Since 2008 the Chinese government awarded a preferential tax status of “High and New Technology Enterprise” (HNTE) to companies that work in special high tech areas and fulfil the innovation requirements as listed in the Administrative Measures for Recognition of High and New Technology. Many companies, including foreign companies with R&D activities in China, have been able to apply for this tax status successfully which effectively reduces the corporate income tax to 15% (a significant tax benefit to the normal 25% rate).

The Administrative Measures have now been revised (Guokefahuo [2016] No.32 as issued by Ministry of Science and Technology (MOST), Ministry of Finance (MOF) and State Administration of Taxation (SAT), issued on 29 January 2016). Whilst the requirements for minimum R&D expense ratio and academic qualification of personnel have been relaxed, the requirement for Intellectual Property (IP) Ownership has been tightened.

IP counsel should be aware that “a global exclusive license for over five years” can no longer be the basis of the IP ownership requirement for the benefitted tax entity. A licensing practice of this type will not be supported from now on to obtain the status and has been deleted from the regulations. The new definition provides that the company in China “shall own IP rights of key technologies which show core support to their main products (services) gained through independent research and development, transfer, donation or acquisition.”

From this definition it is evident that there is a focus on self-independently created high tech innovation and full ownership of the key technologies. Foreign companies with an R&D unit in their Chinese entities must evaluate whether they can meet the tightened requirements considering their IP ownership structure. Although it is currently not clear yet whether current status holders must fulfil the same conditions under reassessment procedures, it can be assumed that is likely the case.

IP counsel in multinational or overseas companies must therefore consider tax matters when deciding whether certain inventions from Chinese R&D centres should be owned locally instead of being transferred to IP holding entities overseas. It may be difficult for many foreign companies to qualify under the new conditions with their existing IP ownership structures.

The new Administrative Measures also increase mandatory document support requirements in the application procedure and establish an annual reporting and audit system.  During such audits IP counsel may be challenged to prove (a) the technology relevance (“key technologies”), and (b) the core linking relationship of the respective IP (specifically the patents) to the main products (services) of the HNTE.

Loss of tax benefits for past periods as well as penalties may result from such audits in the case of incorrect representations or statements in the application documents.