TMF Group's IPT expert looks at China's move towards VAT for the services sector and compares this to how similar introductions have fared elsewhere.
Aimed at tackling double taxation caused by levying both business tax and corporate income tax on the services sector, tax reform has been in progress in China since 2012 by removing business tax and introducing value added tax (VAT) to the services sector.
The reform first hit the transport industry in highly developed cities such as Shanghai and Beijing before expanding to other cities all over the country. The plan was to include the financial industry some time in 2015 and bring VAT reform to an end within the year. However, the Minister of Finance Mr. Lou concluded in his recent report to the National People's Congress Standing Committee that the introduction of VAT to the financial industry would require a revised timeline.
What's going on in China?
Since 1994, China has included its financial industry in the current tax system where business tax and corporate income tax co-exist. Business tax is an insurer tax charged at 5% on insurance premiums. In addition, insurance companies are subject to 25% corporate income tax.
Apart from the two taxes, insurance companies bear eight other parafiscal charges, namely: educational surtax; local educational surtax; urban construction tax stamp duty; insurance protection fund; insurance regulation fee; and, anti-flood tax.
What are the difficulties in implementing VAT on the insurance industry?
Accurately defining added value generated by the insurance industry has been for years a worldwide concern. The reason usually given for the difficulty is that many products' life cycle is of a long-term nature, such as a life policy, and defining the added value of the service requires an account for the reinvestment of the premium received. Plus, most of the costs generated by insurance companies are difficult to obtain a VAT invoice for, which plays a role in balancing with the input VAT. Last but not least, VAT is eventually borne by the insured, but business tax is currently paid by the insurance company.
The replacement is not a simple change between types of tax, but will affect important economic data such as profit and loss, so it requires the insurance companies to restructure their pricing, financing and operating systems.
How do they do it in other countries?
VAT is an important system for taxing the added value generated in the economy and provides a holistic approach to monitor economic dynamics. However, the difficulty of integrating the insurance industry has pushed authorities to configure other tax methodologies as an alternative to VAT, although these maintain the nature of a sales tax. For example:
- Insurance premium tax is adopted by most EU member states with rates varying from 1.1% to 30%. Some Canadian provinces name it as "provincial sales tax" or "retail sales tax", with rates of 8% and 9% respectively; in the USA the insurance industry is regulated by individual state authorities so tax rates vary across all states.
- Stamp duty is adopted by a few countries including Portugal, Switzerland and Cyprus.
However, there are many jurisdictions that have incorporated the insurance industry into the VAT system; countries where stamp duty or other tax methods used to be commonplace have replaced these with VAT.
- Oceania: New Zealand and Australia have had VAT - called a Goods and Services Tax or GST in Australia - in force for a long time, with rates of 15% and 10% respectively. In addition Australia keeps Stamp Duty effective alongside VAT.
- South Asia: Singapore has applied Goods & Services Tax to the insurance industry since 1994. Thailand, Vietnam, Malaysia and Laos caught up in the last few years and now charge VAT on insurance.
- South America: The last decade has seen several Latin American countries replace stamp duty with VAT, with rates ranging from 10% in Paraguay to 21% in Argentina.
- Africa: Algeria, Botswana, Cameroon, Ghana, Tanzania, and many French-speaking countries have implemented VAT, with rates varying from 12% to 20%.
Where is the ship heading - and where does IPT Quote stand?
As so many countries have been carrying out this tax reform, what is the real difficulty for the Chinese? Some media has reported that carrying out the original plan would result in a significant fiscal deficit, which would worsen the state's ability to digest the current recession.
Although the Chinese authorities are determined to proceed, our understanding is that the VAT reform on the insurance industry will not be implemented until the end of next year (2016) given the current economic conditions.
Accordingly, IPT Quote, our online insurance tax calculation tool, will continue to display the nine different taxes (business tax and other linked-rate taxes) for the 31 provinces in China with some rates varying across provinces and certain types of tax.
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.