management on enjoying preferential policy has been changed to following the principle that the tax payer can directly enjoy the policy by tax filing if the tax payer identifies by itself that the conditions are satisfied for enjoying the policy. The tax payer shall file with itself, all relevant materials required by tax rules for at least 10 years. The materials shall only be submitted to the tax authority when requested. The tax authority will execute post management and checking.
In this manner, the enterprise takes all responsibilities of regulation compliance in enjoying the preferential policy. The tax risk for tax payer is obviously higher than before when the tax payer needs obtain prior approval before enjoying the policy and tax authority takes partial risk of regulation compliance. Now, the enterprise shall understand the tax requirement clearly in advance and any missing or misunderstanding may lead tax loss.
In all, as long as R&D activity is an area encouraged by the government, tax preferential policy would continually be offered to the enterprises which meet the conditions. What we shall concern is to follow the policy carefully in arranging the implementation or tax plan so as to reduce the tax compliance risk when taking the benefits.
If you need further assistance on the details of tax regulations or other concerns on enjoying the tax preferential policy, please contact us.
Please note that the article only represents the opinion of the writer. Regarding the implementation of the tax treatment, the consultation with the local in-charge tax authority is required.