Technology innovation is the engine that will drive the 21st century economy. With growing economic demand for core technologies from Chinese enterprises, recent years have witnessed the robust development of Intellectual Properties ("IP") transactions in China, in which tax issues are often important elements to consider when structuring IP transactions, especially for the IP transfers carried out in the context of IPOs, mergers, acquisitions, or investment projects. We will discuss in the article the major PRC tax considerations for IP transfers, especially for cross-border IP transactions, with a view to achieve tax optimization and ensure tax compliance for such transactions.

I. Tax Cost of IP Transfers

Under the PRC tax regime, transfer of IP ownership and IP use rights are both regarded as a transfer of intangible assets, and the applicable tax cost may include income tax (enterprise income tax ("EIT") or individual income tax ("IIT"), business tax ("BT") and stamp duty ("SD").

In an IP transaction, the resident enterprise transferor shall consolidate the income derived from the IP transfer with its other taxable income and subject to EIT at 25%. While non-resident enterprise transferors are usually liable for withholding tax on the income derived from the IP transfer, at the general tax rate of 10%, or a lower withholding tax rate as stipulated by the applicable tax treaty (tax arrangement).

If the transferor is a Chinese individual, the transferor shall be subject to IIT at 20%, and the transferee shall have withholding obligations. If the transferor is a foreigner, the relevant tax treaty (arrangement) may apply.

Pursuant to Provisional Regulation of Business Tax i, BT shall be imposed on IP transferors, which includes not only resident enterprises and individuals of China, but also non-resident enterprises and foreign individuals. The tax base is the total consideration and additional fees and charges the transferor receives from the IP transfer, and the BT rate is 5% ii. In terms of cross-border IP transfers, the domestic transferees shall act as the BT withholding agent.

According to the relevant stamp duty regulations, any enterprises or individuals (including non-resident enterprises and foreign individuals) that enter into IP transfer contracts in China shall be subject to SD, at the rate of 0.03% or 0.05% of total contract amount iii, payable by each contracting paritie respectively.

II. Tax Incentives for IP Transfer

To encourage the development of the technology industry and accelerate technology innovation and communication, the State Administration of Taxation ("SAT") has issued a series of tax preferential policies in recent years, encouraging IP transactions, especially technology transfers. The preferential policies regarding IP transfer are mainly focused on EIT and BT.

A. EIT Exemption for Technology Transfer by Resident Enterprises

The EIT Law provides that, when the technology transfer meets certain criteria, the resident enterprise, as the transferor, may be exempted from EIT on the gains for the first RMB5 million, and is subject to 50% reduction of EIT. for the amount exceeding RMB5 million.

B. BT Incentives for Technology Transfer

According to the Circular on Tax Issues Related to the Implementation of the Decision of Strengthening Technical Innovation, Development of High Technology and the Realization of Industrialization ("Circular 273") iv, income derived by enterprises or individuals v from technology transfer and related technology consultation and technology services vi may be exempt from BT, subject to the relevant registration and application procedures.

C. BT Exemption for IP contribution as Capital

According to the Circular on Business Tax Issues Concerning Equity Transfer[vii], for a capital contribution in form of intangible assets, if the contributor is entitled to profit sharing and assumes corresponding risks for the investment, the IP contribution as capital shall not be subject to BT. As such, it can be a tax efficient tactic to utilize IP when devising investment or business divestment strategies.

III. Key Tax Considerations in relation to Cross- Border IP Transfer

In light of the rapid development of technology exchange and increasing demand of IP in China's marketplace, the tax issues involved in cross-border IP transfers become increasingly important. Tax treaty provisions, transfer pricing , and tax withholding obligations shall also be considered for the cross-border IP transactions.

A. Tax Treaty Benefits

Generally speaking, the cross-border transfer of IP ownershipshall be governed by the provision of "capital gains" under relevant tax treaties, while the transfer of IP use rights shall be subject to the provision of "royalties" of the tax treaties. The foreign transferor may benefit from preferential tax treatment on "royalties" as stipulated by the relevant tax treaties (such as a withholding tax rate of 7%, rather than the general 10% tax rate, on royalties under China-Hong Kong Tax Arrangement, and the following issues shall be noted when applying for the treaty benefits:

  1. The Scope of Royalties

  2. Royalties shall be in relation to the use, or the right to use the following items: various forms of literature and art constituting rights and property, or intellectual property identified in the relevant texts and information concerning industrial, commercial or scientific experimentation. Royalties include the income derived from the use of, or the right to use, industrial, commercial or scientific equipment, i.e., rental of equipment, and the damages paid for infringement of IP rights.

