Insight

With recent news that Apple plans to open a new R&D centre in China, what is Australia’s largest trading partner doing right to attract and retain R&D, innovation and commercialisation?

One contributor is the “High and New-Technology Enterprise Program”, a patent box style program with strong links to local R&D, reinvestment of revenue into IP development, and creation of high value jobs.

At Griffith Hack we’ve put on our myth busting goggles to analyse the claims and lay out the facts.

Like other patent box style regimes around the world, the Chinese HNTE program operates to reduce the corporate tax payable on profits for intellectual property rich enterprises that meet the eligibility criteria.

The regime reduces China’s general corporate tax rate from 25% to 15% for eligible HNTEs, and has been in force since 2008.

What does it cover?

China’s program goes beyond traditional patent box schemes to provide lower tax rates to firms that qualify for HNTE status, the requirements for which include that the company:

  • spend at least 3% to 5% of gross revenue on R&D;
  • have 60% of firm revenue from core IP (defined as inventions, utility model patents, software, copyrights, proprietary layout designs, and new plant varieties); and
  • have 10% of their workforce employed in R&D or high tech occupations.

This explicit focus on company activity is a relatively unique approach to determining eligibility for the reduced tax rate. Where many European patent box programs focus on the IP assets themselves (and where they were developed), the HTNE program hones in on what the company is actually doing in China in terms of R&D investment and employment.

This clearly links the benefit to the intent of the policy - to encourage investment in innovation and knowledge development for the long-term benefit of the Chinese economy.

How does it work in practice?

To use an example of how these requirements would encourage both R&D activity and the retention of IP in China, we can look at Apple’s decision to open its new R&D centre.

The requirement for Chinese R&D and employment means that Apple can’t simply move ownership of its existing IP (e.g. patents) to China, and access the reduced tax rate. To access the program, Apple needs to set up a physical R&D presence in China, develop new technology and IP, and maintain ownership of that IP in China. The flow on effects of this are knowledge retention in China, the creation of high-value jobs, and the generation of new revenue (which can be taxed by the Chinese government).

Over the period since the HNTE program was introduced, total spend on manufacturing R&D in China has jumped from $US92 billion in 2008 to $US243 billion in 2013, according to the Organisation for Economic Cooperation and Development.

Compared to other patent box nations, China is ahead of the curve in terms of ensuring that its program encourages substantive activities like R&D and manufacturing. It does this by only offering the reduced tax rate to companies that have undertaken R&D predominantly in-country, as well as linking the program to specific R&D spend and employment requirements.

These factors clearly show China’s willingness to invest in its own future by forfeiting some immediate tax revenue in pursuit of long-term knowledge development and exploitation. They also help to ensure the integrity of the program by preventing exploitation through relocation of intellectual property purely to take advantage of the benefit.