In recent years, foreign companies have been building up their research and development activities in China. According to the Ministry of Commerce, there are more than 2010 R&D branches of multinational corporations in China, involving the likes of Motorola, IBM, Lucent, GE, DuPont, P&G, GM, Volkswagen and Intel.
Most are situated in the big cities. Beijing is the most popular location for the IT sector and US companies, while European companies in the automotive and chemical sectors prefer Shanghai. R&D centers in Guangzhou and Shenzhen are generally found in the IT and electronic sectors. The Ministry of Commerce estimates that, in the next five years, the number of R&D centers will double.
There are several factors behind this rapid expansion. First, R&D offices help to expand market share by introducing new products that satisfy local needs. For instance, the Chinese versions of Windows developed by Microsoft Beijing R&D Centre have been very successful in the local market.
Second, there are plenty of universities and institutions in the big cities where it is easy to and high quality researchers and engineers. Labour costs are also low compared with other parts of the world. In the software industry, for example, the average labour cost in India is twice that of China. Third, the Chinese government has provided policy incentives to foreign investment in R&D, mainly in the form of tax incentives.
The Catalogue of Guidance on Foreign Investment Industries, promulgated by the Ministry of Foreign Economic & Trade Cooperation (Moftec, which was merged into the Ministry of Commerce in April 2003), classified foreign investment into four categories – encouraged, permitted, restricted and prohibited. The latest revision to the catalogue in April 2002 promoted R&D from 'permitted' to 'encouraged' foreign investment. The new catagorisation means that, whatever the total investment size, setting up an R&D centre only needs government approval up to provincial level, approval from the central government is no longer necessary. In April 2000, Moftec issued a notice that specified the permitted forms of foreign-invested R&D; incorporated as a limited liability company, or a department or branch office of a limited liability company.
Under the Moftec notice, foreign-invested R&D centers must engage in research, development and experimental activities in the area of natural science and related scientific fields. They may conduct research in basic science, applicable science and high technology. The notice prohibits them from engaging in any manufacturing activities for commercial purposes and technology trade activities, except the transfer of its own research products to other parties.
Basically, there are two types of operation model for an R&D centre to transfer its research products. If it decides upon the research activity, the research product may be transferred to any party. The alternative is when the foreign parent company instructs its R&D centre to conduct research, for which it would be paid expenses plus a reasonable profit. Here, the intellectual property ownership of the research product would belong to the foreign parent company.
In both these cases, the R&D centre is subject to the provisions of China's Administration Regulation on Technology Import & Export. If the research product involves freely transferred technology, it may be transferred to any foreign company. However, if it falls into the category of export-restricted technology, an export license is required before the transfer can be made.
The government has granted certain tax incentives to foreign-invested R&D centers.
When a R&D centre imports equipment, instruments or spare parts for its own use, import duty and import-related VAT on such materials are exempted. To be eligible for exemption, the value of the imported material may not exceed the sum of the center's total investment. The imported material must also not feature in the Catalogue of Imported Material without Tax Exemption for Foreign-invested Projects, issued by Customs in 1997.
When equipment, instruments or spare parts are imported to replace or repair existing equipment, import duty and import-related VAT are waived no matter what the value. The funds used to import equipment and spare parts may come from its revenues. reserves or depreciation, but not from a loan.
When an R&D centre acquires intangibles from foreign companies, which are list-ed in the Catalogue of the State High and New Technology, it is granted relief to pay import duty and imported-related VAT on royalties paid by the centre in connection with the acquired intangible.
Any act involving the transfer of technology or the provision of technical consultancy services is subject to 5 percent turnover tax. R&D centers are exempt from paying this tax.
A R&D center has to pay income tax at a rate of 33 percent if it is not located in a special economic zone such as Shenzhen, or a high-tech industrial zone, such as Suzhou Industrial Park. However, if its research or experimental expenditures -increase by at least 10 percent on the previous year, half of such expenditures are deductible from its taxable income.
Although the Chinese government has tried to reduce the tax burden for R&D centers in order to attract more foreign investment – in this area, the current tax incentives are widely considered to be insufficient. For instance, while foreign-invested manufacturers enjoy a two-year exemption period and then a three-year reduction in income tax, there are no such inducements for R&D centers.
Moreover, they face a problem when it comes to turnover tax exemption. Currently, they are required to pay turnover tax at the outset and then file an application for exemption and reimbursement with the tax-authorities. When reviewing the application, the tax authorities require an appraisal report from the government agency in charge of science and technology. The R&D center has to go through a complicated and lengthy process to get the appraisal report from the government agency. Some would rather pay the turnover tax than go through such a laborious procedure.
Another problem involves the fact that computers and automobiles are not exempt from import duty and import-related VAT, which significantly increases the cost burden for R&D centers in the computer and auto-mobile sectors. They need to pay these taxes when importing advanced computers or automobiles as samples for research or trial manufacture purposes.
This article was written by Yue Tang of the Jun He Law firm in Beijing. Set 01) in 1989, Jun He is one of the top China-based Law firms with some 130 attorneys in Beijing, Shanghai, Haikou, Dalian and New York.