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VAT China – How does it work for inter-company services

(December 31st, 2013)

VAT-case

By Richard Hoffmann, ECOVIS Beijing China

The following email inquiry from one of our readers will bring light into the darkness of pilot services applicable to VAT in China. A big foreign company group “The Group”, faces increasing inquiries from within China and thus needs to know how to handle China VAT. Currently they provide most of their services from within Europe to those Chinese companies. Because of the inconvenience caused to clients and the staff of The Group’s subsidiaries in Europe, they decided to set up their own WFOE in Beijing. This subsidiary, “Company A”, almost completely provides its IT services to the ”Group’s” subsidiaries and some Chinese companies but seldom to other companies.

But because of the new VAT regulations it was necessary to have a clear look at all the possible occurring transactions among the different parties mentioned above and bring light into the VAT reform.

Assuming that Company A will have the status of a General Tax Payer and thus be allowed to deduct Input VAT from their Output VAT. The typical cases are listed below and in detail shown in the graphic. Although IT services belong to the pilot services of the VAT reform, depending on different factors they will be applicable to 6% VAT, 0% VAT or Tax Exemption. To get an insight of how the services will be invoiced and what amount of VAT will apply, the six different cases are shown in the graphic below.

The Group is considering to set up its own WFOE not only because it could ease their work flow but also because they want to optimize their tax structure. The VAT reform in China started in Shanghai and only in certain industries but is now rolled out in the whole of China with more industries.

These are the planned transactions between Company A and its clients and between The Group and China based companies. Below a list of the direction of the service provided.

  • The Group provides services to Company A
  • The Group provides services to Buyer in China
  • Company A provides services to Buyer in China
  • Company A provides services to Client outside China
  • Supplier CH provides services to Company A
  • Company A provides services to The Group

 

The questioner was not sure about the current situation also because of the change from Business Tax (BT) to VAT in China. In the past, BT was charged for most of the transactions but now it’s only applicable to a few industries.

These were the main concerns of the inquirer:

  1. Currently the foreign subsidiary provides services to companies in China, but they don’t know which VAT rate applies.
  2. Because they have trouble handling the Services provided to China, they want to set up a WFOE. They also want to know when VAT applies and how to handle it.

 

Concerning the first point, the IT service they will provide, belongs to the pilot, and will we be taxed with 6% VAT on the foreign invoice. The Buyers in China which are General VAT Tax Payer (GP), have to withhold 6% VAT before transferring money to the foreign subsidiaries. That means they can use the 6% withheld VAT to credit it as its input VAT. Thus the overall effect is neutral.

Taking a look at point 2 we see parallels to the first point, as Company A, the WFOE of The Group is also a General VAT Payer and thus has the right to deduct its Input VAT from its Output VAT. On a monthly basis it will then pay any excess Output VAT to the Tax Authorities. That means in the case that Company A receives any IT Services from The Group, it will still withhold the 6% VAT. On the other hand, and this is the more important case here, if it provides services to foreign subsidiaries of The Group, there is a chance for VAT exemption or Zero % VAT! That means export of IT services will usually not result in any disadvantage caused by that tax and thus not create a barrier for foreign companies to purchase those services. In the past when Business Tax (BT) was still applicable, such kind of transactions often created an extra burden for foreign companies as they had to pay BT in China and VAT in their home country.

As there exist two different types of VAT Payers, the already mentioned General VAT Tax Payer and the Small Scale VAT Tax Payer, they have different rights and duties concerning VAT payment. The most important one is that GP are allowed to deduct their Input VAT from their Output VAT. On the other hand, Small Scale Tax Payers don’t charge 6% VAT but just 3%, but the tax rate is still 6% for withholding VAT when making payments to a foreign party. But there is no deduction system for the Small Scale VAT Tax Payer.

If you have any questions or for further information about Tax in China:

Contact us Ecovis Beijing

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Author:
Richard Hoffmann
richard.hoffmann@ecovis.com
Office website

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