Brief Overview of China’s VAT Reform and its Impact on Companies

6 min.

By Richard Hoffmann, ECOVIS Beijing China

The indirect tax system in China is undergoing a significant reform with the objective of gradually unifying its Business Tax (BT) and VAT system.

Background

Under the old system supply of goods, imports of goods into China and processing/ repair/replacement services were taxed at a a VAT rate of 13% or 17%, while services and the transfer of intangible assets, sales of  immovable property  and certain labour services were subject to business tax at rates of 3% or 5% (entertainment industry 5-20%).

The implications of the reform can have a substantial impact on FIEs and foreign companies conducting business with Chinese firms. Considering the large quantity of recent changes we were asked many questions by our clients regarding the effects of the reform. This article aims to provide an overview of the reform and to answer some of the most relevant questions

The reform started out as a pilot program on  1 January 2012 in Shanghai and was further rolled out to Shanghai, Beijing, Tianjin, Jiangsu, Zhejiang, Anhui, Fujian, Hubei, and Guangdong provinces.

Since 1 August 2013 the pilot program has been expanded nationally. By 2015 the State Administration of Taxation (SAT) and the Ministry of Finance (MOF) aim to complete the nationwide transition from BT to VAT.

Recent regulatory changes

The relevant regulation  “Circular 37” specifying the most recent changes is replacing seven previously issued regulations.

The following table provides  an overview of services subject to VAT with the corresponding tax rates (since 01.08.2013):

Overview of taxable services after VAT-Reform

While the aim of the reform is to improve the efficiency of China’s indirect tax system, the actual effects on companies affected may vary depending on the industry.

A few interesting facts about  “Circular 37” :

  • The new regulations will be applied if the date when tax liabilities arise is after 1 August 2013.
  • Transportation service provided from a Chinese company to a foreign company is subject to 0% VAT (originally BT).
  •  The VAT for international logistics can be exempted. However, each company has to apply at the tax bureau for VAT tax exemption.

In reality, application procedures and required documents are not very transparent in various local tax bureaus. Thus, many companies wihin the logistics and auxiliary services sector are reluctant to complete such procedures and shift the tax burden to the customers by charging them 6% VAT.

The threshold to be considered a general VAT tax payer has been raised to RMB 5 million (Previously RMB 500,000 and RMB 800,000 for trading or manufacturing companies respectively). A general VAT tax payer can deduct the input VAT from the output VAT. Hence the formula for calculating the tax payable is: Current Output VAT- Current Input VAT.

For a Small-Scale tax payer there is a much lower standard rate of 3%, irrespective of the service rendered, but input VAT cannot be deducted. Therefore the formula for calculating the tax payable is: Sales * 0.03

Possible scenarios after the VAT reform

Depending on the industry and business scope the reform can have a different impact on foreign invested enterprises.

In many cases the VAT reform can lead to tax reductions for foreign invested enterprises in China. However, the exact impacts for foreign companies inside and outside of China are often  more complex and for some firms the reform can lead to tax increases. Influencing factors include tax status of the customer (General or Small-VAT tax payer),  tax status of the supplier,  amount of input VAT available and the VAT tax rate.

The following examples illustrate how different service providers and recipients might be affected by the reform:

Case 1

A general VAT tax payer provides a taxable service that is subject to VAT (hereinafter referred to as “taxable services”) to another general VAT payer.

Case 1 Example VAT-Reform

Taxes to be paid by will decrease for A and can be reclaimed by B. Input VAT of A can be credited against output VAT. Before the reform services provided were subject to BT, which cannot be recovered. In this case A can charge VAT to B, which can be reclaimed by B as input VAT.

Case 2

A general VAT tax payer provides a taxable service to a small-scale VAT payer.

Case 2 Example VAT-Reform

Small-scale VAT payers are unable to  recover any VAT costs due to the fact that they cannot credit any input VAT. Therefore costs for B effectively increase.

Company A can credit input VAT against output VAT and is therefore not affected.

However, a general VAT service provider might be affected by the reform if many customers are small VAT tax payers. In this case customers might decide to hire a service provider, who is a small VAT tax payer instead to save costs.

Case 3

Provision of a logistics service by a Chinese company to a foreign company.

ecovis-VAT-english-graph

If Company X provides logistics and auxiliary services it can apply for a VAT exemption according to “Circular 37.” However, as explained before the exact procedures for such an application are not clear yet. Therefore many Chinese companies started to shift the 6% tax burden for logistics and auxiliary services to the customers. At present, this will result in higher costs for foreign companies.

If the VAT-tax exemption was actually approved by local tax bureaus, VAT-caused costs for Y would decrease to the original level.

Please note that the above examples are a simplification. The overall tax situation might be more complex and  individual cases might differ. It is highly recommended to consult with an expert to discuss recent changes of the reform and develop a tax optimization strategy.

Impact of the VAT reform on companies

As stated before, the impact of the reform may vary depending on the business scope. Companies that trade with goods are already used to VAT and for these companies only the services provided, if any, are impacted by the reform.

However, for traditional service providers the impact of the reform might be significant and understanding all of its implications can be challenging.

In order to adapt successfully to the new reform, the following should be considered

  • Impact on the business model. How can the tax strategy be optimized to save costs?
  • Thorough analysis of service flows and income derived from services
  • Impact on pricing (especially of taxable services).
  • How do accounting and IT systems need to be updated to implement necessary changes in order to be compliant with the new reform.
  • Is there a need to provide training to employees to adjust to the reform
  • How many of the customers are small VAT tax payers and unable to recover input VAT?

As mentioned before, the implications of the reform can be complex and it is advisable to discuss the individual impact with a professional.


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Lawyer in Heidelberg, Richard Hoffmann
Richard Hoffmann
Lawyer in Heidelberg
Phone: +49 6221 9985 639
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