Background of the reform
In China, there are two major kinds of turnover taxes, i.e. VAT
and business tax ("BT"). They cover different scopes of
transactions. The VAT system mainly covers import and sales of
movable/tangible goods, while the BT system covers services,
transfer of intangibles and immovable properties. A few exceptions
are processing, repairing and maintenance services which are
covered by the VAT system, not the BT system.
The BT system has been widely criticized for not having the
input-output credit mechanism which is adopted in the VAT system.
Such feature of the BT system means that BT costs are not
recoverable by either party. Further, in case of subcontracting of
services, the portion of the subcontracted service value will be
taxed twice for BT purposes (once at the main-contractor and once
at the subcontractor). In addition, due to the different tax rates
and systems, the simultaneous operation of both VAT and BT systems
has caused various administrative problems for both taxpayers and
tax authorities.
To solve the above problems and to ultimately eliminate the BT
system, the PRC government has recently taken actions to launch a
pilot tax reform starting from 1 January 2012. For the time being,
this reform is limited to Shanghai. However, ultimately, it is
expected to be extended to all over China in the future. On 16
November 2011, the PRC State Administration of Taxation (SAT) and
the Ministry of Finance ("MoF") jointly issued a notice
regarding their general plan of replacing the BT system with the
VAT system ("the Plan"). In accordance with the Plan,
details of the Shanghai Pilot Program are provided under the Tax
Circular Caishui [2011] No.111 ("Circular
111").
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Full Article
Background of the reform
In China, there are two major kinds of turnover taxes, i.e. VAT
and business tax ("BT"). They cover different scopes of
transactions. The VAT system mainly covers import and sales of
movable/tangible goods, while the BT system covers services,
transfer of intangibles and immovable properties. A few exceptions
are processing, repairing and maintenance services which are
covered by the VAT system, not the BT system.
The BT system has been widely criticized for not having the
input-output credit mechanism which is adopted in the VAT system.
Such feature of the BT system means that BT costs are not
recoverable by either party. Further, in case of subcontracting of
services, the portion of the subcontracted service value will be
taxed twice for BT purposes (once at the main-contractor and once
at the subcontractor). In addition, due to the different tax rates
and systems, the simultaneous operation of both VAT and BT systems
has caused various administrative problems for both taxpayers and
tax authorities.
To solve the above problems and to ultimately eliminate the BT
system, the PRC government has recently taken actions to launch a
pilot tax reform starting from 1 January 2012. For the time being,
this reform is limited to Shanghai. However, ultimately, it is
expected to be extended to all over China in the future. On 16
November 2011, the PRC State Administration of Taxation (SAT) and
the Ministry of Finance ("MoF") jointly issued a notice
regarding their general plan of replacing the BT system with the
VAT system ("the Plan"). In accordance with the Plan,
details of the Shanghai Pilot Program are provided under the Tax
Circular Caishui [2011] No.111 ("Circular 111").
Main Content of the Shanghai Pilot Reform
1. Affected industries and taxpayers Starting from 1 January
2011, tax payers registered in Shanghai shall pay VAT instead of BT
for the following Taxable Services:
- Transportation services (including road, water, air and pipeline transportation);
- R&D, technology transfer, technology consulting, energy management contract and reconnaissance and prospecting;
- IT technology services including software services, circuit design and testing, IT system services and business process management;
- Design services; transfer of trademark, goodwill and copy rights; IP related services; advertisement; conference and exhibition services;
- Logistics-related services such as warehousing, fright forwarding, customs agency services, etc;
- Lease of movable tangible assets (including financial lease and operation lease);
- Certification services, authentication services (including authentication services in the areas of accounting, tax, asset appraisal, law, real estate evaluation and project cost estimation) and consulting services (including consulting services in the areas of finance, tax, law, internal management, business operation and process management).
Foreign entities and individuals providing the above Taxable
Services to tax payers in Shanghai shall also pay VAT (not BT) in
China. In such case, the Shanghai service recipients shall withhold
the VAT payable by the foreign service providers from the gross
amount and remit it to the competent tax authority in
Shanghai.
2. Applicable VAT rates and tax calculation
a) General VAT payers and small-scale VAT payers
VAT payers are divided into general VAT payers and small-scale VAT
payers with different tax rates and calculation methods.
A tax payer engaged in the above Taxable Services with an annual
transaction value of above RMB 5 million is required to apply for
the general VAT payer status. Small-scale enterprises with a
transaction value below the threshold can also become general VAT
payer upon application if they keep proper accounting
records.
b) Tax rates for general VAT payers A general VAT payer can issue
VAT invoices and credit its input VAT against its output VAT. The
applicable VAT rates for calculating output VAT are as
follows:
- 17°/о for lease of movable tangible assets;
- 11 °/о for transportation services;
- 6°/о for other Taxable Services.
c) Small-scale tax payers
A small-scale VAT payer shall pay VAT at 3°/о on the
gross amount for its Taxable Services and is not able to credit any
input VAT. A small-scale VAT payer can not issue VAT invoices by
itself but can ask the tax authority to issue VAT invoices for
it.
d) Exportation of services
The Plan stipulates that a zero VAT rate or VAT exemption shall
apply to exportation of services. Technically speaking, a zero VAT
rate is different from VAT exemption. In case of a zero VAT rate,
the input VAT attributable to the exported services is still
creditable, while in case of VAT exemption, the relevant input VAT
shall be excluded from the creditable input VAT.
