Whether Research and Development activities related are deductable under VAT

Within an enterprise, for the research and development activities (R & D activities), purchasing raw materials is subject to the corresponding input tax for deduction. In practice, there has been controversy.    (Summary as follows)

Firstly, Scope of Input of VAT related to the R & D activities

R & D activities, within the enterprise, involves anyone of the followings which correspondently includes input VAT items which are deductible, namely: -

  • (1)  R & D activities consume raw materials, tools, consumables, etc.
  • (2)  R & D activities consume water, electricity, fuel, power and so on.
  • (3)  Purchases of machinery and equipment under R & D activities.
  • (4)  R & D activities due to VAT taxable services purchased.

Secondly, the definition of R & D activities:-

VAT legislation does not specifically define R & D activities, but in the "State Administration of Taxation on the Issuance" of corporate research and development, expenses for tax deduction management approach (Trial) “Notice" ( Guo Shui Fa [ 2008 ] No. 116 ) and the "High-tech enterprises - the Management Guidelines" ( Guo Ke Fa [ 2008 ] No. 362 ), it is somewhere involved. These two documents cover the definition of R & D activities which are basically the same. According to the requirements of Guo Ke Fa [ 2008 ] No. 362, “research and development activities” means "to obtain scientific and technical (not including the humanities, social sciences) new knowledge and creative application of scientific technology and new knowledge, or substantially improves the technology, products (services) and on-going activities with clear objectives. Creative application of new scientific and technological knowledge, or substantially improved technology, products (services) is an enterprise with technology, product (services) innovations that has made valuable progress in the region (province, autonomous region, municipality or planning cities) with relevant industry role in promoting technological progress, not including companies engaged in routine upgrades or direct application of research which results in a particular and other activities (such as direct introduction of new processes, materials, devices, products, services or knowledge, etc.)"  In view of the above, the regulations are mainly for the purpose of limiting the scope to enjoy preferential corporate income tax. For research and development activities, the required standard is relatively high, with particular emphasis on "for the region (province, autonomous region, municipality or planning cities) with relevant industry role in promoting technological progress", which apparently ruled out a lot of the smaller internal R & D activities.

Accounting requirements that may be much more universal. "Enterprise Accounting Standards No. 6 - Intangible Assets", it provides internal research and development expenditures that should distinguish between research expenditures and development expenditures. Research is to acquire and understand new scientific or technological knowledge of the original and planned investigation.  Development means of commercial production or use of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, etc.  In contrast, the accounting provisions for "flexible" is bigger, but whether it is accounting or tax regulations, it have emphasized the "new or substantially improved," the basic characteristics of R & D activities.

Further research which combines with general practice can be drawn from the R & D activities that covered by the terms:  1. Although income tax regulations exclude "the humanities and social sciences", there are no restrictions on the accounting, which not only refers to natural science research and development activities, but also including the humanities and social sciences.     2. R & D activities that is not only occur in the field of VAT taxation, but may occur in non-VAT taxable sectors such as agriculture, construction and installation industry, post and telecommunications, other services and so on.

In the process of R & D activities:-

  • (1)   R&D activities that are divided into research and development phase.
  • (2)   R&D activities that are likely to be successful, generating scientific and technological achievements, these results including patents (invention patents, utility model patents and foreign concept design patents) and non-patented technology.
  • (3)   R & D and technological achievements are in line with certain conditions that should be capitalized.
  • (4)   In practice, successful research and development activities may also be the produced products, product sales, and in an extreme case, the product sales revenue. Even be larger than the entire R & D investment.
  • (5)   R & D activities are likely to fail or it does not produce any scientific and technological achievements or products.

R & D activities must have different results and it obviously has various situations. Deductibility of its input also should not be unique.

Thirdly, Analysis of Input of the R & D activities that are VAT deductable

  • (1) If the company is mainly engaged in the industrial area of non-value-added tax, those input related to R & D activities occurred during the process, even it has obtained VAT invoice, cannot be deducted.
  • (2) If the company is mainly engaged in the industry of the VAT tax field, this R & D activities occurred during the corresponding process. Can it be deductable?  This requires a detailed analysis:-


(A) Those involved a major regulatory authorized deductable input in VAT

A.   "The People's Republic of China Provisional Regulations on VAT" Article 10, the following items of input tax shall be tax deducted:-

  • 1. For non-VAT taxable items, VAT exemption items, the collective welfare or personal consumption goods or taxable services;
  • 2. Abnormal losses related to purchase of goods and taxable services;
  • 3. Abnormal losses in finishing products when consumed, purchased goods or taxable services;
  • 4. The accounts, tax authorities which define those self-own consumer goods of the taxpayers.

B.   “Provisional Regulations of the PRC VAT " Article 23, in Article 10 (1) of the Regulation, items and the rules referred to non-VAT taxable items, refers to the provision of non-VAT taxable services, transfer of non-intangible assets, sales of real estate and real estate construction in progress.

