China Tax: VAT incentives for equipment purchased by R&D centers

The major change under the 2009 reform to China's VAT rules is that general VAT taxpayers can now deduct input VAT incurred on purchases of fixed assets from their output VAT. The reform also abolished the preferential import VAT treatment available to foreign-invested enterprises, including the exemption from import VAT on equipment for R&D centers. However, because R&D centers are not general VAT taxpayers, they are unable to credit input VAT incurred on purchased equipment against output VAT. This potentially can discourage R&D investment – a result that is not in line with China's industrial policy. To resolve this unintended effect of the VAT reform, the Chinese government has issued a circular and a series of detailed implementation rules to provide VAT incentives to R&D centers for purchased equipment, with a view to mitigating their VAT burden.


Regulations on VAT incentives for R&D centers

Circular on Tax Policy of Purchase of Equipment by R&D Centers – The Ministry of Finance (MOF), General Administration of Customs (GAC) and State Administration of Taxation (SAT) jointly issued a circular (Circular No. 115) in October 2009 that grants an import VAT exemption on equipment imported by R&D centers and a full VAT refund on domestically manufactured equipment purchased by R&D centers. The benefits under Circular No. 115 (import VAT exemption and VAT refund), however, only apply until 31 December 2010.

- Import VAT exemption on imported equipment – The import VAT exemption is available to foreign-invested R&D centers (as independent legal entities, R&D departments or R&D branches of foreign-invested companies) provided certain criteria is met and which differs depending on whether the R&D center was established before or after 30 September 2009.

- Full VAT refund on domestically manufactured equipment purchased by R&D centers – R&D centers that are entitled to a VAT refund on domestically manufactured equipment include foreign-invested R&D centers meeting the above criteria, as well as national engineering R&D centers, state key laboratories, enterprise technical centers and other qualified R&D institutes approved by the National Development and Reform Commission, the MOF, GAC, SAT and the Ministry of Science and Technology.

Equipment referred to in Circular No. 115 means experimental equipment and appliances needed to carry out scientific and technology research, development and teaching (a list of qualified equipment is appended to the circular).

Administrative Measures on VAT Refund Policies on Purchase of Domestically Manufactured Equipment by R&D Centers – Further to Circular No. 115, the SAT issued Circular No. 9 in January 2010 that provides details on the procedure to apply for a VAT refund for domestically manufactured equipment purchased by qualified R&D centers and the documentation that must accompany the application.

Measures for Tax Refund/Exemption Qualification Review for Foreign-Invested R&D Centers – In March 2010, the Ministry of Commerce, MOF, GAC and SAT jointly issued more guidance (Circular No. 93) to further clarify the requirements that must be met by foreign-invested R&D centers referred to in Circular No. 115 and the documents to be submitted to support a qualification for the VAT exemption and refund.


Supervision of equipment benefiting from VAT exemption and refund

Domestically manufactured equipment on which input VAT has been refunded will be subject to a five-year review by the in-charge tax authorities. However, it has not been clarified whether the review period commences from the date of the refund or the date the VAT invoice was issued. If the equipment is sold or used for another purpose within the five-year period, the refunded VAT will be recaptured based on the depreciated value of the equipment. VAT invoices relating to equipment on which input VAT has been refunded may no longer be used to claim an input VAT credit.

The Customs authorities also will have a five-year period to review equipment imported by a foreign-invested R&D center with an import tax exemption. If the imported goods are disposed of or used for another purpose within that period, the R&D center will be required to repay the suspended duty and import VAT based on the depreciated value of the imported goods.

Circular No. 93 specifies that if an R&D center transfers, sells, disposes of or uses the equipment for another purpose without approval, an administrative (or possibly criminal) penalty will be imposed. In addition, an R&D center will not be permitted to enjoy the VAT exemption and refund policy for one year or three years if a criminal charge is filed (despite the anomaly that the policy applies only until the end of 2010 according to Circular No. 115) from the date the violation is found to exist.


Comments and recommendations

Expediting and maximizing input VAT recovery is always an issue to be considered, as this will affect the cash flow and operation costs of a company.

Circular No. 115 sets out the VAT exemption and refund policy on equipment purchased by qualified R&D centers, which gives companies a tool for VAT recovery. However, as noted above, the VAT exemption and refund policy is only valid until 31 December 2010. With less than nine months remaining, affected companies should immediately review and assess whether their R&D departments/branches or legal entities engaged in R&D activities qualify. If possible, documents should be prepared and an application submitted to take full advantage of the VAT incentives during 2010. For companies that already benefit from the VAT exemption and refund policy, a sound internal control should be put in place to manage accounting and the actual equipment to ensure compliance with the rules.