Global Tax Alert | 20 August 2013

China clarifies implementation of preferential corporate income tax policies for software and integrated circuit industries

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On 25 July 2013, China’s Ministry of Finance (MOF) and the State Administration of Taxation (SAT) released SAT Announcement [2013] No. 43 (Announcement 43) to provide clarifications related to the implementation of preferential corporate income tax (CIT) policies for the software and IC sectors. Announcement 43 is retroactively effective from 1 January 2011.

Software enterprises applicable to preferential CIT policies

Software enterprises eligible for preferential CIT policies (qualifying software enterprises) are those that are recognized as software enterprises by authorized in-charge authorities, obtain software enterprises certification, and are taxed on an actual taxable income basis.

Turnover

The total turnover of qualifying software enterprises includes1 revenue derived from the sale of goods, provision of services, transfers of property, dividends and other equity investment income, interest, rental, royalties, receipt of donation proceeds and other revenues.

First profit-making year

The first profit-making year of qualifying software enterprises is the year that follows the commencement of operations and generates positive taxable income, net of loss carry forwards. Positive taxable income under a deemed basis is also taken into account when determining the first profit-making year.

Continuity of tax holiday period

Once a tax holiday period starts, it continues until a fixed holiday period expires, regardless of whether there is an intervening loss year or for any other reason.

Calculation of research and development (R&D) expenses

Unless otherwise specified, R&D expenses are to be calculated consistent with the principles put forward under Guoshuifa [2008] No. 116.

Transitional arrangements related to the recognition and administration of qualifying software enterprises

Type of enterprises

Provisions

Qualifying software enterprises established and recognized on or after 1 January 2011

  • Recognition and administration of qualifying software enterprises established on or after 1 January 2011 will be in accordance with SAT Announcement [2012] No. 19 (Announcement 19).

Enterprises established prior to 31 December 2010 and yet to be recognized as software enterprises

  • Enterprises recognized as software enterprises pursuant to the criteria as prescribed in Xinbulianchan [2000] No. 968 (Circular 968) will enjoy preferential tax treatments as stipulated in Article 1 of Caishui [2008] No. 1., provided they comply with relevant procedures.
  • Software enterprise qualification will be reassessed annually based on the criteria as prescribed in Circular 968 during their tax holiday.

Announcement 43 also covers matters related to criteria of recognizing IC manufacturing/design enterprises and administration on respective preferential tax policies.

The following summarizes preferential CIT policies for the software and IC sectors.

Item

Software enterprises

IC design enterprises

IC manufacturing enterprises

Preferential CIT policies2

  • Two-year CIT exemption followed by a three-year 50% CIT reduction (generally known as “two plus three tax holiday”) available for newly established qualifying software enterprises and IC design enterprises from the first profit making year commencing prior to 31 December 2017.
  • A 10% reduced CIT rate for qualifying key software enterprises and IC design enterprises under the State's plan, provided that no CIT exemption applies in that particular year.
  • Employee training expenses actually incurred by qualifying software enterprises and IC design enterprises are fully deductible for CIT purposes.
  • Two plus three tax holiday available for IC manufacturing enterprises producing products with IC line width equal to or less than 0.8μm from the first profit making year commencing prior to 31 December 2017.
  • A reduced 15% CIT rate for IC manufacturing enterprises producing products with IC line width equal to or less than 0.25μm or with total investment exceeding RMB8 billion (approximately USD1.3 billion).
  • Five-year exemption followed by a five-year 50% CIT reduction available for IC manufacturing enterprises with an operating period of more than 15 from the first profit-making year commencing prior to 31 December 2017.
  • Depreciation of manufacturing equipment of IC manufacturing enterprises over three years or more.

Value-Added Tax (VAT) refunds received by qualifying software enterprises will be excluded from taxable income provided that VAT refunds are solely used for R&D of software products or expansion of production capacity, and are accounted for separately.

Purchased software that meets the criteria of fixed or intangible assets can be depreciated over two years or longer.

Announcement 43 clarifies the following:

  • Tax holidays for qualifying software enterprises are only applicable to those taxed on an actual basis but when determining the first profit-making year, either actual or deemed positive taxable income is acceptable.
  • The tax holiday period continues consecutively once started. In addition, qualifying software enterprises that commence their operations in the middle of a year are allowed to choose their first profit-making year according to a reasonable principle, but further clarification on implementation is not provided in either Announcement 43 or other prevailing circulars.

Endnotes

1. The term “total turnover amount” is defined in Article 6 of the CIT Law.

2. If a taxpayer is qualified for both IC manufacturing/design enterprise and software enterprise status, the taxpayer must elect either of the two statuses.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Tax Services Limited, Hong Kong
  • Jane Hui
    +852 2629 3836
    jane.hui@hk.ey.com
  • Becky Lai
    +852 2629 3188
    becky.lai@hk.ey.com
Ernst & Young LLP, China Tax Desk, New York
  • David Kuo
    +1 212 773 3660
    david.kuo1@ey.com
  • Vickie Lin
    +1 212 773 6001
    vickie.lin@ey.com
  • Susan Qiu
    +1 212 773 9382
    susan.qiu@ey.com
  • Jessia Sun
    +1 212 773 5955
    jessia.sun@ey.com
Ernst & Young LLP, China Tax Desk, San Jose
  • Diana Wu
    +1 408 947 6873
    diana.wu@ey.com

Ernst & Young LLP, Asia Pacific Business Group
  • Chris Finnerty
    +1 212 773 7479
    chris.finnerty@ey.com
  • Jeff Hongo
    +1 212 773 6143
    jeff.hongo@ey.com
  • Kaz Parsch
    +1 212 773 7201
    kazuyo.parsch@ey.com
  • Bee-Khun Yap
    +1 212 773 1816
    bee-khun.yap@ey.com

EYG no. CM3744