Asia-Pacific Spotlight: Structuring R&D Activities...Generally, China R&D centers have two legal...

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Global R&D Tax News

Issue No. 3October 2011

Asia-Pacific Spotlight: Structuring R&D Activities

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include the United Kingdom’s plan to introduce a patent box regime and the recently approved R&D tax incentives in Australia for Australian-owned subsidiaries and permanent establishments of multinational companies that would enable those businesses to claim the R&D tax offset regardless of intellectual property ownership.

Although a variety of factors affect a business’ decision to locate its R&D operations in a jurisdiction, in this issue, we take a closer look at the structuring of R&D activities in the Asia-Pacific region, focusing on four countries that offer significant R&D incentives: Australia, China, India, and Japan.

I hope you find this issue informative and encourage you to visit us on the web by clicking here.

If you have any thoughts or comments on any of the topics covered, please contact me or any of our country contacts listed at the end of this issue.

Jim ShanahanGlobal Leader, Global R&D Incentives Group +1 (202) 414 1684 [email protected]

Welcome to our October issue of PwC’s Global R&D Tax News

On 20 September, 2011, the OECD released its tenth issue of the “OECD Science, Technology and Industry Scoreboard” which highlights economies using research and development incentives as a means of recovering from the recent financial and sis. The OECD notes that emerging players such as the BRIICS (Brazil, Russia, India, Indonesia, China, and South Africa) are becoming more integrated in the global economy. In efforts to attract business investment, established economies are actively using R&D incentives to attract business investment. Some of these examples

Welcome

©2011 PwC. All rights reserved. “PricewaterhouseCoopers” refers to PricewaterhouseCoopers LLP, a Delaware limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate legal entity.

Global R&D Tax NewsOctober 2011

http://www.pwc.com/gx/en/tax/global-research-development-incentives-group/global-research-development-incentives-group.jhtml

PwC 2© 2011 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers LLP, a Delaware limited liability partnership, which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.

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The Australian Federal Parliament has passed the Tax Laws Amendment (Research and Development) Bill 2010 and the Income Tax Rates Amendment (Research and Development) Bill 2010, which received Royal Assent on 8 September 2011. This development is a “game changer” for Australian business and we are really excited by the opportunities it opens as it begins from 1 July 2011. The outline below will be of interest to companies that have operations in Australia.

Of particular interest may be the relaxation of Australia’s IP rules (allowing for companies now to have IP offshore) and the ability to do certain of activities overseas and still gain support. The new provisions also enables PEs to make claims in Australia for the first time.

Australia Passes New R&D Tax Incentive Program

Old Regime New R&D Tax Incentive (income years commencing on or after 1 July 2011)

Tax Incentive/Relief 1. 125% “super deduction” and2. 175% “super deduction”

1. 45% refundable R&D tax offset for grouped turnover of less than $20 million; or

2. 40% non-refundable R&D tax offset for grouped turnover of more than $20 million.

Volume-based or incremental?

1. Deduction on volume and

2. Deduction on incremental spending

Tax credit based on volume and tax position (additional benefit if <$20mln grouped turnover and in tax loss)

May the R&D be performed outside the country?

Up to 10% if R&D cannot be performed in Australia

Available if less than the amount of expenditure on “core” Australian R&D and:1. R&D cannot be solely performed in Australia and 2. the overseas activity has significant scientific linkage

to at least one of the Australian core R&D activities

May the resulting IP reside outside the country?

IP is commonly owned by the company incorporated in Australia claiming the R&D Tax Concession; however, some situations may arise where IP is held outside Australia subject to “on own behalf” rules

Under the new R&D Tax Incentive, IP may be held outside Australia subject to certain rules

Refundable option? Only for small Companies If grouped turnover <$20 million

Carryforward? Deductions may be carried forward indefinitely in the form of tax losses subject to the normal tax loss rules

Carried forward losses for the non-refundable R&D tax credit

Grants/other Discreet grant funding available and other business incentive

Discreet grant funding available and other business incentive



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Australia Passes New R&D Tax Incentive ProgramContinued

What does this mean for you?The tax incentive program gives rise to new opportunities, including:

• potential cash savings of up to 15 cents for every $1 spent on eligible R&D activities,

• relaxation of the IP rules - greater opportunity to claim ,

• an increased ability to claim overseas R&D, and

• the opportunity to apply for a Private Binding Ruling on R&D activities.

