China Releases New Regulations to Clarify Issues in Expanding VAT Reform

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Dec. 17 – After China’s State Council revealed the further expansion of their value-added tax (VAT) reform to the railway transportation and postal service industries in early December, the Ministry of Finance (MoF) and the State Administration of Taxation (SAT) jointly released the “Notice Regarding the Inclusion of Railway Transportation and Postal Service Industries under ‘VAT in lieu of Business Tax’ Pilot Reform” (Caishui [2013] No. 106, hereinafter referred to as “Circular 106”), which will come into effect on January 1, 2014.

It abolishes the “Notice Concerning the Nationwide Adoption of VAT in lieu of Business Tax (BT) Pilot Tax Collection Policy in the Transportation Industry and Certain Modern Service Industries (Caishui [2013] No. 37, hereinafter referred to as ‘Circular 37’)”, which is the current major guideline for enforcing the VAT reform.

Circular 106 specifies that 11 percent VAT rate will be applied to railway transportation and postal service industries nationwide. It also specifies that common pickup and delivery services will be considered a type of logistics auxiliary service and subject to the 6 percent VAT rate.

Circular 106 also includes translation services (categorized as a type of consulting service) and space transportation service in the VAT pilot collection.

The new regulation also alters the rules on leaseback services, providing relief to the financial leasing industry. Leaseback service, or sales-and-leaseback, refers to a financial transaction where one party sells an asset to a financial leasing company and leases the asset back for long-term use. These transactions help improve the company’s cash flow and financial performance. According to an official announcement made by the SAT in 2010 (SAT Announcement [2010] No. 13, hereinafter referred to as “Announcement 13”), the lessee in a leaseback service is not subject to VAT or BT, while Circular 37 released earlier this year stipulates a 17 percent VAT charge for the provider of the leasing service of tangible movable assets. Such arrangements raised the tax burden for the financial leasing companies as they were not able to get input VAT from the lessee (as outlined in Announcement 13), but where still facing the 17 percent VAT charge (as outlined in Circular 37). Circular 106 allows the financial leasing company to deduct the cost of the tangible movable asset.

Furthermore, Circular 106 removes the unequal tax treatment of foreign shipping companies. Chinese law requires foreign shipping companies to use either wholly-owned subsidiaries or third-party agents to collect ocean freight, while Chinese shipping companies can charge shippers directly without engaging a freight forwarder. Under the previous BT regime, 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 a 6 percent VAT charge, as well as local surcharges (including the urban maintenance and construction tax, education levy and local education levy) on gross proceeds collected from clients, which means the foreign shipping companies end up bearing more tax burden than Chinese shipping companies.

In attachment 2 of Circular 106, the deduction of international freight from the taxable income of freight forwarders is allowed, which draws the cost of foreign shipping companies back to the same level as domestic shipping companies.

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