Introduction to the Policy on Pre-tax Deduction of Research and Development Expense in China
Research and development (R&D) expenses are those paid for the activities of project research and development. The regulation of R&D expenses in China’s relevant systems exists in two aspects: Accounting Standard for Business Enterprises No. 6 - Intangible Assets and the Enterprise Income Tax Law of the People’s Republic of China.
Accounting Standard for Business Enterprises No. 6 - Intangible Assets regulates the methods of recognition, measurement, recording and reporting of R&D expenses by enterprises from the perspective of accounting; the Enterprise Income Tax Law of the People’s Republic of China regulates the aggregation, amortization and deduction of R&D expenses from the perspective of tax law. This article will analyse the relevant provisions of pre-tax deduction for R&D expenses from the perspective of tax law.
- Scope of Application of the R&D Expenses Deduction Policy
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Applicable Industries
R&D expenses deduction policy applies to industries other than tobacco manufacturing, accommodation and catering, wholesale and retail trade, real estate industry, leasing and business service industry, and entertainment industry.
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Applicable Activities R&D activities refer to systematic activities with clear objectives that enterprises continue to carry out to obtain new knowledge of science and technology, creatively apply new knowledge of science and technology, or substantially improve technology, products (services) and processes. Therefore, the accrual deduction policy applies to the costs incurred. However, there is no clear definition of which costs arising from specific activities can be deducted. It is clearly stipulated that the pre-tax deduction policy is not applicable to the following activities.
- Routine upgrade of enterprise products (services).
- Direct application of a scientific research result, such as the direct use of disclosed new processes, materials, devices, products, services or knowledge.
- Technical support activities provided by enterprises for customers after commercialization.
- Repetitive or simple changes to existing products, services, technologies, materials or processes
- Market research, efficiency investigation or management research.
- As an industrial (service) process link or routine quality control, test analysis, maintenance.
- Research in social sciences, arts or humanities.
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R&D Expenses
- Personnel Labour Costs.
Wages and salaries of personnel directly engaged in R&D activities, basic pension insurance, basic medical insurance, unemployment insurance, employee injury insurance, maternity insurance, and housing provident fund, as well as labour costs for external R&D personnel.
- Direct Input Costs.
(i) Materials, fuel and power costs directly consumed by R&D activities.
(ii) The development and manufacturing costs of moulds, process equipment and equipment used for intermediate tests and product trial production, which do not constitute fixed assets, the purchase cost of samples, prototypes and general testing methods, and the inspection fees of trial products.
(iii) Costs for the operation, maintenance, adjustment, inspection, and maintenance of instruments and equipment used for R&D activities, as well as leasing fees for instruments and equipment used for R&D activities leased through operating leases.
- Depreciation Expense.
Depreciation of instruments and equipment used for R&D activities.
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Amortization of Intangible Assets.
Amortization costs for software, patent rights, and non-patented technologies (including licenses, know-how, designs, and calculation methods, etc.) used for R&D activities.
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New Product Design Fee, New Process Specification Formulation Fee, Clinical Trial Fee for New Drug Development and Field Test Fee for Exploration and Development Technology.
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Other Related Expenses.
Other expenses directly related to R&D activities, such as technical library material fees, data translation fees, expert consulting fees, high-tech R&D insurance fees, R&D results search, analysis, review, demonstration, appraisal, appraisal, appraisal, acceptance costs, intellectual property application fees, registration fees, agency fees, travel expenses, conference fees, etc. The total amount of this expense shall not exceed 10% of the total R&D expenses that can be deducted.
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Other Expenses Stipulated by the Ministry of Finance and the State Administration of Taxation. |
- Additional 75% of R&D Expenses Shall be Deduct
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Applicable Entities
Enterprises (except manufacturing) which are not tobacco manufacturing, accommodation and catering, wholesale and retail trade, real estate industry, leasing and business service industry, entertainment industry (known as negative list industries).
Enterprises except manufacturing industries whose main business does not belong to but concurrently engage in negative list industry business, and whose main business income is more than 50% of the total income calculated according to the provisions of the tax law, minus the non-taxable income and investment income, can still enjoy the preferential policy of additional deduction.
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Specific Provisions
Where the R&D expenses actually incurred by an enterprise in carrying out R&D activities (no intangible assets formed) are included in the profit or loss of the current period, are allowed to be deducted before tax at 175% of actual expenses incurred before December 31, 2023. If an intangible asset is formed, it is amortized before tax at 175% of the cost of the intangible assets during the above period.
Example 1
An enterprise carried out two R&D activities A and B in 2021. Project A incurred R&D expenses a total of CNY 1 million, including CNY 120,000 which were directly related to R&D activities. Project B incurred R&D expenses a total of CNY 1 million, including CNY 80,000 which were other expenses directly related to R&D activities. All are not formed as intangible assets and R&D activities are subject to the relevant provisions of the additional deduction.
Other related expense limits of project A = (1m-120,000) * 10%/ (1-10%) =CNY 97,777.78
Less than the actual CNY 120,000.
