Interpretations on New Policy for High-tech Enterprises: Circular Guo Ke Fa Huo [2012] No.1220

Posted by hwuason2012 on January 29, 2013 under High Tech Enterprises | Be the First to Comment

On January 11th 2013, Notice of Inspections on High and New Technology Enterprises Recognition and Administration (Circular Guo Ke Fa Huo [2012] No.1220), jointly issued by the Ministry of Science and Technology, Ministry of Finance and State Administration of Taxation, was released by the Ministry of Science and Technology on its official website. The Notice points out that the three ministries would launch joint inspections on high-tech enterprises nationwide. Considering the subjects, the scope and the time periods of the inspection, it has been the most stringent and extensive inspection since the promulgation and implementation of the Administration Measures for High and New Technology Enterprises Recognition and Administration (Circular Guo Ke Fa Huo [2008] No.172) in 2008. Based on our knowledge and expertise accumulated in providing tax services for high-tech enterprises, Hwuason Lawyers hereinafter interprets the Notice with respect to its background, key points and coping strategies for the enterprises.
Ⅰ. Background on formulation of Circular Guo Ke Fa Huo [2012] No.1220
Looking back at the implementations of High and New Technology Enterprises Recognition and Administration over the past five years, it is not difficult to figure out the hidden political and economical factors behind this circular. Concluded from some tracking surveys focusing on the High and New Technology Enterprises, the following three aspects are worthy to be noticed.
A. Follow-up inspections on high-tech enterprises keep intensifying
Over the past five years, National Audit Office, Ministry of Finance and Ministry of Science and Technology respectively launched a variety of special inspections on High and New Technology Enterprises. And according to their reports, many high- tech enterprises did not satisfy the requirements of High and New Technology Enterprises on certain aspects.
According to Audit Results Announcement [2009] No. 9 and Audit Results Announcement [2011] No. 34 published by National Audit Office, 102 high-tech enterprises in total were found disqualified as High and New Technology Enterprises. And the tax incentive amount enjoyed by these fake High and New Technology Enterprises reached up to 6.296 billion RMB during the fiscal year 2009 and 2010. Meanwhile, Ministry of Finance also carried out special inspections concerning High and New Technology Enterprises. And 35 high-tech enterprises were cancelled of their High and New Technology Enterprises Statues in spot checks in Beijing. Owing to the cancellation, these enterprises were not allowed to apply for High and New Technology Enterprises within five years and would later be imposed by the tax authorities to pay the back taxes and penalties correspondingly.
Influenced by the terrifying results revealed by National Audit Office and Ministry of Finance, Ministry of Science and Technology also takes steps to strengthen the inspections on High and New Technology Enterprises gradually. So far, it has already cancelled more than 1000 high-tech enterprises (mainly large and medium sized enterprises) in Beijing, Shanghai, Jiangsu, Guangdong, Tianjin, etc.
B. The tax incentive has significant impacts on the national tax revenues
According to official statistics, the total number of High and New Technology Enterprises reached over 60,000 by the end of 2012. And that number in Beijing alone exceeded 8000, almost 13% of the total number. Taking the four main cities for instance, namely Beijing, Shanghai, Suzhou and Tianjin, the amount of enterprises successfully gaining High and New Technology Enterprises Statues has been declining each year since 2008. Meanwhile, the figure of New Technology Enterprises which successfully renewed their statues in fiscal year 2011 and 2012 has also been reducing drastically. (See chart below)


