By Lachlan Wolfers
On May 1, 2016, the final stage of the Chinese government’s major tax reform initiative took effect, which saw Business Tax (BT) fully replaced by a Value Added Tax (VAT) in China.
Historically, China has had a VAT applicable to the sale and importation of goods, and a separate BT applicable to the provision of services. This bifurcated indirect tax system was regarded as inefficient and inappropriate for a modern economy because BT was essentially a tax on business, which cascaded throughout a supply chain, whereas VAT is a tax that is collected by business, but ultimately imposed on the end consumer. This is achieved through a system of giving credits for business expenses.
The replacement of BT with a VAT system had been implemented progressively since 2012, but on May 1 the final stage of these reforms went live. In effect, there are three key sectors most impacted by this final stage – financial services and insurance, real estate and construction and lifestyle services (which comprises food and beverage, hospitality/hotels, entertainment, healthcare, education, personal services and every other type of service that was still subject to BT). The old BT rates, as compared with the new VAT rates are as follows:
|
Industry |
BT rate |
New VAT rate |
|
Construction services |
3% |
11%, though some transitional rules may apply to existing projects to allow the rate to be reduced to a 3% simplified VAT rate |
|
Real estate |
5% |
11%, though some transitional rules may apply to existing properties to allow the rate to be reduced to a 5% simplified VAT rate |
|
Financial services & insurance |
5% |
6% |
|
Lifestyle services |
Generally 5%, though some entertainment services were subject to rates from 3% to 20% |
6% |
VAT is effectively assessed on a net basis (outputs less inputs), while BT is ordinarily assessed on a gross basis (outputs only). From a compliance perspective, businesses in China that are registered as general VAT taxpayers will need to obtain special VAT invoices to potentially claim input VAT credits for their expenses.
China’s new VAT system is quite different from that of other countries. Here are some key aspects that highlight the breadth of its application:
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VAT applies to virtually all financial services, including interest income earned by financial institutions, gains from trading in financial products, insurance products, asset management services, trust and fund products. China is one of the first countries in the world to apply a VAT to financial services.
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VAT applies to virtually all types of real-estate-related transactions – both the sale and leasing of residential property, and all major types of commercial property asset classes including retail, office and industrial.
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China’s VAT system has multiple rates, with most goods subject to 17 percent VAT, and many services subject to rates of either 6 percent or 11 percent.
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China’s VAT ordinarily applies where either the supplier or the recipient is in China. Consequently, services being provided into China from overseas, including under inter-company arrangements between headquarters and a China Wholly Foreign-Owned Enterprise (WFOE), will typically be subject to VAT. In that instance, the VAT is collected either by an agent or a customer in China on a withholding basis. This means that if the overseas entity is not aware of the VAT, and therefore does not take any steps to adjust the price for VAT purposes, they may suffer a reduction in their revenue.
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Exports of most services from China qualify for either exemption from VAT, or zero rating. There are often difficult compliance obligations involved in claiming an exemption or zero rating.
The government has tried to ensure that the tax burden impact on business will not increase as a result of these reforms. However, that outcome will often depend upon the proactive steps being taken by businesses to adjust to the new VAT system. These include:
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Pricing and contracting – businesses may need to adjust their prices for the new VAT rates. From a contracting perspective, they need to consider whether they can pass on the VAT to their customers. Otherwise, businesses may have to assume the tax burden.
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Invoicing – China operates a highly regulated invoicing system referred to as the “Golden Tax System.” Affected businesses need to purchase the equipment to issue invoices.
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IT systems – China’s Golden Tax System is a standalone system, which means that many businesses will need to build a bridge or interface with their own Enterprise Resource Planning systems to enable data to flow.
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Compliance – VAT returns generally need to be filed monthly by businesses, with the first VAT return filing deadline set for June 25, 2016.
While the shift from BT to VAT represents a major tax reform initiative, it also signals a significant change to business in China. It is critical that businesses understand and manage the effects of the reforms, and take proactive measures to adjust to the new VAT system.
Lachlan Wolfers is Head of Indirect Taxes at KPMG China.