China’s VAT Reform and Its Impact on the Transportation Industry
Richard Cant, regional director of Dezan Shira & Associates‘ Shanghai offices, was recently interviewed by Australia’s Freight and Trade Alliance about China’s value-added tax reform, its impact on the shipping and logistics industries, and opportunities within Shanghai’s new free trade zone.
His interview, which was originally published in Lloyd’s List, is excerpted below.
What is your background and how did you end up in your current role?
I am the Regional Director of the Shanghai and Yangtze River Delta offices of Dezan Shira & Associates. We assist foreign-invested companies set up, operate and expand their businesses in China and Asia. Our areas of expertise include corporate establishment, tax, accounting, and HR administration for these jurisdictions. Many of our clients in the logistics industry have come to us with some of the issues that we’re talking about today.
What are some of the key differences between the previous Business Tax and current VAT?
Currently value-added tax (VAT) applies to all individuals and enterprises engaged in the sale of goods, import of goods, the provision of repair, replacement and processing services, modern services, lease of tangible movable property and transportation services within China. VAT in China exhibits some of the features of other VAT regimes throughout the world in the sense that it taxes final consumption expenditure, by generally relieving the burden of VAT on transactions between businesses through the input tax credit mechanism.
Business tax (BT), which applies to the provision of all other services, the transfer of intangible assets and the sale of immovable property, is not creditable. BT is a cascading turnover tax, in which taxes are paid on the whole cost of the product at every point of the supply chain. By taxing only the “value added” components throughout the supply chain, instead of taxing the entire business turnover, the VAT reform potentially removes extra costs facing businesses that are currently subject to cascading BT.
What were the key changes from Circular 37?
Circular 37 was a comprehensive circular consolidating and formalizing the prevailing implementation and administrative rules contained in various circulars on VAT Pilot Program. At the same time, it defined the scope of the new service sector to be added to the Pilot Program.
Circular 37 expanded VAT to a new service sector: radio, film and television with different stages of production, distribution channels and broadcasting models to be covered and defined.
The Appendix of the Circular listed out the services that were qualified for VAT zero-rating and VAT exemption. For instance, design services provided to overseas entities would be VAT zero-rated. It was also defined that if pilot services eligible for both VAT zero-rating and exemption, VAT zero-rating would take precedence over VAT exemption.
Significant changes applied for international transportation industry. Previously, a foreign service provider without a bilateral transportation treaty protection would be subject to a transitional VAT rate of 3% for the provision of international transportation services. However, starting from 1 August 2013, depending whether foreign country has a bilateral treaty or not, VAT exemption or 11% VAT withholding applied.
Moreover, Circular 37 removed the concession of the “net basic method” for computing their VAT liabilities, except for taxpayers engaged in the financial leasing of tangible movable assets.
There were also a few beneficial changes for some taxpayers eligible to deduct certain expenses. For instance, input VAT credit was allowed for the self-use of motor vehicles, motor cycles and yachts, etc.
What are the general requirements for exemption for exported goods?
Exported goods from China are generally subject to 0% VAT, for these goods, the VAT exemption and rebate policy applies. For exempt goods, input VAT credits cannot be refunded nor used to deduct output VAT from domestically sold goods, but can be added into the cost of the exported goods. The following goods are eligible for a VAT exemption and are not refunded:
- Goods manufactured and exported by small-scale taxpayers;
- Software products;
- Used equipment;
- Agricultural products produced by agricultural manufactures;
- Duty-free exports such as oil paintings, nuts or black beans;
Also in regards to VAT exemption for exported services, filling procedures were issued recently in the Announcement 52 and general conditions are the following:
- Written contract in Chinese should be provided;
- Payment must come from overseas. (This could pose problems for intercompany arrangements as if a local branch or company pays then there is no exemption);
- In the process of claiming exemption, separate accounting must be undertaken
- If exemption is satisfied, then no special VAT invoice can be issued;
- The service recipient company which is located overseas should provide requisite registration documents including the lease agreement;
It should be noted that VAT exemption in bonded or free trade zones can only apply for goods but not for services.