Data Sources: http://www.innocom.gov.cn/web/

Although the overall number of High and New Technology Enterprises decreased substantially each year, the tax incentives enjoyed by high-tech enterprises are still huge and their impacts on the national tax revenues could never be underestimated. It is said, in the taxable year 2012 alone, the tax relief amount enjoyed by all current High and New Technology Enterprises may surpass 200 billion RMB. Therefore, it is for sure that tax incentives on high-tech enterprises have significant influence on the domestic tax revenues. And this also explains why the relevant ministries including State Administration of Taxation and Ministry of Finance pay more and more attentions to the Recognition and Administration of High and New Technology Enterprises.
C. The application materials may partly differ from the reality of the enterprises
There are some differences between the requirements of High and New Technology Enterprises and their implementation. In fact, the requirements of high-tech enterprises are stricter than their implementation. Since the high-tech statue is quite beneficial to tax saving and financing, some enterprises make up their research projects and financial data in order to fit for the requirements, which actually leads to the inconsistency between the application materials and the reality of the enterprises.
The purpose of the inspection jointly launched by Ministry of Science and Technology, Ministry of Finance and State Administration of Taxation, is to cancel those disqualified High and New Technology Enterprises and to make sure that the tax incentives on High and New Technology Enterprises are enjoyed by eligible high-tech enterprises only. It is also an effective measure to ensure the legitimacy and effectiveness of the tax policy and benefits for the industrial structure optimization.
Ⅱ. Interpretations on key points of Circular Guo Ke Fa Huo [2012] No.1220
A. The scope of the inspection is extensive
Since the enactment of the Administration Measures for High and New Technology Enterprises Recognition and Administration (hereinafter referred to as “the Measures”) in 2008, the central departments and the local departments have never stopped their inspections on High and New Technology Enterprises. As a matter of fact, previous inspections were solely launched by a certain department such as National Audit Office, Ministry of Finance, the Ministry of Science and Technology, etc. And the scopes of the prior inspections were restricted to certain provinces and the number of the inspected High and New Technology Enterprises (mainly large and medium sized Enterprises) was also quite limited. However, the inspection launched this time has no such limitations. And the scope of the inspection is quite extensive, covering High and New Technology Enterprises Recognition and Administration authorities, intermediary institutions involved in High and New Technology Enterprises Recognition, experts involved in High and New Technology Enterprises Recognition and High and New Technology Enterprises within the validity period.
B. The methods and the time periods of the inspection are concrete and specific
According to the notice, the inspection is divided into two stages, namely self-correcting stage and focused inspection stage. In self-correcting stage, the provincial Recognition and Administration authorities will launch inspections on High and New Technology Enterprises within the validity period concerning their application materials, etc. It begins on January 1st 2013 and lasts until April 30th 2013.
As for the disqualified High and New Technology Enterprises spotted in self-correcting stage, the provincial Recognition and Administration authorities will cancel their High and New Technology Enterprises Status. In focused inspection stage, based on the feedbacks of the first stage, National High and New Technology Enterprises Recognition and Administration Office will conduct focused inspections. High and New Technology Enterprises who reject self-correcting, may be faced with joint inspections by the three ministries and their inspections may date back to the year they obtaining the High and New Technology Enterprises Statues. According to the Measures, Recognition and Administration authorities will refuse to accept the applications from enterprises which are cancelled of their High and New Technology Enterprises Statues within five years. Apart from the back taxes and the penalties, the cancelled high-tech enterprises may also suffer losses of future profits and the sad events will have negative effects on companies’ reputation.
C. The main issues of the inspection and the reminds of potential risks
The inspections on High and New Technology Enterprises are definitely key elements of the notice, although the scope of the inspection also covers the Recognition and Administration authorities, the intermediaries and the experts.
Based on our experiences accumulated in providing tax advisories for high-tech enterprises, Hwuason Lawyers suggest companies pay special attentions to the following issues.
First, most enterprises applying for High and New Technology Enterprises Statues meet the requirement of resident enterprises. However, some enterprises registered no longer than one year want to apply for the Statues. And the R&D expenses, the revenues derived from the high-tech products and services, proprietary intellectual rights, etc. may not reach the standards due to such a short operating period. Second, some groups include certain R&D expenses or proprietary intellectual rights of their subsidiaries into the application materials of their parent companies. However, according to the company law, the parent company and the subsidiary are independent and such mixture do not comply with the law actually. Generally, the Measures set strict rules on High and New Technology Enterprises as for the proprietary intellectual rights, the proportion of the R&D expenses and the proportion of the revenues derived from the high-tech products and services, the proportion of R&D personnel, etc. As far as we known, the following problems are quite common in some High and New Technology Enterprises.
1. Defects on proprietary intellectual rights
