What Are The Tax Incentives In China To Encourage Technology Innovation?
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.
We list the major tax incentives in China to encourage technology innovation and share guidance on how to tap benefits listed in various preferential policies.
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 this article, we summarize the major tax incentives to encourage technology innovation and share our experience on accessing the benefits of the preferential policies.
High And New Technology Enterprises (HNTEs)
HNTE treatment, which reduces a qualified taxpayer’s applicable corporate income tax (CIT) rate from the standard 25 percent to 15 percent, is one of China’s core tax incentives that encourage innovation.
Besides the lower CIT rate, starting from January 1, 2018, an additional preferential tax treatment has been granted to HNTE:
- Losses of qualified HNTE that occur five years prior to 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. For normal enterprises, the maximum carry-forward period for losses is only five years.
Upon obtaining the qualification as an HNTE, the enterprise shall enjoy the HNTE treatment starting from the year when the HNTE certificate is issued.
Qualification And Criteria
To qualify for HNTE status, a company must meet all of the following criteria:
- Be registered in China (not including Hong Kong, Macao, and Taiwan) for at least one years.
- Owns the intellectual property (IP) right for the core technology of its key products or services (services ) through independent R&D, transfer, donation, merger and acquisition, etc.
- The core technology of the enterprise’s key products (services) falls within the scope of the areas outlined in the Regions of Advanced Technologies Strongly Supported by the State, which covers more than 200 categories of technologies, products, and services in eight large technological areas.
- The enterprise’s technical personnel engaging in R&D and relevant technological innovation activities constitute more than 10 percent of the total number of employees in the current year.
- In the last three financial years (the actual operational period for newly established ones), R&D expenditure should account for a certain percentage of the enterprise’s total sales revenue in the same period:
- No less than five percent if the latest annual sales revenue is below RMB 50 million (inclusive, approx. US$7.7 million);
- No less than four percent if the latest annual sales revenue is below between RMB 50 million (approx. US$7.7 million) and RMB 200 million (inclusive, approx. US$30.8 million); and
- No less than three percent if the latest annual sales income is upwards of RMB 200 million (approx. US$30.8 million).
R&D expenditure within China is not less than 60 percent of the total R&D expenses.
- The ratio of income from high-tech related operations against total income is not lower than 60 percent in the current period.
- The enterprise’s innovation capacity evaluation satisfies the corresponding requirements.
- The enterprise has no record of major safety or quality incidents or serious environmental violations during the year preceding the application.
To be certified as HNTEs, the applicants need to go through an application process by submitting required documents and passing the corresponding assessments.
The bureau in charge of the application is an administrative authority for accreditation of HNTE (hereinafter, the HNTE accreditation authority) formed by the provincial-level science and technology administration and management authority, together with the provincial level finance and tax authorities. The provincial-level HNTE accreditation authority is led by the Leading Team for Administration of Accreditation of HNTE Nationwide (hereinafter, the National HNTE Leading Team).
Step 1: Self-assessment and application by the enterprises
If an enterprise satisfies the HNTE criteria upon self-assessment, it should register on the “Network for Administration of Accreditation of HNTE” and submit an application for accreditation to the authority in charge. At the same time, the applicants should submit required documents that demonstrate their qualifications, such as materials related to IP, statements on the enterprise’s employee and technical personnel, financial accounting reports from the past three years, among others.
Step 2: Expert assessment
The HNTE accreditation authority shall randomly select experts who satisfy the evaluation requirements to form an expert panel. The expert panel shall evaluate the declaration materials of the enterprise and form an evaluation opinion.
Step 3: Review and public comments
The HNTE accreditation authority shall examine the applicants and take into account the evaluation opinion of the expert panel, issue an accreditation opinion and submit to the National HNTE Leading Team office. A public announcement of accredited HNTEs shall be placed on the Network for Administration of Accreditation of HNTE for 10 working days.
Step 4: Accreditation and certification
If no objection is raised, the HNTE list shall be filed and announced on the Network for Administration of Accreditation of HNTE, and a standardized HNTE Certificate shall be issued to the enterprises. Where there is any objection, the accreditation authority shall verify and handle it.
The whole turnaround is around 60 working days if everything is in order.
The qualifications of an accredited HNTE shall be valid for three years from the date of issuance of the HNTE Certificate.
Follow-up Supervision And Administration
Upon accreditation as an HNTE, the enterprise shall submit information on its IP, technical personnel, R&D expenses, operating income, etc. of the preceding year through the Network for Administration of Accreditation of HNTE before May 31 every year.
In the event of a name change or significant change in relation to the accreditation criteria, such as division, merger and acquisition, restructuring, change of business, etc., the enterprise is required to report to the HNTE accreditation authority within three months.
Upon examination by the accreditation authorities, where the enterprise is found to comply with the accreditation criteria, there shall be no change to its HNTE qualification. Failure to promptly report a major change in relation to the accreditation criteria or failing to submit annual reports on development status for two years cumulatively will cause the revocation of the HNTE qualification.
Also, where an accredited HNTE is found in the day-to-day administration to be non-compliant with the accreditation criteria, the relevant authorities shall request the accreditation authorities to conduct a re-examination.
Upon re-examination, where the enterprise is confirmed to be non-compliant with the accreditation criteria, the accreditation authorities shall revoke its HNTE qualification, and notify the tax authorities to recover tax incentives claimed by the enterprise for the year from which it becomes non-compliant with the accreditation criteria.