    Similar to the provisions under Circular No. 273, the income derived from providing technological consultation and services in relation to technology license shall be categorized as royalties. Nevertheless, where the service provider provides certain knowledge or techniques without licensing the right, the relevant fees shall not be categorized as royalties.

  1. The "Beneficial Owner" Test

  2. "Beneficial Owner" refers to a person who has the right to own and dispose of the income and the rights or properties generated from the said income. It is usually engaged in substantial business activities. Circular on How to Understand and Determine the 'Beneficial Owners' in Tax Treaties (Guoshuihan [2009] No. 601) ix provided a series of factors in determining whether the applicant is qualified as "Beneficial Owner", which offers a legal basis for tax authorities in determining "Beneficial Owner" in practice. Notably, where there is another contract between the applicant and the third party on the right to use or own a copyright, patent or technology apart from the contract on the transfer of the right to use or own a copyright or technology, from which the royalties are generated and under which the said royalties are paid (such as "back to back" technologies transfer or license), it may have negative impact on the "Beneficial Owner" assessment. As such, where a cross-border IP transfer may be entitled to a favorable tax treaty provision, the factors that may make adverse impact on "Beneficial Owner" under Circular No. 601 shall be carefully considered when structuring the transactions so that Beneficial Ownership implication will not be triggered.

B. Transfer Pricing Issues

According to relevant tax laws, the principle of "arm's length" shall be adopted for transactions between an enterprise and its related party, if the taxable revenue or profit of the enterprise or its related party is decreased due to deviation from the arms length principle, tax authorities may make an adjustment through a reasonable method. As such, for cross-border IP transaction between related parties, if the transaction price is lower than a reasonable price without sufficient justification, it may be challenged or subject to examination and tax adjustments by the tax authorities.

C. Tax Withholding at Source

According to the PRC Tax Collection and Administrative Law x, where the transferee fails to fulfill the withholding obligations, the tax authorities shall pursue the taxes overdue, and the withholding agent will be subject to penalties within a range from 50% to 300% of the tax overdue.

In light of the above analysis, taxpayers may properly optimize favorable tax policies when structuring IP transactions. For cross-border IP transactions, it is advisable to be well positioned in terms of the eligibility of tax treaty benefits, transfer pricing issues and tax compliance issues in China, to ensure the tax efficiency and manage the potential non-compliance risks.

Foonotes

i The Provisional Regulation of Business Tax was adopted at the 34th executive meeting of the State Council on November 5, 2008 and became effective as of January 1, 2009.
ii Local tax and charges are not taken into consideration for the tax discussion in this article, which include Educational surcharges and urban maintenance and construction tax, mounting to 10% of BT payments.
iii The stamp duty rate is currently 0.03% for patent application transfer and non-patented technology transfer, and 0.05% for patent transfer, patent license contract, as well as transfers or licenses of the trademark or copyright.
iv Circular 273 was jointly issued by Ministry of Finance and State Administration of Taxation on November 2, 1999 and became effective as of October 1, 1999.
v It includes not only resident enterprises, but also non-resident enterprises and foreign individuals.
vi To enjoy this BT exemption, related technology consultation and technology services must be included in the same invoices as that for technology transfer.
vii The Circular on Business Tax Issues Concerning Equity Transfer was jointly issued by Ministry of Finance and State Administration of Taxation on December 10, 2002 and became effective as of January 1, 2003.
viii China-Hong Kong Tax Arrangement was signed by China Mainland and Hong Kong on August 21, 2006 and became effective in China Mainland as of December 8, 2006.
ix Guoshuihan [2009] No. 601, issued by the SAT in 2009.
xTax Collection and Administrative Law was adopted at the 21st meeting of the Standing Committee of the ninth National People's Congress of the PRC on April 28, 2001 and became effective as of May 1, 2001.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.