As discussed in the accompanying article on general tax issues for manufacturing-based foreign investment enterprises ("FIEs") operating in China, most FIEs can benefit from various types of tax incentives, although mostly depending on the nature of the industry, or the location of operations. This article provides specific coverage of the major tax incentives available to technology-based companies.
In considering which incentives may be available to a particular type of entity, it is important to remember that certain entities can fall under more than one classification. As such, multiple entitlements may apply concurrently, rather than being mutually exclusive. However, classification as a technology-related entity depends on meeting certain criteria and certification requirements. Finally, the preferential tax treatment of technology-based companies does not always distinguish between FIEs and domestic enterprises.
I. Enterprise Income Tax ("EIT") Incentives
1. Reduced EIT rates in special investment areas
Subject to national certification rules, High and New Technology Enterprises ("HNTEs") established in High and New Technology Industrial Development Zones ("Hi-tech Zones") can benefit from a reduced EIT rate of 15 percent.
A key certification requirement is that the HNTE must engage in the research, development, or production of one or more of the specified high and new technologies or related products, or provide relevant technical services. These specified technologies include electronics, information technology, biology, new materials, machine computerization, new energy sources and environmental protection.
FIEs that are established in the Coastal Open Economic Zones or in the old urban areas where Special Economic Zones or Economic and Technical Development Zones are located will only be eligible for the reduced rate of EIT at 15 percent if they are recognized as engaging in projects that are either technology or knowledge intensive.
2. Tax holiday
A foreign-invested HNTE established in a national Hi-tech Zone qualifies for two-year exemption from EIT starting from the first year of profit-making. If the HNTE could also be considered as a manufacturing enterprise, the HNTE may enjoy the same 2+3 tax holiday available to foreign invested manufacturing enterprises with an operation term of more than 10 years, that is, two-year exemption from EIT from the first year of profit-making, followed by a three-year period of 50 percent reduction in EIT. Specifically, the HNTEs established in the Zhongguancun Science Park, China's first Hi-tech Zone, may enjoy a 3+3 tax holiday, that is, three-year exemption from EIT from the first year of profit-making, followed by a three-year period of 50 percent reduction in EIT, starting from the year of establishment.
After the expiration of the above tax holiday, if the enterprise could be certified as a Technologically Advanced Enterprise, the enterprise may enjoy 50 percent reduction of EIT for another three years. However, the effective EIT base rate of the enterprise shall not be lower than 10 percent.
Before 2010, the 2+3 tax holiday is also available to certified IC or software enterprises without geographical restrictions.
Once certified, newly established IC design firms can enjoy the standard 2+3 EIT tax holiday. To be certified, the enterprise must demonstrate that its business scope is primarily IC design, that it has the staff, facilities and expertise consistent with basic IC design processes (including quality control), and that at least 30 percent of its annual revenue comes from the sale of independently designed products or commissioned products. Interestingly, there is no certification requirement relating to holding or acquiring intellectual property rights ("IPR").
Newly founded IC manufacturers can also benefit from the 2+3 tax holiday, provided their products have a line width of no more than 0.8 microns. IC manufacturers with a total investment of at least RMB 8 billion, or whose products have a line width of less than 0.25 microns may be entitled to additional tax benefits. In particular, if the enterprise is located in certain areas, it will enjoy a five-year exemption from EIT from the first year of profit-making, followed by a five-year period of 50 percent reduction in EIT. It may also import raw materials and other consumable goods on a VAT-exempt and customs duty-free basis.
Certified software enterprises are also entitled to the 2+3 tax holiday, subject to them developing or holding the IPR to one or more software products. However, off the record discussions with local software associations in Beijing and Shanghai suggest that even if the enterprise only provides software development services on a commissioned basis, and does not hold the IPR, it may still be certified.
3. Reinvestment refund
Among the broader tax incentives available to manufacturing and other FIEs, a number also provide additional preferential treatment for technology-related FIEs. For example, the tax refund for reinvesting profits in an FIE is 100 percent of the EIT already paid on the reinvested amount, where the FIE qualifies as a Technologically Advanced Enterprise.
4. Bonus deduction of R&D expenses
An FIE that increases its annual technological development expenses ("R&D Expenses") by 10 percent or more than the immediately preceding year will be entitled to deduct an extra 50 percent of the actual amount of the R&D Expenses incurred during that year.
II. VAT Refund
General VAT taxpayers can claim VAT refunds on domestic sales of self-developed-and-manufactured software products, in the amount of the VAT that exceeds 3 percent. Training fees, maintenance fees and other fees charged by a general VAT taxpayer together with sales of software products also qualify for the VAT refund. There are national level certification rules for the registration of software products. Interestingly, as provided in the Beijing local rules and in practice, an enterprise that purely manufactures or duplicates software in Beijing can also enjoy a VAT refund.
Previously there was a similar VAT refund available to sales of IC products. The US had claimed that the refund violated the WTO national treatment principle. In July 2004 China reached agreement with the US to withdraw the VAT refund, effective April 1, 2005. Prior to March 31, 2005, the VAT refund remains available only to IC enterprises and IC products certified before July 14, 2004.
III. Business Tax Exemption
A taxpayer's revenue from technology transfers, technology developments and related technical consultancy and technical services is exempt from business tax. The exemption applies to all enterprises including foreign invested enterprises and foreign enterprises.
By Stephen Nelson / Peng Tao, Baker & McKenzie
