Apr. 25 – Newly appointed Minister of the Ministry of Finance (MOF) Lou Jiwei and Director of the State Administration of Taxation (SAT) Wang Jun were interviewed by the official central media of China on April 16 concerning the further development of the pilot reforms on the value-added tax (VAT) in lieu of business tax (BT) and how to deepen the reforms in the financial and tax systems. The Chinese State Council previously announced its plans to have the current VAT pilot reforms, which currently only affect certain trial cities, to expand nationwide starting August 1, 2013.
Q: Why are the reforms to the VAT in lieu of BT going to be expanded nationwide simultaneously this year instead of steadily spreading into the different areas like last year?
Lou: The attribution of VAT determined that the VAT in lieu of BT reform is the better option to be simultaneously implemented in all industries nationwide so that the setting of the tax rate would be simpler and so that the deduction chain can be more complete. However, considering the risk of full adoption, we chose certain regions as trial destinations to conduct pilot collections in some industries at first. When the time is ripe, the reforms should be expanded to all areas as soon as possible. After that, the next step would be gradual expansion to all industries.
Q: What new information is implied by expanding the pilot reforms nationwide?
Wang: It implies that, unlike last year’s pilot collection by area, the reforms will be steadily spread by industry. The reforms should be enforced actively and firmly. The reason for selecting the starting date as August 1 is to give sufficient time to the 22 provinces that did not participate in the pilot reforms last year to get ready. These provinces are gathered in the mid-east of China, including the border and mountain areas. Whether the reforms would affect local fiscal revenues and budget arrangements needs to be fully considered.
In addition, the reform delays to the railway transportation and postal and telecommunications industries were taken to further improve the reform scheme. Currently, the SAT and other relevant departments are assisting the MOF to conduct a detailed demonstration of the scheme.
Q: Why were the railway transportation and postal and telecommunications industries not included in the pilot reforms? When will the reforms in these industries start?
Lou: The system of the railway transportation and postal and telecommunication industries is very complicated due to there being a great number of branch institutions. Therefore, it is better to include these industries in the pilot collection a little later.
Railway is an important means of transportation. It is not fair that other transportation companies are included in the VAT pilot collection and, hence, join the deduction chain while the railway companies do not. The manufacturing industry relies a lot on railway and telecommunications; therefore the deduction chain will be more complete with the intake of these two industries in the reforms. The MOF and SAT are trying to release the scheme as soon as possible, maybe even as soon as the end of this year or the beginning of next year.
Q: What are the general status and the results of the VAT in lieu of BT pilot reforms since they were launched last year?
Wang: Generally speaking, the pilot reforms are running stably and better than expected. Up until the end of February of this year, there were a total of 1.12 million pilot enterprises at an average increasing rate of about 5 percent every month in each pilot city, which indicates that the policies are attractive enough to attract more businesses that are willing to join in on the reforms.
Up to the end of February, a RMB 55 billion tax burden had been alleviated for these pilot enterprises. 95 percent of the enterprises faced lesser tax burdens or no changes to their tax burden at all. All small-scale taxpayers, including many sole proprietors, realized about 40 percent tax alleviation.
The reforms solved the problem of double taxation and improved the tax system. It also had an impressive effect on the adjustment of the economic structure. For example, the percentage of the tertiary industry (service industry) contributing to Shanghai’s GDP exceeded 60 percent for the first time ever and increased economic growth by about 0.6 percent. It is estimated by experts that 140,000 more employment opportunities were created because of the VAT in lieu of BT reform.
Q: What do you think of the increase in tax burden for about 5 percent of pilot enterprises?
Lou: It is mostly because of the incomplete deduction chain. With expanding the pilot industries and areas, this problem will be generally solved in the long term. It is estimated that tax alleviation will reach more than RMB 120 billion after this year’s pilot expansion.
Wang: Although some in the transportation industry suffered from the increased tax burden, the expansion of the reforms will cause the increases to disappear. For instance, about 11.5 percent of Shanghai’s enterprises suffered from the increased tax burden during the first pilot month, and it diminished gradually by month until it dropped to 9.2 percent at the end of this past February.
In addition, the provincial governments all provided temporary supportive policies to the enterprises that faced tax increases.
Q: Why is the VAT reform so critical to the financial and tax reforms?
Lou: China mainly adopted an indirect tax system, and VAT is one of the most important types of taxes. The 1994 tax reform left out BT because of the complication of moving the reforms forward and because the service industry only constituted a small portion of businesses back then. The reforms first transferred VAT from being manufacturing-oriented to consumption-oriented, and now we are expanding VAT collection to replace BT collection.
Eventually, VAT will cover all aspects of the manufacturing and service processes, and the double taxation caused by BT collection will become history. Therefore, the VAT in lieu of BT reform is one of the key steps to the overall financial and tax reforms.
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Value-Added Tax Reform
VAT reform is a confusing transition for many and introduces a number of additional questions, such as exactly what types of input VAT are now deductible. Confusion about the new laws may also allow opportunistic companies to charge higher prices and blame the increase on the tax reform. To add some clarity to the issue – and VAT in general – this issue of China Briefing takes a look at a number of VAT-related questions.