Is Your China Subsidiary a High Tech Company? Are You Sure?

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This is not a throwaway question. Having high tech certification (commonly referred to as High/New Technology Enterprise (HNTE) certification) can be the difference between paying 25% enterprise income tax and 15%. A lot of companies have pursued this certification since 2008 when the tax rates were adjusted and a new high tech certification was established. At the time, it looked as though a lot fewer firms would be able to meet the tough new requirements. Now it appears that the process might have been a little easier for some applicants that were willing to cut corners.

[A]long with the arrival of the 10 percent tax reduction was the birth of “false high-tech companies.”

An official at the MST who asked to remain anonymous said, “At least 50 percent of the companies that have already received high-tech certification are not truly qualified. They were certified under falsified materials.” (Caixin)

Well, I suppose this should not come as a shock to anyone. Take a look at the basic requirements, and you can figure out what sort of documentation would be needed and how easy/difficult those documents would be to fake or obtain on the cheap:

According to the High-tech Policy, to obtain certification, companies must meet six requirements. For example, the company must own the intellectual property of the core technology for its main products or services; more than 30 percent of the company’s workforce must hold university degrees, and 10 percent of the employees must work in research and development department; and the company’s research and development budget must account for three to six percent of its total sales.

Let’s see. Is it difficult to get a fake university diploma? No, that’s been demonstrated quite well recently with the Tang Jun diploma scandal. Proving that the tech is being used for a particular purpose, R&D budget issues and ensuring that a certain percentage of the workforce is in R&D is a piece of cake – that’s all internal documentation and easy to manipulate.

That only leaves the IP, and what we’re talking about here is a registered (in China) patent. This can be either owned outright by the China-based firm or licensed (exclusively) from the owner for at least five years.

To give you an indication of some of the flexibility in the system, one client of mine back in 2008 that was filing for HNTE status wanted to use know-how, which is essentially a trade secret(s) that does not enjoy patent protection, to support their application. From the State-level advice we obtained, it was pretty clear that the regulations envisioned a patent right. However, when the company, and perhaps its local agent, approached the approval authorities in Guangdong (I can’t recall what city they were in) to see if a know-how license would be acceptable, they were given the green light.

That story happened during the first year under the HNTE rules, and I haven’t worked for anyone else that was not using a registered China patent to support their application. I don’t know whether other localities have also been flexible on this point, but I have a feeling the government finally drew a line in the sand on this issue and stopped some of these loose application practices.

That being said, there are other ways around the requirement that companies are using. It’s not that difficult to either arrange for a five-year patent license, for a negotiated fee, even if the technology under patent does not quite match up with what the company is planning on doing. Additionally, an applicant could comb through the files of granted patents to find tech that is not being used and purchase it from the owner for the purposes of getting an HNTE application approved.

This is all bad news. The purpose of the program is to provide for a tax incentive to those firms that are using advanced technology. Enterprises that obtain this benefit fraudulently are pretty much guilty of tax evasion and should be punished accordingly.

The good news is that the government agrees with that last point and is now going after these guys. Subsequent inspections of these HNTE certified entities is revealing a lot of these irregularities, and their high-tech status is being revoked. It would also be nice to see some hefty fines and penalties, not to mention criminal prosecutions, but that’s asking a bit too much in a “routine” case of fraud like this.

I know that some foreign-invested enterprises have pursued HNTE certification without meeting all the requirements, and yet through the use of agents, they have received approvals. Perhaps they have done so knowingly, or perhaps their agents have advised them that this sort of thing was tacitly accepted by the authorities.

Either way, companies with HNTE certification should make sure that everything is kosher by performing a quick check of their documentation to ensure that their agent didn’t smooth over a few wrinkles during the application process. You don’t want to get the HNTE rug pulled out from under you sometime in the future.