China: Change from Business Tax to VAT – How are you impacted?

Since the initial pilot of the VAT reform took place in Shanghai in 2012, it has been rolled out nationwide and expanded to more and more service sectors. Starting from 1 May 2016 China has replaced all Business Tax (BT) with Value-Added Tax (VAT). Now all goods and services are covered by the new scheme. As a reminder, effective 1993 Business Tax served as turnover tax levied on sales of real assets and on sales of invisible assets and certain services that were not imposed by VAT. BT rates were between 3% and 20%. It gave 20% of return of duties from total tax collection to China in 2013[1].

The idea of VAT is to tax on the « value added » to the product throughout its production process and supply chain. The VAT system is invoice based (fapiao-based in China). Each seller in the product chain includes a VAT charge on the buyer’s fapiao. Under a VAT taxation system, all sellers collect the tax and then pay it to the government.

Issued Caishui [2016] No. 36 or Circular 36 lays down detailed rules for the transformation of the last four sectors (construction, real estate, financial services and lifestyle service sectors) from BT to VAT and the general VAT framework for all VAT payers started 1 May 2016.

Below is a table describing the most recent changes in VAT rates. For sectors that already adopted the VAT policy earlier, before 1 May, the same VAT rates are maintained. The applicable VAT rates for General VAT payers are 6%, 11% and 17%, as well as the zero-rate for certain cross-border taxable activities specified by the Ministry of Finance (MoF) and the State Administration of Taxation (SAT). The VAT collection rate for small-scale payers is 3%.

Why is it important to revise your tax payment scheme during this transition period? Simply, you can substantially lower your tax burden after auditing your business.

Firstly, you should be aware that even small-scale VAT payers are taxed and for 3% of tax they are not eligible for deduction of input VAT from output VAT. Moreover small-scale companies are not allowed to issue special VAT invoices, that are used as credit against outstanding VAT liabilities. Practically, general taxpayers don’t want to deal with small-scale companies because they can’t receive special invoices for tax deduction purposes thus implying a substantially heavier tax burden. On the other hand, if you are a B2C company that provides a service to end consumers and don’t purchase goods or provisions for further sales, the small-scale VAT scheme is preferred. In all other cases, the general VAT scheme may be more desirable.

There are two points in a company’s history when it could become a general VAT taxpayer.

The first is compulsory when taxpayer’s annual sales revenue reaches a certain threshold:

• RMB 5 million for a services company
• RMB 0.8 million for a trading company
• RMB 0.5 million for a manufacturing company

Second point, the company can meet the requirements of general VAT taxpayer status at the time of its initial establishment. However for that, several conditions need to be met:

• Have an estimated annual taxable turnover exceeding a certain threshold mentioned above
• Have a fixed place of business with certain requirements
• Be capable of setting up legitimate, valid and accurate bookkeeping
• Meet additional soft requirements, such as office size and number of employees

Despite that, the increase in tax burden for General VAT payers there are certain measures that companies can implement:

1. Taxpayers in construction and real estate sectors can deduct subcontracting payments and land cost from the sales amount to compute VAT.
2. Taxpayers in the lifestyle services sector should study carefully taxation items that have been re-categorized under the VAT Reform. Then you can claim input VAT credit, which may help to offset against the negative impact on the output VAT charged on the revenue at a higher applicable tax rate.
3. Financial services taxpayers should use special rules for calculating the output VAT tax base as set out in the Circular 36
4. Taxpayers in other sectors are also expected to directly or indirectly benefit from the final rollout of the reform. In particular, businesses will have the opportunity to get input VAT credit from vendors in the four sectors and reduce their own tax burden.

For most taxpayers registered as general VAT taxpayers, the default filing period is monthly. That is, taxpayers are generally required to file VAT returns each month, and the usual deadline is by the 15th day of the following month. However, as a transitional measure the government has already announced that the VAT return filing deadline for all new VAT taxpayers entering the VAT system will be extended until 25 June 2016 for the first VAT return – in effect, a 10-day deferral.

What should you do to prepare for implementation?

• From now until 25 June 2016 (at the latest) – put in place controls over VAT invoicing, implement internal processes for managing VAT risks; conduct training for staff in (at least) finance, operations, tax, legal and IT; prepare a VAT manual which records the positions being taken and be prepared to update them; implement either an automated interface solution between your Enterprise Resource Planning (“ERP”) system and the Golden Tax System, or a temporary manual compliance solution;
• Post 25 June 2016 – the rules will be new for many of the tax officials, so be prepared for “the unexpected”; anticipate several rounds of refinement or amendment to the rules and ensure your VAT manual and processes are updated to reflect them; expect that claims for VAT exemption for exported services may not be ready to implement until after 25 June 2016.

Orbis will continue to monitor the VAT reform developments. Please feel free to contact us should you have any questions. Our experts provide qualified corporate management support for your tax planning and optimization issues.

[1] China statistical yearbook 2014

By Yun QI, Orbis China partner