China Broadens Scope Of Super R&D Deduction

China has widened the number of qualifying research and development (R&D) costs that are eligible for a super deduction for Chinese corporate income tax purposes.

The country released Circular 119, which would allow Chinese resident enterprises to retroactively deduct qualifying R&D expenses incurred over the past three years, among other things. The information in the guidance is part of China’s continuing efforts to strengthen and encourage R&D innovation and development strategies.

The new rules went into effect on January 1, 2016.

Under Chinese tax law, qualifying R&D expenses, which haven’t been capitalized as an intangible asset, may be deducted at 150% of the actual R&D expenses incurred. However, qualifying R&D expenses that have been capitalized as an intangible asset may be amortized based on 150% of the costs of the intangible asset.

Among other things, Circular 119:

  1. Defines the qualifying R&D activities and industries that are eligible for the R&D super deduction,
  2. Clarifies that outsourced R&D expenses (determined under arm’s length principles) are eligible, but would be subject to an 80% limitation of actual costs incurred and exclude overseas outsourcing fees, and
  3. Makes clear that expenses from group cost sharing and corporate development activities are eligible.

Ineligible activities and industries

Under the new rules, generally all R&D expenses from qualifying activities are eligible, unless specifically listed as ineligible. The following seven activities aren’t eligible:

  1. Routine product or service upgrades,
  2. Application of publicly available scientific research and other R&D results,
  3. Commercialization of technology support activities to customers,
  4. Simple updates to, or duplication of, existing products, services, technologies, materials, or processes,
  5. Market research or studies,
  6. Processes related to regular quality control, test analysis, repair, and maintenance, and
  7. Social sciences, arts, or humanities related studies.

As well, these six industries are excluded:

  1. Tobacco manufacturing,
  2. Accommodation and catering services,
  3. Wholesale and retail,
  4. Real estate,
  5. Leasing and business services, and
  6. Entertainment.

Preapproval eliminated

Under Circular 119, preapproval is no longer required for the R&D super deduction. However, expenses must be properly accounted for by Chinese resident enterprises in accordance with the Chinese national accounting system, calling for regular and annual verification of such expenses. Chinese tax authorities will audit these claims regularly.

© 2016

California Cross Border Accountant