What do you need to do?As the law has now passed through Parliament and applies from 1 July 2011, it is timely for current claimants to:

• proactively review current R&D claims in light of the different eligibility criteria, and particularly the new definition of eligible R&D,

• determine what additional documentation will be required to substantiate claims under the new program,

• establish revised processes to capture R&D information in a contemporaneous manner, and

• consider the additional requirements set out in the legislation (e.g., the required delineation between core and supporting activities and their relevant costs).

If you do not currently have a claim, you should consider whether:

• you meet the new definitional requirements of the new program,

• your company performs R&D in Australia on behalf of a foreign entity (i.e., IP is held offshore),

• you may undertake R&D overseas, and

• to make an R&D claim in light of the increased benefit.

Contact:

Sandra [email protected] + 61 (2) 8266 0470

Tim [email protected] + 61 (2) 8266 5436



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In the past 15 years, China’s economy grew at an average yearly rate of nearly 10%. Recently, China replaced Japan as the second largest economy in the world. In the eyes of many investors, China is not only a low-cost manufacturing location but also an important consumer market. With these significant developments in China, many MNCs’ China strategies change gradually. A new trend among these changes is that more MNCs set up new R&D centers or upgrade existing R&D centers in China to support their expansion in China as well as their global growth.

This article gives a general introduction on the current status of foreign R&D centers in China as well as the major benefits and legal forms for setting up China R&D centers.

Foreign R&D Centers Booming in China

Recent statistics

At of the end of 2009, China had more than 1,200 R&D centers set up by MNCs, of which 465 were established as independent legal entities with approval of the Ministry of Commerce. These independent R&D centers have a total investment amounting to US$ 12.8 billion and registered capital of US$ 7.4 billion. They are mainly located in Shanghai, Beijing, Guangdong, Jiangsu, and Zhejiang.

Currently, most foreign R&D centers in China are focused on products localization, application technology research, and technical support. However, we have seen a trend that some MNCs upgrade their China R&D centers to regional R&D centers or even global R&D centers by moving more important R&D functions to China.



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Major benefits for setting up China R&D centers

Besides facilitating China expansion, setting up China R&D centers would have the following major benefits:

(1) Lower labor cost for R&D activities

Each year China’s universities graduate more engineers (over 500,000) than the US and Germany combined.

(2) Various tax incentives

China provides various tax incentives for R&D-related activities. The following table is a high-level summary of the relevant incentives as well as the IP ownership requirements.

Foreign R&D Centers Booming in ChinaContinued

Tax Type of incentive Description IP Ownership

China-owned

Foreign-owned

Corporate IncomeTax (“CIT”)

Reduced tax rate CIT rate of 25% could be reduced to 15%, if the entity is:• Qualified as New & High Tech Enterprise (“NHTE”); or• Qualified as Technologically-Advanced Service

Enterprise (“TASE”)

(apply for

NHTE status)

(apply for

TASE status)

Tax holiday “2+3” tax holiday for newly established NHTEs in “5 + 1” Zones (e.g., Shanghai, Pudong, Shenzhen, etc.)

Super deduction 150% deduction of qualified R&D expenses Reduction on technology transfer income

• CIT exemption for income not exceeding RMB 5M; and

• Half reduction of CIT on income in excess of RMB 5M

Business Tax (“BT”)

BT exemption Income derived from transfer of technology, technology development, and related consulting service

Income derived from offshore outsourcing services if qualified as TASE

Customs Duty (“CD”)

CD exemption Duty-free importation of self-use equipment and related parts for technology improvement

Local Financial Subsidy

Rebate of the tax revenue retained by the local government authorities



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Foreign R&D Centers Booming in ChinaContinued

Legal forms of China R&D centers

Generally, China R&D centers have two legal forms: stand-alone R&D company, and R&D division of an existing wholly foreign owned enterprise (“WFOE”). We summarize below the pros and cons of these two forms.

