China’s VAT Reform Creates Unequal Tax Treatment for Domestic and Foreign Shipping Companies

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Dec. 13 – China’s Ministry of Finance and the State Administration of Taxation jointly released the “Circular on the Tax Collection Policies for the Nationwide Adoption of the Business Tax to Value-Added Tax Pilot Conversion in the Transportation Industry and Certain Modern Service Industries (caishui [2013] No. 37, hereinafter referred to as Circular 37)” on May 24, 2013, which expands the Business Tax (BT) to Value-Added Tax (VAT) pilot conversion nationwide from August 1, 2013.

Circular 37 has made some significant changes to the VAT implications for companies in the transportation and logistics industries, one of which is the unequal tax treatment of domestic and foreign shipping companies.

Under the previous BT regime and the regional VAT pilot program, freight forwarders were allowed to deduct international freight from their taxable income. However, under Circular 37, this deduction is no longer permitted. Instead, starting from August 1, 2013, they are required to pay 6 percent VAT and local surcharges (including urban maintenance and construction tax, education levy and local education levy) on gross proceeds collected from clients.

This change has a negative impact on foreign shipping companies because Chinese laws require foreign shipping companies to use either wholly-owned subsidiaries or third-party agents to collect ocean freight, both of which are legally considered freight forwarders and are subject to 6 percent VAT and local surcharges. This tax burden will naturally be shifted to the foreign shipping companies, which may not be able to pass on this burden to their customers, especially if these customers are individuals, small-scale taxpayers or foreign companies who are not able to utilize VAT credits. Customers who are able to claim input VAT with the invoices they obtain may nonetheless still be discouraged from using foreign shipping companies because it will take time to file for a VAT return and obtain the VAT refund, with negative impact on their cash flow.

On the other hand, Chinese shipping companies can charge shippers directly without engaging any freight forwarder, thus avoiding the 6 percent VAT and local surcharges. In addition, under Circular 37, Chinese carriers are able to enjoy zero VAT rate for the provision of international ocean shipping services, meaning that they can claim deduction and/or refund for input VAT related to the service. This makes them much more competitive in terms of pricing compared to foreign shipping companies.

Consequences

The implementation of the Circular 37 has caused chaos in the market and may result in the following negative consequences:

  • Dramatically increase the VAT burden on the foreign forwarding industry and therefore seriously erode the competiveness of foreign shipping companies which have to engage freight forwarders to collect freight;
  • Push foreign shipping companies to settle international freight outside China, where international freight forwarders are subject to zero-rate tax treatment; and
  • Increase charges on exports originating from China and therefore affect the competitiveness of Chinese products on the global market.

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