Qualifying for China’s Pre-Tax Super Deduction for R&D Expenses – A Case Study Review

China’s tax authorities have released a set of case studies of companies applying for the pre-tax super deduction of R&D expenses, providing valuable context for companies to assess which R&D activity is eligible for the preferential tax policy. We summarize the case studies and discuss what they reveal about the criteria for the China R&D expense pre-tax super deduction.

In March 2023, China’s tax authorities extended the policy of pre-tax super deduction of R&D expenses (“super deduction”) indefinitely, making it a permanent preferential policy for all types of companies in China. 

The super deduction policy allows companies a 200 percent pre-tax deduction of the expenses incurred in conducting R&D activities that do not form intangible assets. The policy means that a company that incurs RMB 10 million in R&D expenses in a given year can deduct 100 percent of the expenses incurred in addition to the pre-tax deduction of RMB 10 million that it would already be granted by law, amounting to a total deduction before tax of RMB 20 million. This will result in considerably lower corporate income tax (CIT) payable for the given tax year.

R&D expenses that lead to the creation of intangible assets, meanwhile, can be amortized before tax at 200 percent of their cost, with no time limit placed on when the intangible assets are formed or amortized. 

While the policy has gradually been extended to all resident companies in China, save those operating in certain restricted industries, the type of R&D activity that a company can claim is still subject to certain eligibility criteria. It is this exact scope that has sometimes been difficult for both companies and the tax authorities to assess, resulting in some confusion and disappointment during the policy’s implementation.

In order to help companies assess whether their R&D activities are eligible for the pre-tax super deduction, the State Tax Administration (STA) has compiled several case studies of companies that successfully or unsuccessfully applied for the deduction. The case studies also explain the reasons for the acceptance or rejection of an application, providing valuable context for the application of the eligibility criteria. 

Below we outline the scope of R&D activity eligible for the super deduction and look at some case studies to better understand how the requirements are implemented in practice. 

Which R&D activities are eligible for the super deduction?  

The scope of R&D activities that are eligible for the super deduction is still implemented in accordance with the 2015 Notice on Improving the Pre-tax Super Deduction Policy for R&D Expenses (Cai Shui [2015] No. 119) (“Announcement No. 119”).  

Announcement No.119 states that, in order for the R&D expenses to be eligible for the super deduction, they must have been spent on “systematic activities with clear objectives that companies continue to carry out to acquire new scientific and technological knowledge, creatively apply new scientific and technological knowledge, or substantially improve technologies, products (or services), and processes.” 

Announcement No. 119 clarifies that expenditures on the following activities are not eligible for super deduction:  

• Routine upgrades of enterprise products and services;  
• The direct application of a scientific research result, such as the direct adoption of publicly available new processes, materials, devices, products, services or knowledge, and so on;
• The technical support activities that companies provide to customers after the commercialization of a product or service;
• Duplication or simple changes to existing products, services, technologies, materials, or processes;
• Market research, efficiency research, or management research;
• Routine quality control, test analysis, repair, and maintenance, or when these activities act as part of an industrial or service process; and
• Research in the social sciences, arts, or humanities.  

In addition to R&D activities carried out by the company itself, the R&D expenses incurred through commission, cooperation, centralized R&D, and other forms can also enjoy the super deduction.   

In July 2023, the STA and the Ministry of Science and Technology released an updated set of implementation guidelines, the Implementation Guidelines for the Super Deduction Policy for R&D Expenses (Version 2.0) (“2.0 Guidelines”). These guidelines provide additional clarity on the different kinds of R&D expenses that are eligible for deductions, as well as more details on the types of activity that are deemed to be R&D. This includes specific explanations of the difference between R&D and non-R&D activity in fields such as technology and software development, as well as requirements for the management structure of R&D projects. 

For a more detailed breakdown of the permitted R&D activity and application procedures, see our full explainer on the Pre-Tax Super Deduction of R&D Expenses in 2023. 

Case studies: Evaluation of R&D activity 

Case 1: Clear R&D objectives and demonstrable technological innovation 

In the first case accepted for the super deduction, a company is seeking to enhance the vehicle braking system response speeds beyond the current standards, based on an analysis of the current status of electronic power-assisted braking systems both domestically and internationally.

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This specific type of project falls under the Chinese Ministry of Commerce’s list of “key nationally supported high-tech areas”, specifically “Advanced Manufacturing and Automation” in the field of “Automotive Key Component Technology”, although this is not a pre-requisite for the super deduction. 

The company has outlined the core technologies and technological innovations that it aims to achieve, as well as technological milestones that it has already attained. 

