In China, qualified software enterprises enjoy a 2+3 tax holiday. Starting from a qualified enterprise’s first profitable year, it receives two years of earned income tax (EIT) exemption followed by a 50% reduced EIT during the next three years. As attractive as the tax incentive is, it has been relatively unsuccessful in attracting multinational software corporations because of the requirement that the software enterprise register its intellectual property (IP) in China. Most multinationals balk at this requirement and forego qualified status and the 2+3 tax holiday.
Recently, the State Administration of Taxation (SAT) and the Ministry of Industry and Information Technology jointly promulgated a new notice, Gong Xin Bu Lian Ruan [2013] No. 64, which introduced a new set of qualification rules for software enterprises, effective from 1 April 2013. Notice No. 64 has made the following changes:
- The approval authority has been changed from the local software industry association to the Ministry of Industry and Information Technology and its provincial level departments;
- The qualification standards for software enterprises have been relaxed in places and made more stringent in others. For example, the required percentage of employees with educational credentials at or above college level and engaged in R&D activities has decreased from 50% to 40%. The required minimum R&D expenditure percentage has been changed from “8% of the software revenue” to “6% of the overall revenue of the enterprise”, with the additional requirement that no less than 60% of the R&D expenditures must be incurred within China. The requirement on sales revenue from self-developed software also changed, from “50% of the software sales revenue” to “40% of the enterprise’s overall business revenue”.
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Another important point is that the 2+3 tax holiday starts to run from the software enterprise’s first profitable year. It is in a company’s best interests to obtain approval for its software enterprise status before the annual EIT settlement for its first profitable year – i.e., 31 May of the following year – to enjoy fully the 2+3 tax holiday. If a company obtains the software enterprise status approval after the annual EIT settlement following its first profitable year, it will only be able to enjoy the remaining years of the tax incentive, i.e. one year of exemption followed by three years of the 50% reduced EIT.
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Business Law Digest is compiled with the assistance of Baker & McKenzie. Readers should not act on this information without seeking professional legal advice. You can contact Baker & McKenzie by e-mail at: Zhang Danian (Shanghai) danian.zhang@bakermckenzie.com
