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Research and development: the perks and pitfalls
By Yang Bin |
December 5, 2012, Wednesday
|
Print Edition
Print Edition
A surge of raw material prices and operational costs have imposed significant challenges for foreign-invested enterprises in China. Faced with these issues, the companies are adopting a range of measures to raise revenue and lower tax burdens in order to enhance profitability.
Relocating group research and development centers to China has, therefore, become a tactical step for many multinational companies with investments in China. Such moves enable them to not only reap the benefits of various R&D incentives offered by the Chinese government, but also to pursue other business opportunities as they shift their focus from manufacturing to innovation.
The Chinese government is granting a range of tax incentives to companies that conduct R&D. They include a 50 percent R&D "super deduction," in addition to the actual expense deduction for R&D expenditure - which is a 12.5 percent benefit for every eligible cost - and a preferential corporate income tax rate of 15 percent for companies recognized as a "high new technology enterprises." There is a preferential corporate income tax rate of 15 percent for companies in the category of "advanced technology service enterprises," with qualified incomes exempt from the business tax. There are also exemptions from import customs duty and value-added tax on qualified R&D equipment imported by research centers.
In recent years, a number of prominent multinational companies have established R&D centers in China. Pepsi recently opened its largest research and develop center outside North America in Shanghai in November.
Shanghai, with strong financial and technical infrastructure, and the ability to attract top class technical personnel, has emerged as a popular destination for these centers. As of July, more than 300 foreign-invested R&D centers had been opened in the city. The value-added tax reform trial that was first introduced in Shanghai is another key factor encouraging foreign-invested enterprises to set up R&D centers in China.
As a result of recent VAT reforms, a number of research activities, such as technology licensing and technical consulting, are now subject to VAT instead of the business tax.
Since taxpayers can now offset their VAT payable under the VAT regime, they end up with more money in hand. Companies setting up R&D centers in Shanghai can also benefit from local subsidies. The Shanghai government has the administrative authority to promote local incentives and financial subsidies available for R&D activities.
Broadly defined
R&D is broadly defined for tax purposes in China. The range of industry sectors potentially eligible for Chinese government incentives is wide. Examples include improvements to water usage, the development of innovative functionality for solving software problems and the application of engineering principles developed within the aerospace industry.
Many companies fail to capture these significant tax savings because they are unable to identify all eligible R&D activities. That may be due to the complexities in the R&D regulations and regulatory approval procedures. Additionally, companies may fail to identify and record eligible R&D expenses, risking challenges from tax authorities.
When assessing the location and circumstances for R&D activities, it is crucial for companies to take into account the relative cost of performing R&D incentives in different countries, net of available R&D incentives.
In addition, companies need to conduct careful evaluation on the associated tax consequences, as well as other factors regarding the creation of an intellectual property, for example, payment and ownership arrangement of the intellectual property, and the location where it will be used.
An additional challenge for multinational corporations is how to tackle transfer pricing issues.
Transfer pricing originated from the development, payment and ownership arrangement of intellectual property. These provisions are complex and vary between different countries as they apply to many aspects, including tax, legal and economic, of transfers of proprietary technology, and auxiliary products or services. Therefore, the arrangement for transfer pricing may affect where companies locate their R&D activities.
The success of Shanghai in accommodating R&D centers may encourage other regional economic hubs to improve their financial and technical infrastructure.
Relocating group research and development centers to China has, therefore, become a tactical step for many multinational companies with investments in China. Such moves enable them to not only reap the benefits of various R&D incentives offered by the Chinese government, but also to pursue other business opportunities as they shift their focus from manufacturing to innovation.
The Chinese government is granting a range of tax incentives to companies that conduct R&D. They include a 50 percent R&D "super deduction," in addition to the actual expense deduction for R&D expenditure - which is a 12.5 percent benefit for every eligible cost - and a preferential corporate income tax rate of 15 percent for companies recognized as a "high new technology enterprises." There is a preferential corporate income tax rate of 15 percent for companies in the category of "advanced technology service enterprises," with qualified incomes exempt from the business tax. There are also exemptions from import customs duty and value-added tax on qualified R&D equipment imported by research centers.
In recent years, a number of prominent multinational companies have established R&D centers in China. Pepsi recently opened its largest research and develop center outside North America in Shanghai in November.
Shanghai, with strong financial and technical infrastructure, and the ability to attract top class technical personnel, has emerged as a popular destination for these centers. As of July, more than 300 foreign-invested R&D centers had been opened in the city. The value-added tax reform trial that was first introduced in Shanghai is another key factor encouraging foreign-invested enterprises to set up R&D centers in China.
As a result of recent VAT reforms, a number of research activities, such as technology licensing and technical consulting, are now subject to VAT instead of the business tax.
Since taxpayers can now offset their VAT payable under the VAT regime, they end up with more money in hand. Companies setting up R&D centers in Shanghai can also benefit from local subsidies. The Shanghai government has the administrative authority to promote local incentives and financial subsidies available for R&D activities.
Broadly defined
R&D is broadly defined for tax purposes in China. The range of industry sectors potentially eligible for Chinese government incentives is wide. Examples include improvements to water usage, the development of innovative functionality for solving software problems and the application of engineering principles developed within the aerospace industry.
Many companies fail to capture these significant tax savings because they are unable to identify all eligible R&D activities. That may be due to the complexities in the R&D regulations and regulatory approval procedures. Additionally, companies may fail to identify and record eligible R&D expenses, risking challenges from tax authorities.
When assessing the location and circumstances for R&D activities, it is crucial for companies to take into account the relative cost of performing R&D incentives in different countries, net of available R&D incentives.
In addition, companies need to conduct careful evaluation on the associated tax consequences, as well as other factors regarding the creation of an intellectual property, for example, payment and ownership arrangement of the intellectual property, and the location where it will be used.
An additional challenge for multinational corporations is how to tackle transfer pricing issues.
Transfer pricing originated from the development, payment and ownership arrangement of intellectual property. These provisions are complex and vary between different countries as they apply to many aspects, including tax, legal and economic, of transfers of proprietary technology, and auxiliary products or services. Therefore, the arrangement for transfer pricing may affect where companies locate their R&D activities.
The success of Shanghai in accommodating R&D centers may encourage other regional economic hubs to improve their financial and technical infrastructure.
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