Stand-alone R&D company R&D division of an existing WFOE

Pre-requisites • Minimum registered capital: US$ 1.4M• Qualified personnel 80%

• Separate accounting• Business scope amendment required if R&D is not part of

original business scope

Pros • Company identification (e.g., could bear the company brand, logo, or other identification) to build up reputation

• May obtain financial subsidy as a newly established company

• The profit generated from the existing business can be offset against the start-up loss of R&D activities

• Share the same management team and lower admin cost • R&D business can be started in short term, i.e., after the

business scope expansion (about 1-2 months)

Cons • Capital commitment • Additional cost to maintain back

office team• Additional compliance requirement

(e.g., tax filing, annual inspection)• Time-consuming for establishment of a

new entity (at least 3-4 months)

• Additional capital injection might be requested• Difficult to obtain local financial subsidy• No company identification

Looking forward

China already has attracted thousands of companies setting up their R&D centers in China to support the local, regional, or even global market. We believe that China’s enhancement in innovation ability and IP protection will further drive this trend. Considering the complex tax and foreign exchange regulations in China, we would recommend companies plan upfront, analyze, and select the suitable R&D models so as to maximize the benefits and manage the risks.

Contact:

Rebecca Lei WangChina Tax Desk [email protected] +1 (646) 471 7384



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Manufacturing companies in India increasingly are being encouraged through fiscal incentives to undertake “in house” R&D. A popular form of fiscal incentive is to provide weighted deduction of R&D expenditure. The trend started from 1997 when the benefit was advanced only to selected industries. In 2009, this benefit was extended to most industries. The rate of weighted deduction has been progressively enhanced from 125% of the expenditure to 200% at present. This has resulted in many manufacturing industrial houses evincing interest in R&D activities.

However, the law is still relatively new, with several areas open to multiple interpretations. The objective of this article is to discuss one such area: what exactly constitutes expenditure on scientific research?

Weighted Deduction of R&D Expenditure under Indian Tax Law

This is the single most important question for both the taxpayer and tax authorities alike.

“Scientific research” and expenditure on scientific research are defined as follows:

“scientific research” means any activities for the extension of knowledge in the fields of natural or applied science including agriculture, animal husbandry or fisheries;

(ii) references to expenditure incurred on scientific research include all expenditure incurred for the prosecution, or the provision of facilities for the prosecution, of scientific research, but do not include any expenditure incurred in the acquisition of rights in, or arising out of, scientific research;

(iii) references to scientific research related to a business or class of business include:

(a) any scientific research which may lead to or facilitate an extension of that business or, as the case may be, all businesses of that class;

(b) any scientific research of a medical nature which has a special relation to the welfare of workers employed in that business or, as the case may be, all businesses of that class;….

Drawing analogy from above, scientific research in the context of a company carrying on business could be issued to include any activity for the extension of knowledge in the field of applied science that may lead to or facilitate an extension of that business or all businesses of that class.

All expenditures related to the aforesaid should qualify as expenditure on scientific research.



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Weighted Deduction of R&D Expenditure under Indian Tax LawContinued

The question arises: where does scientific research stop and routine begins? This question becomes difficult to answer in a manufacturing setup where the following cycle turns very fast:

The challenge then is to find a robust definition of expenditure on scientific research. As can be seen from the diagram, scientific research draws upon feedback from experience derived in routine working. Is it therefore possible to attribute any part of routine working with the character of scientific research?

Herein starts the dispute with tax authorities. The tax authorities tend to take a view that certain expenditure is part of routine operation only and that it has nothing to do with scientific research, while the taxpayer contends that it is an expenditure on scientific research or is incurred in course of scientific research.

Take the following instances for illustration:

It is provided in the law that the R&D facility should not relate purely to market research, sales promotion, quality control,

testing, commercial production, style changes, routine data collection, or activities of a like nature.

While it is understandable that an R&D facility cannot be involved purely in market research, sales promotion, and similar activity, how about functions like quality control, testing, style changes, etc.?

Quality control

Quality control of products generated in course of routine operation does not qualify as R&D. However, data from quality control may flow as feedback to R&D, which then researches how to remove the defects found in the rejects. If R&D feeds upon basic data from the quality control organization, why is not a part of quality control expenditure eligible as R&D expenditure?