On 29 December 2011, the SAT and MoF issued the Tax Circular
Caishui [2011] No. 131 ("Circular 131') concerning VAT
treatments for exportation of services in the context of the Pilot
Program. Circular 131 clarifies that for international
transportation services, R&D services and design services, zero
VAT rate applies. For exportation of other Taxation Services, VAT
exemption applies.
3. I mpacts of the tax reform
The tax reform is generally viewed as a tax reduction program.
However, the exact impacts are complex and in some cases, the
actual tax burden could also increase. To better understand the
real changes in the tax burden, it is necessary to take into
consideration various factors such as the VAT rate, the tax status
of the customers (general VAT payer or not), the amount of input
VAT available to the service provider, etc.
a) Taxable Services provided by Shanghai general VAT payers to
general VAT payers (whether located in Shanghai or not) The tax
burden for such services will be decreased significantly. The
service provider does not need to pay BT any more. It can charge
the output VAT to its customers which can be recovered by the
latter and is therefore not a real cost. In addition, the service
provider can now credit its input VAT against its output VAT.
Therefore, the overall tax burden will roughly be decreased by the
sum of the BT amount (otherwise payable in the past) and the input
VAT (otherwise not creditable in the past). In the end, such tax
benefit may be shared by both the service provider and the customer
depending on how the service fee is adjusted in response to the tax
reform.
b) Taxable Services provided by Shanghai general VAT payers to
small-scale VAT payers or BT payers Since the Chinese customer is
not a general VAT payer, it can not credit any input VAT.
Therefore, the VAT costs can not be recovered and are real costs of
the Chinese customer. On the other hand, the input VAT of the
service provider now becomes creditable. As such, for such
services, the change in the tax burden can be roughly calculated as
follows: Change in the Tax Burden = Output VAT – Business
Tax (otherwise payable in the past) + Input VAT of the service
provider (otherwise not creditable in the past) The result could be
either positive (increase) or negative (decrease) as the case may
be. Therefore, the reform is not necessarily benefiting those
companies which mainly provide Taxable Services to non-general VAT
payers.
c) Taxable Services provided by Shanghai general VAT payers to
overseas customers In case tax exemption is adopted, no BT or VAT
would payable for exportation of Taxable Services. However,
technically speaking, the relevant input VAT would also be
non-creditable. As such, the decrease in the tax burden equals to
the BT otherwise payable. In case a zero tax rate is adopted, the
output VAT is zero and the input VAT is still creditable or
refundable. As such, the overall tax burden will roughly be
decreased by the sum of the BT amount (otherwise payable in the
past) and the input VAT (otherwise not creditable or refundable in
the past).
d) Taxable Services provided by a foreign party to a Shanghai
general VAT payer Under the VAT system, the Chinese customer shall
withhold the VAT payable by the foreign party and remit it to the
Chinese tax authority. However, such VAT paid are not real costs
since the Chinese customer can credit the same amount against its
output VAT. As such, the decrease in the tax burden equals to the
BT amount otherwise payable by the foreign party. Considering the
above, the foreign party may wish to shift the VAT costs to the
Shanghai customer.
e) Taxable Services provided by a foreign party to a Shanghai
small-scale VAT payer or BT payer The Chinese customer shall also
withhold the VAT amount from the gross payment, which are real
costs because the customer can not recover them by any crediting
system. The change in the tax burden is (VAT – BT
otherwise payable in the past), which represents an increase since
the VAT rate is higher than the standard BT rate of 5% (applicable
to the vast majority of services). The above lit a) – e)
are a simplified analysis of the changes in the tax burden. The
real world is more complex and the actual results for a specific
industry or transaction may differ from the general conclusion of
the above analysis.
4. BT exemption
Generally speaking, VAT exemption is also granted to transactions
which previously enjoyed BT exemption treatment, e.g. technology
transfer, technology development and related technical services.
The Plan provides VAT exemption for those transactions which
enjoyed BT exemption under the BT system in the past.
5. Old Contracts
The Plan does not provide any transitional arrangements for old
contracts concluded before 1 January 2012. However, as an
exception, outstanding contracts for lease of movable tangible
assets concluded before 1 January 2012 continue to be covered by
the BT system until the termination of such contracts.
6. Circular 111 also covers various other topics such as mixed
sales, consolidated VAT declaration, deemed sales of Taxable
Services, conditions for creditable input VAT, non-creditable input
VAT, consequence of not applying for the general VAT payer status,
exchange rate, timing of VAT liability, tax declaration deadline,
tax payment location, value threshold for individuals, issuance of
VAT invoices, and a detailed explanation of the scope of Taxable
Services, etc.
CMS suggestions:
1. Tax payers located in Shanghai providing Taxable Services are
advised to start applying for the general VAT payer status (where
applicable) and prepare themselves to the VAT regime;
2. Group companies with entities in Shanghai may need to make an
in-depth analysis of the changes in the tax burden, adjust their
pricing where necessary and restructure business models where
possible;
3. Foreign companies providing Taxable Services to customers in
Shanghai shall also take the BT/VAT issue into consideration when
concluding the relevant contracts.
This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq
Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.
The original publication date for this article was 12/01/2012.