Simplified HNTE Application In Beijing
To further promote the expansion and opening of the service industry, starting in 2021, certain enterprises can be submitted to lower qualifications and simplified procedures for HNTE status application in Beijing. To be eligible for the simplified procedures, the enterprises must:
- Be a production and research enterprise above designated size (report annual revenue of over RMB 20 million from main business) engaging in integrated circuits, artificial intelligence, biopharmaceuticals, and key materials;
- Be registered in Beijing and be in operation for over a year;
- Spend at least 50 percent of total R&D expenses within China; and
- Satisfy other criteria for the HNTE application.
Qualified enterprises are required to provide far fewer materials than usual to apply for HNTE status, which can be submitted online. The National HNTE Leading Team Office will approve the application soon after the application has undergone expert assessment and review by the HNTE accreditation authority. The public comment procedure has been exempted. The whole turnaround shall be much shorter.
Technology Based Small and Medium-sized Enterprises (TSMEs)
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.
Being qualified as a TSME, 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.
Different from the 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.
Qualification and Criteria
A ATSE 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”, 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.
Follow-up Supervision And Administration
The enterprises that have been included in the TSME Database shall update their information through the TMSE Service Platform by the end of March each year. They shall make an independent evaluation on whether they still meet the criteria for TSMEs and go through the application procedures again.
If enterprises included in the TSME Database change their names or have significant changes related to the criteria, they shall enter the changes on the TSME Service Platform within three months.
Advanced Technology Service Enterprises (ATSEs)
In addition to HNTE and TSME, ATSE status is another core innovation tax policy in China to encourage the provision of information technology outsourcing (ITO), business process outsourcing (BPO), or knowledge process outsourcing (KPO) services to overseas entities.
Originally launched in the Suzhou Industrial Park in 2016, the ATSE incentive was rolled out nationwide in 2017, reducing the CIT rate for a qualified ATSE from the standard 25 percent to 15 percent, similar to the HNTE treatment.
Besides, ATSEs are subject to zero value added tax (VAT) rate for the provision of certain offshore services, which means they can be exempted from the corresponding VAT payment where the simple tax computation method is applicable, or they can enjoy the tax exemption, credit, and refund method where VAT general tax computation method is applicable.
Previously, the ATSEs also had the privilege to deduct employee education expenses that do not exceed eight percent of the said enterprise’s total salaries from the taxable income of the CIT, and the part exceeding eight percent could be carried forward to subsequent years. However, since January 1, 2018, this policy has been made available to all enterprises unless stipulated otherwise.
Qualification And Criteria
To be qualified as a ATSE, an enterprise must fulfill all the following requirements:
- Be registered in China (excluding Hong Kong, Macao, and Taiwan).
- Be engaged in one or more categories of advanced technology service businesses listed in the Scopes of Recognized Advanced Technology Service Businesses (for Trial Implementation, hereinafter, the Scope) and adopt advanced technologies or has strong research and development capabilities.
- More than 50 percent of its staff hold a college degree or above.
- More than 50 percent of its total revenue at the current year come from the revenue generated from the advanced technology service businesses listed in the Scope.
- Revenue generated from offshore service outsourcing business is not less than 35 percent of total revenue at the current year.
“Revenue generated from offshore service outsourcing business” refers to the revenue generated by an enterprise from overseas entities by providing the ITO, BPO, KPO services specified in the Scope for the overseas entities by the enterprise itself or by other enterprises directly subcontracted by the enterprise under the entrustment contract signed between the enterprise and the overseas entities.
Enterprises that satisfy the ATSE criteria can apply to the department of science and technology at the provincial level and submit required documents.
The department of science and technology at the provincial level shall, jointly with the departments of commerce, finance, taxation, and commissions of development and reform at the same level, carry out a review and then issue official documents of recognition, and shall file the list of the recognized ATSE through the ATSE Platform.
The whole turnaround is around 60 working days, if everything is in order.
The Ministry of Science and Technology (MOST) shall share the filing information with the other relevant ministries.
The ATSE status is valid for three years.
Follow-up Supervision And Administration
According to the MOST requirements, ATSEs within the valid period are required to submit the “Enterprise Information of the Previous Year” and “Annual Enterprise Statistic” through the ATSE Platform before the end of March every year. The provincial-level accreditation authority shall review the information submitted.
Super Deduction On R&D Expenditure
In an effort to encourage innovation, beyond the lower CIT rates and loss carry-forward policy introduced above, China also allows for the super deduction of the enterprise’s R&D expenses.
When calculating the CIT taxable income, while the cost is usually 100 percent deductible and the expenses, such as employee education expenses and advertising expenses, are subject to a deduction cap, the expense actually incurred by an enterprise in R&D activities enjoys the below preferential policies:
- 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.
Besides the major innovation tax policies introduced above, there are other preferential tax policies to encourage the development of the tech sector, such as the tax incentives to the integrated circuit and software sector, the timelier refund of the VAT incremental credit balance to advanced manufacturing taxpayers, etc.
As such incentives can reduce the enterprise’s tax burden to a large extent, potentially qualified enterprises are suggested to carefully study the application requirements of each incentive and choose the one or more that are most preferential and suitable to their own situation. For example, for an enterprise that doesn’t own local IP rights of the key technologies representing the enterprise’s core products or services, the ATSE status is more suitable for it than the HNTE status, as the latter involves local IP requirement.