VAT in China Part 3

The VAT reform in China: What has changed since 1^st of August 2013?

Chinas Value Added Tax (VAT) reform is executed since August 2013 everywhere In China. On services in the transportation sector and on so called modern services there is no Business Tax (BT) anymore but a deductible Output VAT.

What is the VAT reform?

Until now in China there was a two layer tax system consisting of Business Tax and Value Added Tax. The VAT was mainly used on the disposition of goods whereas the BT was charged on the selling of services. Since for BT already paid taxes were not deductible double taxation occurred.

This problem was faced by the Chinese government at the 12. Five years planning, which provided the framework for some special branches. Therefore 2012 a trial project in Shanghai was launched, which was later extended to Beijing and other regions. It has always been the aim to execute a countrywide reform in which the BT would be fully replaced by the deductible VAT. Such an extention of the VAT reform was enforced in August 2013.

What´s the current status?

The table shows all of the currently applicable service and tax rates. In the near future it is planned to extend the reform in order to also cover the construction and real estate as well as the financial and insurance sector. Additionally there are a couple of services which are either charged with 0% or are exempted from VAT. Although practically in both cases VAT doesn´t have to be paid, there is still quite a big difference. From services which are charged with 0% VAT, Input VAT can be deducted, whereas the Input VAT of exempted services is not deductible. That means if the VAT is 0% all the on an earlier stage paid Input VAT is going to be refunded in the next month. This is mostly the case if the government wants to subsidize the product. If the VAT is exempted the already paid VAT stays unrefunded. VAT of 0% for example has to be applied for international transportation, export services as well as research and development services for foreign legal entities. Some export services however, are VAT exempted.

In the course of the reform it is also necessary to distinguish the Small Scale VAT Payer status and the General VAT Payer status. Only for General VAT Payers the below mentioned tax rates are applicable and only they qualify for VAT deduction. Small Scale VAT Payers do not qualify for the VAT deduction. However, they are generally charged with 3% VAT no matter what kind of services they perform.

Examples

The hereafter mentioned examples illustrate the impacts of the VAT reform for different service providers and receivers.

Case 1

A General Tax Payer company provides a taxable transportation service. The customer also has a General Tax Payer status.

The tax burden for both companies is now less than before, since both tax payers A and B qualify for VAT deduction. The 11% VAT therefore is channeled to the customer, who purchases the final service. Before the reform enforcement, transportation services were indeed charged with a Business Tax rate of 5% instead of VAT. However this Business Tax was not Output VAT deductible.

Case 2:

A General Tax Payer company provides a taxable IT service. The customer has the Small Scale Tax Payer status.

The 6% Output VAT deductibility leads to tax saving for the General Tax Payer. However the tax burden for service receiver B increased. Before the reform, IT-services were charged with a 5% Business Tax. The currently effective VAT of 6% however can only be deducted from service provider A. Since Small Tax Payer B doesn´t qualify for VAT deduction the tax burden will be the total VAT of 6% of the IT service value. This results in a larger tax burden for B of 1% (compared to the 5% BT before).

Case 3

A Chinese firm provides logistics services to a foreign enterprise. According to the new law statutes, international logistics services are subject to a tax rate of 0% as long as this was applied for in advance at the state tax authorities. At the moment however, this procedure is very intransparent and connected to severe bureaucratic burdens. Therefore many logistics providing companies have decided to renounce the application and just pass over the tax burden to their clients.

Although in theory the application for 0% VAT is possible, for the above mentioned reasons the 0% VAT in practice in most cases won´t be realized. Therefore at the moment international services are mostly charged with a VAT rate of 6% (equals the VAT rate of domestic services).

In this case the Chinese company A is passing over the 6% Output VAT to the foreign company B. While A can deduct the Input VAT from the Output VAT, B has no possibility to deduct anything.

For the future, there are more practical solution for the VAT exemption application procedure planned.

Prospects:

All in all, due to the new VAT deduction possibility for services, the VAT reform is a success to all of the companies and is a step to reduce the overall tax burden. The reform and its impact will not lose its importance in the next years, since it will be extended to other sectors. The original aim to completely replace the BT with the VAT will be further approached during the next years.

Since the current situation is quite complicated, especially companies which are performing both manufacturing and service supply are strongly advised to consult external tax professionals like ECOVIS Beijing, since it is often not clear if VAT or BT is applicable.

Also read VAT in China part 1, 2 and 4 of our VAT article series and get to know the basis of the VAT system in China. In our final VAT in China part 4 article you can read about how foreign mother companies can transfer money to their Chinese subsidiaries.

If you have any further questions about VAT in China you contact our Partner Grace Shi via email: grace.shi@ecovis.com.

With contribution of Julius Haimerl