(B) R & D activities related to the main points of the input tax deductible:-

A. One view is that R & D activities, if successfully developed and meet the "Accounting Standards" which provide conditions, it should be capitalized. That is some kind of scientific and technological achievements in the development of successful accounting. it should be credited as "Intangible assets."  If it is later have transferred to the intangible asset, then according to the tax law, it provides that "transfer of assets" belongings to non-VAT taxable project, it should be transferred with the original input VAT that charged to the corresponding intangible assets for transferred out. If the intangible asset is not transfer, but it has been used by a company for amortization, because it is not related to "transfer of assets" behavior, according to the tax law, it is not a "for non-taxable items", then it should not be made VAT payments for turn out.
B. Another view is that the R & D activities spend in the entries in the "Intangible", then it should be the input tax out at the time of transfer. Because the reference to real estate regulations, tax law also provides that "Sales of real estate and real estate in construction project" does not allow deductible input tax, but in practice, as long as the enterprises purchase raw materials for the real Estate, or real estate construction in progress, regardless of whether sales should be done immediately transferred out of input VAT.
C. There is a much more stringent view on R & D activities, whether it generates intangible assets that are a "Non-value-added tax taxable services" and are supposed to put into input tax for roll-out.

(C)  Analysis

The core of the problem that R & D activities related to input tax deduction lies in where the general industrial enterprises that engaged in R & D activities are "Non-VAT taxable services."

According to "Provisional Regulations on VAT implementation”, Article 5, it stipulates in details that for non-VAT taxable services,  the payable inputs are transportation, construction, finance and insurance, post and telecommunications, culture and sports, entertainment, service tax items such kinds within scope of services. In addition, according to Cai Shui Zi [1999] No. 273, it stipulates that the unit and individual that engaged in the transfer of technology, skills, technique development business and related technical consulting, technology services business achieved revenue, are exempt from sales tax, technology development. It refers to the developer to accept on behalf of others, new technologies, new products, new processes or new materials and systems for research and development behavior. From a general point of view, R & D activities are basically the same as mentioned in the document of the "Technology development", not only had it a "trustee development," the other is "self-developed" in the essence that it should be of no difference. From this point of view, R & D activities involve these points should not be allowed for input tax deductible.

However, as previously mentioned, if there is a successful R & D activities for new products, new product for sales revenue, even with greater R & D investment, it is necessary to levy VAT on the new products, but also the corresponding input tax for deduction that is not allowed. It is not only that it meets the normal logic, but also it conforms to the principle of VAT taxation. Crack lies in another statute, namely taxation [2005] No.165 document, although under normal circumstances for technology transfer, technical develop of the scope of taxation are sales tax, but there are exceptions, according to the taxation [2005] No. 165, it provides that the taxpayer entrusted with the development of software products, the copyright belongs to the trustees of the VAT, the copyright belongs or belonged to both sides of the commissioning party which have not subject to VAT. In the tax policy of software development, the distinction between value-added tax or sales tax is "Copyright belongs to" metastasis, if copyright is not transferred, the development activities are considered as "soft products", the essence is to provide a value-added tax service for VAT, if there is a transfer of work which is considered as non-VAT service, sales tax levy.

(D)  Conclusion

For industrial enterprises, R & D activities are more generally for the purpose of production of new products or improve processes, although it may appear as the transfer of technologies that is a minority. According to Law "substance over form" in principle, it is believed that the reference for software development company requires an enterprise regardless of its success of R & D activities, involves input VAT that should be allowed deductible in the current purchase.

  1. Consider VAT taxation principles, for general industrial enterprises, R & D activities are more closely related to their products or services from. The point of view is its nature should belong to a kind of "right product, labor production (processing) processes, reprocessing procedures". This "re-processing program", the value regardless of the purpose or results are, is ultimately reflected into the product.
  2. If the R & D activities in the formation of intangible assets, and the transfer of that assets has not completed, then either according to the tax or accounting requirements, this part of the intangible assets should be amortized as intangible assets from the entire life cycle, the value of intangible assets has actually passed into an annual amortization of the value of the product and the product through sales already paid the corresponding output tax payments. From this perspective, this part of the intangible asset is ultimately bore output tax payments. So according to the general principles of VAT, which corresponds to the input tax shall also be deducted.
  3. If the intangible asset is not in the enterprise that has been used, but the midway was transferred, then refer on the fiscal tax [2005] No. 165, as it ultimately did not subject to the "VAT taxable items", the transfer should be in that period, have been considered as amortization period of the corresponding input VAT for roll-out.


Fourth,   Another issues for R & D activities related input for VAT deduction

Another issue that needs to be clarified for R & D activities is that it cannot deduct input tax payments per requisitioned materials. Another failure is based on research that consumed raw material, power and other losses belong to the "Provisional Regulations on VAT" Article 10 (b) "Abnormal losses in finished products consumed by purchasing goods or taxable services."  For this point of view, according to the "Provisional Regulations on VAT implementation details,”  The provisions of Article 24, Article 10 of the Regulations (2), the term abnormal loss is the result of mismanagement by stolen, lost, spoiled rotten losses. It can clearly conclude that R & D activities failure is a common condition under the "mismanagement".  There is no relationship but do not belong to the "stolen, lost, rotten bad", so it clearly do not belong to the above-mentioned documents under the abnormal range of loss.