What is meant by Zero-rated VAT?
The difference between zero-rated and exempt goods from VAT lies in the ability to refund input VAT. For both zero-rated and exempt goods, no output VAT is payable. However for zero-rated goods, kinput VAT is refundable.
What are the main reforms for foreign logistics and transportation industry?
On the 1st of August 2013, Circular 37 announced that service sectors like transportation and logistics were assessed on their gross revenue for VAT purposes. Deemed input VAT credits for expenses which were previously deductable for BT purposes (e.g. overseas freight charges, port charges and handling changes) could no longer be claimed. Freight Forwarders were required to apply 6% VAT and additional local surcharges on gross proceeds collected from clients.
Moreover, new changes were introduced for transportation services, which were eligible for 11% VAT. It was also announced that international transportation services which were provided by providers based in China were eligible for zero-rating or exemption for their services.
At the same time, international transportation services from providers located in a jurisdiction which has a bilateral tax treaty with China, the ocean freight remitted out of China was exempt from VAT under the relevant treaties. If international transportation services are provided by companies located in a foreign jurisdiction that does not have a bilateral tax treaty with China, the payee is required to withhold 11% VAT.
Furthermore, Circular 106, which will come into effect on January 1, 2014, removes the unequal tax treatment of foreign shipping companies. In Attachment 2, 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
What are the implications for ocean transportation?
According to the law, foreign shipping companies are required to use either wholly-owned agents or third party agents to collect ocean freight. Unlike international shipping companies, domestic shipping companies can carry out business operations through their principals without involving shipping agencies and sell directly to the forwarders or the end customer. Moreover, a Chinese principal incorporated in China can enjoy VAT exemption or zero-rated VAT.
What are the implications for air transportation?
Similar to ocean transportation, foreign airlines have to set up Representative Office in China with license issued by Civil Aviation Administration of China (CAAC) and in order to be engaged with China RO of foreign air carrier, freight forwarders need to get a CAAC license.
What commercial advantages did domestic operators have over Foreign Service providers?
The tax burden was naturally shifted to the foreign shipping companies, which were not able to pass on this burden to their customers, especially if these customers were individuals, small-scale taxpayers or foreign companies who were not able to utilize VAT credits. Customers who were not able to claim input VAT with the invoices they obtain were discouraged from using foreign shipping companies because it would take time to file for a VAT return and obtain the VAT refund, with negative impact on their cash flow. Therefore, domestic service providers enjoying VAT exempt and zero-rated VAT were much more competitive in terms of pricing compared to the foreign service providers.
What are some of the considerations that the logistics sector should consider when examining the Shanghai Free Trade Zone?
For the industries which fall outside of Foreign Investment Administrative Measures of Foreign Access “Negative List,” pre-approval will no longer be required for foreign investment projects or establishment of foreign investment enterprises. Instead, filling requirements will apply. The logistics sector might be a subject of simplified procedures as it was not particularly mentioned on the Negative List.
The Shanghai government has focused on developing a sophisticated trade system for the Shanghai Pilot Free Trade Zone to optimize the cargo flow, while also making it more convenient for cargo to go in and out.
Therefore, a new programme is being tested where a company can import its goods into the FTZ with only a warehouse receipt. Six companies are currently trailing this system. They also on a plan to make inbound registration easier by simplifying the current administrative forms for inbound goods and avoiding double information request from with Customs.
In the past, China Inspection and Quarantine (CIQ) have monitored cargo from multiple angles; the enterprise, warehousing, assessments. Now, only the status of the cargo (bonded or not bonded) will be monitored.
Multiple bonded transferring might be an issue, therefore the “entry-first & declaration-later” approach has been adopted for SFTZ.
Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.
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