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1. What’s new
Under Circular 119, R&D activities means an enterprise applying new scientific and technological knowledge creatively for the purpose of obtaining new scientific and technological knowledge, or carrying out systematic activities with the specific goals of substantive improvement in technologies, products (services), or processes.
Comparing Circular 119 to Circular 116/70, there are both expansions and removals of R&D items which may qualify for bonus deductions.
1.1 Now creative design activities may be permitted for extra deduction.
Creative design activities means multimedia software, animation game software development, digital animation, game design and production; building construction design (graded three-star for green building evaluation standard), landscape engineering design; industrial design, multimedia design, animation and derivative product design, model design etc.
1.2 The following items are R&D items not permitted an extra deduction
(a) Conventional upgrades of the enterprise’s products (services)
(b) Direct application of certain technological research results, such as direct adoption of openly available new technologies, materials, devices, products, services or knowledge
(c) Technical support activities provided by the enterprise to its customers following commercialization
(d) Repetitive or simple changes to existing products, services, technologies, materials or processes
(e) Market surveys, efficiency surveys or management studies
(f) Quality control, testing and analysis, repair and maintenance in industry (service) process or in regular basis
(g) Research in social sciences, arts or humanities
1.3 The scope of R&D has been required to strictly follow two high-tech guidelines in Circular 116. However, under Circular 119 this requirement has been removed, which will provide flexibility for taxpayers to classify R&D items on their own.
1.4 The classification is more specifically listed in Circular 119
(a) Staff and labour expenses, during which the service fees to external personnel has been added as new item.
(b) Direct costs.
(c) Depreciation.
(d) Amortization of intangible assets.
(e) Design fees for new products, fees for formulation of new processes, clinical trial fees for new drugs, and onsite testing fees for exploration and development technologies.
(f) Other relevant expenses, (other expenses directly related to R&D activities, such as technical books and materials expenses, material translation expenses, expert fees, insurance premiums for research and development of advanced technologies, expenses for search, analysis, evaluation, demonstration, identification, assessment and acceptance of research and development results, application fees, registration fees and agent fees for intellectual property, business trip expenses and conference expenses). The total amount of these expenses shall NOT exceed 10% of the total amount of research and development expenses allowed an extra deduction.
1.5 A limitation on outsourced R&D has been enacted.
For expenses related to R&D activities carried out by an external organization or an individual entrusted by the enterprise, 80% of the actual amount shall be included in the enterprise’s R&D expenses and allowed for additional deduction, and the enterprise shall not make receive any additional deduction. Where the enterprise and the entrusted party are related, the entrusted party shall provide a detailed breakdown of its research and development expenses to the enterprise.
Expenses incurred in research and development activities carried out by an overseas organization or individual entrusted by the enterprise shall not be allowed an extra deduction.
1.6 Certain industries are excluded from this preferential treatment
(a) Tobacco manufacturing
(b) Lodging and F&B
(c) Wholesale and retail
(d) Real estate
(e) Leasing and commercial services
(f) Entertainment
(g) Any other industries stipulated by the Ministry of Finance and State Administration of Taxation
1.7 Retrospective clause
Enterprises which comply with the criteria but have not claimed the tax incentives after 1 January 2016, shall be allowed to make retrospective claims and perform the filing formalities. These retrospective claims may be made within three years
2. Issues
There are several issues concerning Circular 119.
For example, the rule is effective from 1 January 2016, however the Chinese 2015 annual corporate tax filing will be conducted in April/May 2016. The gap between the filing timing and allocation period lead to one important question, whether the 2015 R&D extra deduction will follow Circular 119? It appears not.
Another issue is the retrospective clause. If the rule is effective after January 2016, will the retrospective benefits apply to the corporate tax extra deduction in year 2013 or 2014, considering that some items may be treated differently under the new rule and old rule. It appears not. There is no official comment or answer to these queries yet.
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The annual corporate tax filing is approaching, Circular 119 has created practice difficulties for those Chinese companies who may have R&D extra deductions in 2015. The above issues have placed companies in a tricky situation. They must treat this year’s filing more carefully, i so they do not to lose any available tax benefit or become over exposed. The pre-check with the tax officer or tax consultant on these R&D extra deduction items is a prudent and suggested approach.