As for proprietary intellectual rights, the inspection will emphasize on several aspects, mainly the obtaining time of intellectual property, the compliance of exclusive license agreement, the scope of intellectual property and its certificate, the relatedness of intellectual property, etc. In High and New Technology Enterprises Recognition Work of 2012, some provincial High and New Technology Enterprises Recognition did not recognize proprietary intellectual rights gaining from the exclusive license agreements and the obtaining time of intellectual property was restraint from 2009 to 2011, which meant the intellectual property acquired in 2012 would not take into account. In addition, the proprietary intellectual rights of some traditional enterprises are software copyrights which may suffer substantial higher risks of being questioned on intellectual property aspects.
2. Deficiencies on R&D expenses imputation
As for R&D expenses, the inspection will mainly emphasize on recognitions of the R&D activities, imputation of R&D expenses, proportion of the R&D expenditure, compliance of external R&D activities, etc. In practice, some high-tech enterprises have deficiencies on R&D expenses imputation, such as lacking auxiliary accounts to impute R&D costs, low proportions of the R&D expenditure in total sales revenues, the source of external R&D expenses, etc. For example, a High and New Technology Enterprise in Zhejiang province was cancelled of its High and New Technology Enterprise Status during a previous inspection because the proportion of R&D expenditures is only 0.65%, which obviously was required to pay back taxes and penalties in the fiscal year 2008 and 2009 by the tax authority. Some foreign-invested companies include their royalty expenditures into external R&D expenditures, which indeed do not accord with the law. In addition, some enterprises don’t set R&D auxiliary accounts to impute the R&D expenses and their R&D expenses are mixed with other expenditures. In such circumstance, the reported R&D expenses statistics may not recognized easily by the High and New Technology Enterprises Recognition and Administration authorities.
3. Deficiencies on the proportion of revenues derived from the high-tech products and services
As for the revenues derived from the high-tech products and services, the inspection will mainly stress on the scope of high technology, the imputation of the revenue and its proportion, the relatedness of the revenue, etc. According to the Measures, the proportion of revenues gained from high-tech products or services of annual gross income shall exceed 60%. In 2010, due to the low proportion of high-tech revenues, a listed company in Wuhan was cancelled of its High and New Technology Enterprise Statue and was required to pay back taxes and penalties accordingly. In addition, as for some high-tech enterprises, a large proportion of high-tech revenues come from technology services. However, some enterprises fail to put their technology contracts on records in technology contract registration organizations. According to the Administration Measures on Recognition and Registration of Technology Contracts, technology contracts for which no application for recognition and registration has been made or which have been denied registration shall not be eligible for State preferential policies in such areas as tax, credit, incentives, etc. for the promotion of the technological transformation of scientific and technological achievements.
4. Deficiencies on majors, degrees and proportions of personnel
As for personnel, the inspection will mainly focus on the imputation of personnel, the proportion of scientific and technological personnel and R&D personnel, etc. According to the Measures, the proportion of scientific and technical personnel of total employees shall exceed 30% and the proportion of R&D personnel of total employees shall exceed 10%. When calculating certain kind of personnel, it is worth mentioning that the scientific and technical personnel and R&D personnel are divided into full-time employees and part-time or temporary employees. As for full-time employees, enterprises shall sign labor contracts with them. As for part-time or temporary employees, their accumulated working time in the enterprises shall be over 183 days annually. There are certain requirements on majors, degrees and proportions of R&D personnel as well. Therefore, it is in vain that some enterprises include certain staff majored in art or not engaged in R&D work into R&D personnel.
Aside from the above four aspects, the enterprises shall also attach great importance to the interrelationships among R&D, Intellectual Properties and high-tech revenues. And the controversies between R&D and Intellectual Properties or between R&D and high-tech revenues are easily discovered during the inspections. At the same time, the R&D organization and management level, the ability to transform scientific and technological achievements, the growth rate of sales and assets shall all keep in line with the requirements in the High and New Technology Enterprises Recognition and Administration Guidelines.
Ⅲ. Coping strategies to Circular Guo Ke Fa Huo [2012] No.1220
According to the Measures, High and New Technology Enterprises shall be cancelled of their status on condition of providing false information, evading taxes, having major safety or quality accident, being punished by certain authorities, etc. Once the enterprises are cancelled of their statues, the Recognition and Administration authorities shall not accept their applications within five years. Since the inspection has retrospective effects on the process of High and New Technology Enterprises recognition, High and New Technology Enterprise shall pay attention to the inspection and avoid potential risks after gaining the status. The following suggestions are provided by Hwuason Lawyers in order to help enterprises better coping with the inspection.
A. Improve the abilities to obtain intellectual properties and their transformation
As for proprietary intellectual rights, the centrality and the relevance with main business are key elements in inspection. Hwuason Lawyers suggest enterprises check their authorized intellectual properties carefully. Assuming the enterprises possess the patents by signing exclusive license contracts instead of independent R&D and the patents are not highly related to their high-tech domains, enterprises shall confirm their R&D achievements by other reasonable methods. As far as we known, intellectual properties which are closely connected with main business and high-tech domain are more likely to be recognized by the Recognition and Administration authorities. Any problems concerning proprietary intellectual rights, enterprises may resort to professional consulting firms for advisories if necessary.