Product/process obsolescence

Product mass produced/process becomes routine

Commercialization

Development of new product/process

Scientific research

Manufacturing set-up



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Testing

The law seems to put a blanket ban on claiming expenditure on any testing as R&D expenditure. However, testing may be required not only of products churned out in routine operation but also in course of R&D. A car manufacturer, for instance, may test every car for road-worthiness prior to releasing it in the market. It is acceptable that such testing is not R&D. But the same manufacturer may be in the process of developing a concept car (which will run, say, on solar energy) and it has to test its idea or prototype again and again till it reaches the stage when it can think of commercializing the concept. If such testing is also not to be considered as part of R&D then the basic foundation of R&D, falls because R&D is all about testing repeatedly till success (at the commercial level) is reached.

Style change

Similarly, it is not clear why style change brought about in course of R&D does not qualify as a permissible R&D activity.

The drift of the law seems to suggest that only very high-end research, which perhaps dwells more in the realm of theory than in practice, is eligible for R&D weighted deduction.

It is doubtful whether that is ever achievable in the commercial world, where some mingling between theoretical R&D with day-to-day business activities is inevitable.

‘In-house’ R&D and its relation with the business of the researcher

The other line of dispute may arise on the import of the phrase “in house.” Today there are very few industrial houses that manufacture a complex piece of

Weighted Deduction of R&D Expenditure under Indian Tax LawContinued

equipment by itself. In many cases, parts of the equipment are manufactured by different entities and the most important part (e.g., the part that requires utilization of proprietary knowledge) and assembling is done by the entity who is known to be the manufacturer of the equipment. If this last entity carried on R&D concerning individual parts which may be manufactured by other contractors, can it be said that it is doing in-house R&D? The tax authority may say that the R&D is not relevant to the business of the researcher because the researcher only assembles such part to make something bigger. Is it a response to contend that its research is relevant to the broader class of business that it is engaged in, even though it may not be relevant to the exact product that it manufactures?

It is in the interest of providing better clarity to tax laws and removing uncertainties that the tax authorities should make public functional details of R&D claims that have been accepted for the claim of weighted expenditure deductions. New rules and laws will develop accordingly.

Contact:

Saurav Bhattacharya

[email protected] +91 (124) 3306527

Rahul Garg

[email protected] + 91 (11) 2321 0543



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Tax credit for R&D costs

In order to enhance sustainable economic growth, Japan provides incentives for innovation. Japanese companies are entitled to various tax credit incentives for R&D costs as outlined in the following table.

Japan - Treatment of Offshore R&D Activities

Tax Type of incentive Description

Tax credit

a) Tax credit calculated on gross R&D cost base 8~10%* of the gross R&D costs* Rate to be applied will depend on the R&D ratio (R&D costs/ average sales)

b) Tax credit calculated on increased R&D cost base (Applicable for the fiscal years beginning between April 1, 2008 to March 31, 2012)

Tax credit of i) or ii), as elected by the taxpayer: i) 5% of the excess R&D costs over the annual average of R&D costs for the last three years (this tax credit

is applicable providing that the current gross R&D costs exceed the one which the company incurred in the last year as well as in the year before the last year); or

ii) excess R&D costs over 10% of the average sales amount x tax credit ratio** ** Tax credit ratio = ((R&D costs /average sales) -10%) × 0.2

c) Specific joint R&D costs 12% (less the above (a) R&D ratio) of the specified R&D costs, including R&D activities jointly conducted with certain institutes such as national research institute or universities.

d) Tax Credit on Technology for Small and Medium Sized Companies (this credit is not available if the company applies a) or c) above)

12% of the gross R&D costs

Limitation of the credit amount 20%*** of the current income tax liabilities for a), c) and d)10% of the current income liabilities for b)***30% for fiscal years commencing between April 1, 2009 through March 31, 2012

Carryover period for excess R&D tax credit amount is one year. The carryover period for the excess R&D tax credit amount occurred in the fiscal years beginning between April 1, 2009 to March 31, 2011 is extended to be available until the fiscal years beginning between April 1, 2010 to March 31, 2013.



