On 17 November 2011, the Ministry of Finance
("MOF") and the State Administration of
Taxation ("SAT") introduced a pilot
programme in Shanghai to replace Business Tax with Value-added Tax
("VAT") commencing 1 January 2012. The
pilot programme marks a major step forward for China in aligning
its indirect tax system to the VAT systems of other countries.
Although its application is limited to selected industries in
Shanghai only, the pilot programme will have a far-reaching impact
and is likely to serve as a roadmap on how the reform of indirect
taxes will be ultimately implemented nationwide. On 29 December
2011, it was reported that the Beijing Municipal Government had
filed an official application with MOF and SAT for launching the
same pilot programme.
VAT and Business Tax are the two most important, but different,
indirect taxes in China. Under the current Chinese rules VAT is
levied at the statutory rate of 17% or reduced rates, on the sale
of goods, provision of repairs, processing and replacement
services, and importation of goods. A regular VAT taxpayer
can deduct VAT paid on a purchase from its own VAT liability. As a
result, VAT avoids the cascade effect of other indirect taxes by
taxing only the value added at each stage of production.
Business Tax, on the other hand, is levied at 3% or 5% generally
on assignment of intangible assets, transfer of immovable
properties, and provision of services that are not subject to VAT.
Business Tax differs from VAT in that it cannot be credited and
will add up through the supply chain. This results in serious
issues, such as double taxation and price distortions. China
therefore is endeavouring to reform its indirect tax system to
apply VAT across goods and service sectors.
Under the pilot programme, the transportation services industry
and "modern services industry" (together
"selected industries") in Shanghai,
which are currently subject to Business Tax, will be subject to VAT
as of 1 January 2012. The transportation service industry,
including road transportation services, water transportation
services, air transportation services and pipeline transportation
services, will be subject to 11% VAT. Most of the selected modern
services, including R&D and technology services, IT services,
cultural and innovation services, logistics and auxiliary services,
attestation and consulting services, will be subject to 6% VAT; the
rate of VAT on tangible movable property leasing services will be
The pilot programme will mainly affect businesses in Shanghai,
but may also affect businesses elsewhere, including foreign
parties. The key elements in that respect are the following:
Businesses registered in Shanghai and engaged in the selected
industries ("pilot VAT taxpayers") will
be the most affected as they will become eligible to register as
regular VAT taxpayers and have to pay VAT, instead of Business Tax,
on sales as of 1 January 2012. As a result, they will be able to
claim input VAT credit charged on purchases of goods and services
against their own VAT liability.
Foreign parties that provide services that fall within the
selected industries in Shanghai will be subject to VAT as well,
rather than Business Tax.
VAT taxpayers (both in Shanghai and elsewhere in China) that
purchase services from pilot VAT taxpayers after 1 January 2012
will be able to claim input VAT credit on these purchases.
The pilot programme provides that, in principle, export of
services will be either zero-rated (i.e. VAT refunded) or VAT
Generally zero-rated are the supply of international transport
services, design services (excluding design services in respect of
immovable properties located in China) and R&D services to
VAT exempt are the export of other services and the supply of
some services actually performed outside China, such as exploration
services, exhibition services and warehousing services, as well as
providing leasing services relating to tangible movable properties
which will be used outside China (unless in each case MOF and SAT
provide that a zero rate is applicable).
In addition, the relevant circulars provide detailed rules
regarding the choice of simplified VAT reporting, transition and
retention of Business Tax preferences, etc.
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.
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