B. Optimize the account management of R&D expenses
1. The imputation of R&D expenses
It is suggested that enterprises with High and New Technology Enterprise Statues review their current financial systems and set up independent accounts for the imputation of R&D expenses in order to be better fit for the requirements of the Measures. If possible, enterprises may conduct R & D expenses audits annually and reflect such expenses directly in financial statements.
To be more specific, enterprises may set up independent accounts under the subject of administrative expenses to impute the R&D expenses. And usually enterprises may need to set up three to six sub-accounts in accordance with their actual needs.
2. The establishment of auxiliary accounts
Circular Guo Ke Fa Huo [2012] No.1220 clearly states that enterprises shall impute expenses strictly in accordance with the provisions. And enterprises shall establish auxiliary accounts for supplements. In addition, auxiliary accounts shall be consistent with the special audit reports. Meanwhile, enterprises shall also optimize the collecting process of financial receipts concerning R&D projects and activities. And it is recommended that the financial receipts are attached with sufficient demonstrations of exclusive expenditures for R&D activities. For example, the raw materials for production shall separate from the raw materials for R&D. And the raw materials for R&D shall be marked and attached with the specific project’s name and the signature of R&D personnel. Previously, enterprises impute the raw materials for R&D by a certain proportion of the total raw materials. And there is a trend that such imputation may be denied by the authorities. Moreover, the raw materials for R&D shall highly relate to R&D projects.
3. The management of R&D projects
After acquiring High and New Technology Enterprise Statues, enterprises may also enjoy other tax incentives such as the additional deduction for R&D expenses. Most of these tax incentives are based on R&D projects. Therefore, we suggest enterprises strengthen their management of R&D projects, especially their regulations on R&D projects management and regulations on R&D investment accounting.
4. The filing procedure of High and New Technology Enterprise
After acquiring High and New Technology Enterprise Statues, enterprises need to go to local tax authorities for filing procedures. Meanwhile, according to Notice on the Issues Concerning Implementation of the Preferential Income Tax for High-Tech Enterprises (Circular Guo Shui Han [2009] No.203), enterprises shall submit the following materials to the tax authorities before submitting the annual tax return.
(a) Demonstrations on high-tech products or services belonging to national key supported high-tech fields;
(b) Annual schedules of R&D expenses structure;
(c) Demonstrations on proportions of revenues derived from high-tech products or services in gross revenues;
(d) Demonstrations on proportions of the scientific and technological personnel and R&D personnel.
R&D expenses and revenue schedules are two main concerns during almost all inspections every year. Therefore, enterprises shall impute their R&D expenses by R&D projects constantly and attach relevant demonstrations on revenues, which are sure to benefit for later inspections.
Take a foreign invested group in China (hereinafter referred to as Group A) as an example. Group A is a world leading supplier of auto parts and auto accessories. It has a headquarters, several manufacturing plants, trading companies, procurement centers and R&D centers in China, which covers R&D, manufacture and sales systems of major auto markets. Currently, many subsidiaries of Group A have the High and New Technology Enterprise Statues and enjoy the tax incentive. It is alleged that these subsidiaries suffered deficiencies on proprietary intellectual rights or proportion of R&D expenses. As for proprietary intellectual rights, since Group A is a foreign invested group, a considerable number of intellectual properties of Group A are acquired in the foreign county which doesn’t satisfy the requirements of the Measures. As for R&D expenses, it wrongly included the royalty expenses into external R&D expenses. When providing tax consulting services to High and New Technology Enterprise, we met many groups with similar structures. With strong sense of risk management and professional tax advisories on business operation, Group A well fits for all requirements with respect to proprietary intellectual rights, proportion of revenues derived from high-tech products or services, etc. Meanwhile, Group A annually sets aside 6% of turnovers for R&D and gradually increases the R&D investments in China markets. And it plans to deliver relevant materials to State Intellectual Property Office to apply intellectual properties for its R&D achievements. All these work will be beneficial for the maintenance of its High and New Technology Enterprise Statues.
As the growth rate of China’s macro economy slows down, the tax authorities are under great pressure to collect sufficient taxes. Some tax authorities have already cancelled a certain amount of High and New Technology Enterprises by tax audits. And these enterprises paid the back taxes and penalties subsequently. Therefore, all high-tech enterprises within valid period shall strictly comply with the law and manage the potential tax risks in order to cope with the severe inspections smoothly.

For more information or advice on the above tax issues, please feel free to contact us by Tianyong Liu (liutianyong@hwuason.com) or Lingyan Hu (hulingyan@hwuason.com). You can visit our website at www.hwuason.com or our tax blog at www.chinataxblog.com.

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Hwuason Lawyers, a prominent law firm with a focus on taxation, are committed to providing comprehensive tax law services including international tax, tax consulting, tax planning, tax incentives, tax controversy, etc. And we are granted ALB China Law Awards and Chambers China Awards respectively in 2012 for our excellent performance in taxation.

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