This application underwent an expert evaluation organized by the Ministry of Science and Technology (MOST), which determined that the project qualifies as being involved in R&D activity. The rationale for this decision is that: 

1. The project has clear innovation objectives and is considered to be “breaking through existing technological bottlenecks” This is listed as one of the considerations for whether a project can be considered “R&D activity” in the 2.0 Guidelines. Specifically, the company outlines how it combined certain technologies and processes in order to improve the performance of the current braking system. It also outlined six improved functions of the braking system, four key technologies that it had mastered, and six technical index values or numerical ranges that it had achieved, which were compared with those of similar domestic and international products.
2. The project follows a systematic organizational structure, beginning with a project feasibility report and proceeding with project implementation involving a diverse range of personnel with various expertise and clearly defined responsibilities. In addition, the company’s existing technological capabilities, equipment, facilities, and other necessities met the requirements for the described R&D activity.
3. The R&D results carry uncertainty. The project will be implemented over a three-year period, progressing from “data absorption and product design development” to “small-scale trial production”. This indicates that the outcomes of the project were not certain from the offset, and the company also detailed necessary testing, improvements, and enhancement that will be conducted at each stage in order to reach the expected technological milestones through an iterative trial-and-error process.
4. The company provided adequate documentation to support the claims of the project, having filed patent applications for the technology involved. 

Case 2: Lack of innovation in objectives and inadequate demonstration of processes 

In the second case provided by the STA, a company applied for the super deduction for a project which aimed to “achieve breakthrough innovations in office intelligence and comfort” through the development of a “Smart Multi-functional Office Desk”. 

When detailing the technologies and innovations used for the project, the company provided a description of some of the functions of the technology used. The company did not provide any details of technological milestones that it hoped to achieve during the course of the project. 

The project was submitted for an expert evaluation organized by MOST, who concluded that the project “lacks innovation and does not qualify as R&D activity”.  

The reasons for this outcome were: 

1. The project objectives lack innovativeness, as the “Smart Multi-functional Office Desk” merely combines existing mature components (such as “office desk”, “rotating drawer,” “USB port”, “power outlet”, and “LED light”), which are already well-established products in the market. 
2. The company did not adequately demonstrate the project’s technological roadmap from the perspective of the path to technical implementation. Instead, the development roadmap is briefly outlined from “project feasibility analysis to the overall design to confirmation of the technical scheme and manufacturing process to sample production”, and so on. In addition, no quantitative technological indicators were established during the project’s implementation.
3. The company did not provide adequate experimental records in the project implementation process (such as relevant experimental test records, performance data, product photos, or supporting materials), instead describing the completion of the project merely as “completed according to the project requirements and achieved corresponding technical goals.” Without setting quantitative assessment criteria, the conclusion states that “all parameters have met the standards and satisfy the requirements of the project design.” 

Due to the project’s lack of innovativeness, the expert evaluation found that it fell under one of the scenarios that are not considered R&D activities outlined in Announcement No. 119, specifically, under the item of “Duplication or simple changes to existing products, services, technologies, materials, or processes”. 

Case 3: Lack of innovation and uncertainty of outcome 

In the final case provided by the STA, a company aims to develop a “WeChat Community Fan Management Platform” that incorporates conversation monitoring and AI customer service, in an effort to address what it sees as operational pressures, inadequate services, and emerging security risks of companies conducting business operations through the social media platform and super-app WeChat. 

In the application, the company detailed the various new technologies and software that it will use for the project, including various types of ACS cloud technology, data transmission security technology, and data protection technology. 

The company did not set any intended quantitative technological milestones. 

In this case, the expert evaluation organized by MOST concluded that the project did not amount to R&D activity as it lacked innovation. The reasons for this were: 

1. The project objectives lack innovativeness, as it involved the development of a simple application for the WeChat platform, with objectives that are similar to various types of online customer community management that already exist in the current market.
2. The project primarily utilizes existing mature technologies to modify business processes, failing to showcase technological innovation. The company employs WeChat mini-program technology for frontend development and existing technologies for backend processes. In addition, the messaging systems used are well-established software technology frameworks that have been demonstrated to be highly accessible and user-friendly.
3. The R&D results lack uncertainty as they involve routine software-related activities using existing information technology for WeChat application development. The outcomes of these activities are therefore predetermined. 

The evaluation determined that the project falls under the category of “direct application of a scientific research result, such as the direct adoption of new publicly available processes, materials, devices, products, services or knowledge” under the disqualified activity outlined in Announcement 119. 

Key takeaways for evaluating R&D activity 

The case studies provided by the STA show a clear emphasis on the need for a company to show that its R&D project involves a certain degree of innovativeness. In addition, the cases highlight the importance for companies to adequately clarify the technologies they are using or plan to use, the implementation processes (which may include a clear project roadmap, key personnel, and project management structure), milestones, and breakthroughs that have already been achieved, and the desired outcomes of the project.

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Finally, the cases also highlight the importance of uncertainty in evaluating whether a project can be considered an R&D activity. Within the parameters of R&D, uncertainty is important to prove whether the potential outcomes of a project are indeed innovative. A certain or pre-determined outcome of a project would indicate that the technologies, processes, uses, or other parameters have already been established in previous research, therefore eliminating the possibility that the project outcomes are indeed new or innovative. 

In the table below, we provide a sample checklist of the criteria for a successful application for the super deduction, based on the outcomes of the case studies published by the STA. Note that this checklist is for reference only and that the tax authorities may consider more criteria when evaluating whether a project is considered R&D activity. 

The STA notes that the above evaluations are made within the context of the current level of technological advancement within a given industry, which is subject to constant change. An R&D project which is considered to be making breakthroughs one year may therefore no longer be considered innovative the next year if it has already become established within the industry in the meantime. It is therefore important for companies to consider the current level of technological development within their industry when considering which project may be eligible for the R&D deduction.

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