Following the issuance of the new Enterprise Income Tax Law and its implementing regulations in 2007, the Ministry of Science and Technology (“MOST”), the Ministry of Finance (“MOF”) and the State Administration of Taxation (“SAT”) promulgated on 14 April 2008 the 《Administrative Measures for Designation of High- and New-Technology Enterprises》 (the “Measures”) and the accompanying catalogue of 《High- and New-Technology Sectors Designated for Key State Support 》 (the “Hi-Tech Sector Catalogue”). The Measures took effect retroactively from January 1, 2008, on the same date the Enterprise Income Tax Law and its implementing regulations took effect.
Foreign investors in China have long benefited from significant tax advantages over domestic companies, whether through location- or industry-based incentives. The new Enterprise Income Tax Law and its implementing regulations, which was an attempt to unify the tax regimes for foreign-invested and domestic enterprises, clarified an important issue, i.e., the special tax incentives enjoyed by high- and new- technology (“hi-tech") enterprises would continue. But the question is how?
The recent issuance of the Measures sheds some light on this issue and reinforces the general expectation that China wishes to encourage the growth of the nation’s industry and will continue to offer incentives to hi-tech enterprises to achieve that objective. The Measures set out the framework, procedure and criteria for awarding such designations to qualified high-tech enterprises so that they may be eligible for certain tax incentives.
Eligibility for tax incentives in the hi-tech industry
Qualified industry sectors
Companies that fall into the following industry sectors may be eligible for designation as a hi-tech enterprise:
- Electronic information technology
- Biotechnology and new pharmaceutical technology
- Aviation technology
- New materials technology
- Hi-tech services industry
- New energy and energy conservation technology
- Resources and environmental technology
- Use of hi-tech to transform traditional industries
The Hi-Tech Sector Catalogue provides more detailed guidance with respect to the specific types of technologies the government wishes to promote R&D in and would therefore consider granting tax incentives in relation thereto.
Qualification Criteria for Hi-Tech Enterprises
To be designated as a hi-tech enterprise that is eligible for tax benefits, the applicant company must fulfill the following criteria:
- it must be registered as an enterprise in the PRC;
- it must have held the intellectual property for the core technology underlying its main products (services) through its R&D, assignment, donation, or acquisition for the past three years or an exclusive license for more than five years;
- its products (services) must fall within the scope set out in the list of Hi-Tech Sectors Designated for Key Support from the State;
- technical personnel with a college degree or above must comprise more than 30% of the enterprise’s total personnel, of which the R&D personnel must comprise more than 10% of the enterprise’s total personnel;
- it has been continuously engaged in R&D activities for the purpose of obtaining new knowledge in science and technology (not including humanities or social sciences) or to make material improvements to technologies, products and services, and its R&D expenditures calculated as a percentage of its total sales revenue over the most recent three fiscal years fulfill the following criteria:
- Not less than 6%, if the enterprise had sales revenues of less than RMB 50 million over the last year.
- Not less than 4%, if the enterprise had sales revenues of between RMB 50 million and RMB 200 million over the last year.
- Not less than 3%, if the enterprise had sales revenues of more than RMB 200 million over the last year.
The R&D expenditures that the enterprise has incurred within China must be not less than 60% of the total amount of R&D expenditures that it has incurred. If an enterprise has been registered and established for less than three years, the determination of whether it has fulfilled the above criteria will be based upon its years of operation to date.
- revenues from hi-tech products (services) comprise more than 60% of its total enterprise revenues for the year
- the indices that illustrate its R&D organisation’s management level, ability to transform scientific and technological results, quantity of self-controlled intellectual property, growth of sales and total assets meet the requirements set out in the 《Working Guide for Administering the Designation of Hi-Tech Enterprises》 (“Working Guide”). Please note that the Working Guide has yet to be promulgated but a draft is currently being circulated for comments.
Note the emphasis on “self-controlled” intellectual property, which reiterates the position that the applicant enterprise must hold its core technology, whether by direct ownership or exclusive license. It is consistent with the government’s desire to have intellectual property owned or controlled by entities within China as opposed to offshore entities. This position is reinforced by the 3rd draft revision to the Patent Law issued early last year, which imposes a new requirement to seek approval for foreign patent filings with respect to inventions made in China and punishes any failure to comply by nullification of the China patent application for the same invention.
Unlike the Measures, the Working Guide and the Hi-Tech Sector Catalogue are not intended to be laws or regulations of relative permanence, but may be revised periodically as deemed appropriate by the National Task Force for Administering the Designation of Hi-Tech Enterprises (“Task Force”). The Task Force, which will be comprised of MOST, MOF and SAT representatives, has supervisory authority over its local counterparts, and will handle most of the tasks relating to the actual designation of hi-tech enterprises. The Task Force has been delegated with responsibility for various tasks relating to the designation of hi-tech enterprises under the Measures, e.g., to coordinate and resolve important policy issues that arise in the course of implementation, to adjudicate large-scale disputes relating to the designation of hi-tech enterprises, and to submit reform proposals for areas where there are serious problems relating to the designation of hi-tech enterprises.
The application process
Set forth below is the application process as set out in the Measures and the current draft of the Working Guide.
- Self assessment – Enterprise to log onto the Designation of Hi-Tech Enterprises Administrative Task Network (the “Hi-Tech Network”, web site address at: http://www.innocom.gov.cn/ (not yet available) to conduct a self assessment as to whether it would be eligible to file an application for designation as a hi-tech enterprise.
- Online registration – Enterprise to log onto the Hi-Tech Network and fill in an online registration form and upload it to the Network. Upon verification of identity, the enterprise will be issued a username and password.
- Preparation and submission of materials – Enterprise to select qualified intermediary to conduct the relevant audits and appraisals for preparation of supporting materials for the application.
- Examination and Designation – Experts in the relevant industry selected from the Task Force’s expert database will review application materials submitted by Enterprise and provide comments to be considered by the Task Force when deciding whether to grant the hi-tech enterprise designation to the Enterprise.
Public notification – the Task Force’s decision will be posted on the Hi-Tech Network for 15 working days to provide an opportunity for third parties to file any relevant objections to the decision.
Filing for the record, Public Announcement, Issuance of Certificate - If no third party objection to the Task Force’s decision is filed, then a filing will be made for the record, followed by a public announcement on the Hi-Tech Network and issuance of a Hi-Tech Enterprise Certificate to the Enterprise. This certificate is effective for three years and should be renewed three months prior to its expiration date.
Apply for tax incentives – an Enterprise that has received designation as a Hi-Tech Enterprise may enjoy a 15% enterprise income tax rate (compare with standard rate of 25% for most enterprises) and may also be eligible for other industry- or location-based incentives.
Technology companies seeking to enter the China market should consider looking into whether its China subsidiaries can be designated as a hi-tech enterprise and thus become eligible for certain tax incentives, and if not, how its China operations can be restructured in order to qualify for these incentives.