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Japan - Treatment of Offshore R&D ActivitiesContinued

The Japanese R&D cost includes expense for outsourcing of R&D activities, unlike the US R&D tax credit. Therefore, there may be an opportunity to claim an R&D tax credit for expense that is paid for R&D activities outsourced to US corporations. Consideration should be given to US R&D tax credit as well as Japanese R&D tax credit in this context.

Contact:

Toshi Matsunaga [email protected] +1 (646) 471 3990

Masato Iwajima [email protected] +1 (213) 830-8347

Mitsumasa Wada [email protected] +1 (213) 356-6348

Toshihiko Kishino [email protected] +1 (213) 830-8344



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PwC Global R&D Incentives Group

Australia Sandra Mason [email protected] + 61 (2) 8266 0470

Tim [email protected] + 61 (2) 8266 5436

Belgium Axel Smits [email protected] + 32 (3) 2593120

Thierry [email protected] + 32 (2) 7107422

BrazilNelio [email protected] + 55 (11) 3674 2000

Canada Vik Sachdev [email protected] + 1 (416) 869 2424

Central Asia and CaucasusRobin [email protected] +1 (995) 32 250 8050

China

Charles Lee (South China)[email protected] + 86 (755) 8261 8899

Edward Shum (North China)[email protected] + 86 (10) 6533 2866

Peter Ng (Central China)[email protected] + 86 (21) 2323 1828

Czech Republic David [email protected] + 42 (02) 5115 2561

Denmark

Søren Jesper [email protected] + 45 3945 3945

France Rémi [email protected] + 33 (1) 5657 4154

Richard [email protected] + 33 (1) 5657 4054

Germany Thomas [email protected] + 49 30 2636 5297

Christian [email protected] + 49 30 2636 3592

Hungary Paul Grocott [email protected] + 36 (1) 461 9260

Robin [email protected] +1 (995) 32 250 8050

India Rahul Garg [email protected] + 91 (11) 2321 0543

Ireland Liam Diamond [email protected] + 353 (1) 792 6579

Stephen [email protected] + 353 (1) 792 6505

Israel Doron Sadan [email protected] + 972 (3) 7954584



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Japan Jack Bird [email protected] + 81 (03) 5251 2577

Ian McDade [email protected] + 81 (03) 5251 2190

KenyaGilles de [email protected] + 1 646 471 1301

Korea Dong-Keon Lee [email protected] + 82 (0) 2 709 0561

Mexico Luis Lozano [email protected] + 52 (0) 55 5263 6000 ext. 8648

Netherlands Richard Hiemstra [email protected] + 31 (20) 88 792 7618

Auke Lamers [email protected] + 1 (646) 471 0570

Chris [email protected] + 31 88 792 32 20

Poland Andrzej [email protected] + 48 (61) 8505151

PortugalPedro [email protected] + (351) 225 433 131

RussiaDavid C. [email protected] + 7 (495) 232 5588

PwC Global R&D Incentives Group continue

Singapore Elaine Ng [email protected] + (65) 6236 3627

Slovak Republic Christiana [email protected] + (421) 2 59 350 614

South Africa Bennie Botha [email protected] + (27) 12 429 0292

Gilles de [email protected] + 1 646 471 1301

Spain José Elías Tomé Gó[email protected] + (34) 915 684 292

Sweden Jorgen Haglund [email protected] + 46 (0) 8 55533151

SwitzerlandStefan [email protected] + 41 (58) 792 4482

Christian [email protected] + 1 (646) 471 5152

Taiwan Shuo-Yen Lin [email protected] + 886 (2) 27296666 3679

TurkeyKadir [email protected] + 90 (212) 326 6526


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This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

SOLICITATION

© 2011 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers LLP, a Delaware limited liability partnership, which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.

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PwC Global R&D Incentives Group continue

United Kingdom Diarmuid MacDougall [email protected] + (44) 1895 52 2112

Rachel [email protected] + (44) 1223 55 2276

United States Jim Shanahan* [email protected] + 1 (202) 414 1684

Jeff [email protected] + 1 415 498 5340

Tim Gogerty [email protected] + 1 (646) 471 6547

For questions about this issue of Global R&D tax news, please contact

Carolyn Singh [email protected] +1 (202) 346 5264

For more information about us, click here.

*Global R&D Incentives Group Leader.


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