So, the R&D expenses allowed to be deducted = 1m-12,000 + 97,777.78 = CNY 977,777.78
Other related expenses limit of the project B = (1m-80,000) * 10% / (1-10%) =CNY 102,222.22
Greater than the actual CNY 80,000
Therefore, the R&D expenses allowed to be deducted are CNY 1 million
The R&D expenses that the enterprise can enjoy= (977,777.78 + 1m) * 75% =CNY 1,483,333.34 |
- Additional 100% of R&D Expenses Shall be Deducted
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Applicable Entities
Manufacturing enterprises, whose main business is manufacturing and whose main business income are more than 50% of the total income in the year of preferential treatment. Other enterprises, whose manufacturing revenue as a proportion of total revenue is less than 50%.
Example 2
While an enterprise conducting R&D activities in 2021 also engaged in other businesses, including the manufacture and sales of electronic products, and wholesale and retail. At the same time, a building is used for leasing and the catering business. In 2021, a total of CNY 30 million was generated, including product manufacturing income CNY 17 million, wholesale and retail income CNY 4 million, catering income 4 million yuan, and rental income CNY 5 million.
The business activities of the enterprise including wholesale and retail, catering, commercial leasing which are negative list industries, that is, industries where the policy clearly stipulates that the additional deduction is not applicable. Therefore, it is necessary to calculate whether the proportion of manufacturing income exceeds 50% to determine whether the enterprise can enjoy the additional deduction policy. The proportion of manufacturing operating income in 2021 = 17m/30m = 56.67% greater than 50%. Therefore, in 2021, the enterprise belongs to the manufacturing enterprise and can enjoy 100% additional deduction according to this provision.
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Specific Provisions
Where the R&D expenses actually incurred by an enterprise in carrying out R&D activities (no intangible assets formed) are included in the profit or loss of the current period, are allowed to be deducted before tax at 200% of actual expenses incurred from January 1, 2021. If intangible assets are formed, they will be amortized before tax at 200% of the cost of intangible assets from January 1, 2021.
Example 3
A pharmaceutical company began to develop a new drug in 2021, and the actual salary of R&D personnel was CNY 900,000, and the expert consulting fee was CNY 100,000, assuming that no other expenses were incurred. On July 1, 2021, the company obtained clinical approval documents to enter the development stage and met the conditions for capitalization, and the incurred expenses included CNY 1 million in the salary of R&D personnel and CNY 200,000 in expert consulting fees.
Pharmaceutical enterprises belong to the manufacturing industry and can enjoy a preferential policy of 100% deduction for R&D expenses.
Research Phase (January 1to June 30, 2021)
R&D Expenses Additional Deduction Amount = (900,000+100,000) * 100% = CNY 1 million
Development Stage (July 1 to December 31, 2021)
Intangible assets taxable amount in December = 1m + 200,000 = CNY 1.2 million
Amortized at 1.2m * 200% = CNY 2.4 million |
- Expenses Incurred in Entrusting Overseas R&D Activities
Expenses incurred by entrusting overseas R&D activities shall be included in the entrusted overseas R&D expenses of the entrusting party according to 80% of the actual amount of expenses incurred. The part of the entrusted overseas R&D expenses that do not exceed two-thirds of the domestic eligible R&D expenses can be deducted before the enterprise income tax in accordance with the regulations.
The actual amount of the above expenses shall be determined in accordance with the principle of independent transactions. Where there is a relationship between the entrusting party and the entrusted party, the entrusted party shall provide the entrusting party with a detailed breakdown of the expenses of the R&D project.
Example 4
If an enterprise entrusts overseas R&D activities with a cost of CNY 1 million, the entrusted overseas R&D expenses of the entrusted party are calculated according to 80% of the actual amount of expenses incurred, that is, CNY 800,000. If the domestic R&D expenses are CNY 3 million, two-thirds of the 3 million is CNY 2 million, and more than CNY 800,000 can be additional deducted. If the domestic R&D expense is CNY 900,000, two-thirds of the 900,000 is CNY 600,000, and less than CNY 800,000, there is CNY 600,000 that can be deducted.
- When to Declare the Additional Deduction
From January 1, 2021, when the enterprise prepays the enterprise income tax for the third quarter of the year in October (quarterly prepayment) or the September (monthly prepayment), it can choose to enjoy the preferential policy of additional deduction for the R&D expenses of the first half of the year.
Adopt the method of "self-identification, declaration, enjoyment and retention of relevant materials for future reference". Eligible enterprises calculate the amount of additional deductions by themselves, fill in the "People’s Republic of China Enterprise Income Tax Monthly (Quarterly) Prepayment Tax Return (Category A)" to enjoy tax incentives, and fill in the "Detailed List of R&D Expenses Plus Deduction Preferences" (A107012) (no need to submit to the tax authorities) according to the R&D expenses that enjoy the additional deductions (first half of the year), which are retained together with other information stipulated in relevant policies for future reference.
Enterprises can also choose to prepay in October, do not enjoy the additional deduction for R&D expenses for the first half of the year, and enjoy it when they handle the settlement and payment of enterprise income tax in the following year.
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