VAT reform in China is expanding
In March 2014, the Ministry of Finance (MOF) announced that it was working with other government departments to further expand the scope of the Value Added Tax (VAT) pilot reform, which started in 2012, to more sectors – including the telecommunications, construction, real estate, finance and living service sectors.
On January 1, 2012, the trial of the value-added tax (“VAT”) Transition from business tax (BT) to VAT (“VAT Transition”) for transportation and certain modern service industries was implemented in Shanghai. In July 2012, the State Council further expanded the pilot area to Beijing and seven other provinces and municipalities in stages: Beijing (September 2012); Jiangsu and Anhui provinces (October 2012); Fujian and Guangdong provinces (November 1, 2012); and Tianjin Municipality, Zhejiang Province and Hubei Province (December 1, 2012). The reform is intended to be completed by the end of the 12th Five-Year Plan (2011-2015).
The objective is to replace the current dual system of indirect taxes – value added tax and business tax – with a single VAT system, which applies to the entire goods and services sector. By the end of last year, the MOF said around 2.7 million enterprises had been covered by the VAT reform, an increase of 160% from the end of 2012, and tax burdens for companies had been reduced by more than RMB 140 billion (US$22.83 billion), up from RMB 42.6 billion in the previous year. According to the MOF, the reform had been effective in reducing double taxation and promoting the service sector’s development.
The VAT Transition program mainly involves the transportation industry and parts of modern service industries. The VAT tax rate is 11% for the transportation industry, 17% for the tangible property leasing services industry, and 6% in the remaining modern service industries. Meanwhile, VAT is imposed on import of services in the domestic process, while zero tax rate or exemption is applicable to exports. A VAT rate of 3% is applicable to the small-scale taxpayers. Foreign invested companies providing the above services are also subject to VAT instead of BT.
The expansion of the VAT programme is therefore likely to be welcomed by the business community, especially multinational companies and other large businesses. The key benefits include:
- Businesses will be required to register as general VAT taxpayers where their turnover exceeds 5 million yuan of annual sales income. In addition to paying output VAT on their services, they will be eligible to claim input VAT credits for the goods, fixed assets and services they purchase from other VAT taxpayers;
- Businesses providing services which are subject to the VAT pilot programme will be eligible to claim VAT zero rating or exemption for certain types of services that are exported. This compares favorably with the existing position by which the export of services is generally subject to 5% BT. Likewise, where services are provided from overseas parties to businesses in mainland China, which are registered as general VAT taxpayers, VAT withholding obligations apply. However, input VAT credits may now be claimed for the purchase of these services so as to offset any real VAT cost impact;
- Small-scale taxpayers will also benefit from a reduction in their tax burden from 5% BT to 3% VAT.
While the introduction of VAT for each of these sectors is challenging, it is clear that officials from the Ministry of Finance and the State Administration of Taxation are ready for the challenge. They have studied international systems and shown a willingness to adopt key principles beneficial to business, and to use international principles to meet the needs of the Chinese economy.
International experience highlights that while the transition to VAT can create ripples in the short-term, the longer-term transition to VAT is expected to be collectively beneficial both to businesses and the economy. China’s new VAT rates of 6 percent and 11 percent, coupled with its existing VAT rate of 17 percent, are all lower than the OECD global average rate of VAT, which now exceeds 18 percent.
The shift to a more modern tax system is consistent with international norms, will help alleviate indirect tax liabilities in B2B transactions, and promote export services. It is an important step in promoting the development of the services sector as part of the government’s 12th Five-Year Plan.
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