China’s VAT Reform Creates Confusion in Remittances to Foreign Suppliers

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Hollywood studios owed millions in just one example

Aug. 5 – Following China’s reform of its value-added tax (VAT) system, effective from August 1st, many international businesses have fallen foul of confusion in the regulations, preventing many from being paid. In the Chinese film industry alone, Hollywood studios including Warner Bros, Sony & Paramount have not been paid by the organization which represents Chinese cinema distributors for a number of months, a period during which blockbusters such as Skyfall, Man of Steel and Star Trek Into Darkness have pulled in hundreds of millions of dollars at the local box office.

The China Film Group Corporation (CFGC), which was originally formed in 1949, is withholding payments following disagreements over the new VAT tax that Beijing expects U.S. studios to pay. The American studios say the tax violates World Trade Organization rules, but so far have not made an official complaint or withdrawn their films from cinemas. All six major U.S. studios are reportedly involved in the uncertainty. Complaints have generally been over a “2 percent VAT style” additional tax burden being imposed upon them.

The WTO legislation that the studios are citing states that the studios receive 25 percent of Chinese box office revenues on their films, with no additional payments (including taxes) coming out of the studios’ split. The Hollywood Reporter estimates that Warner Brothers is owed at least US$31 million for Man of Steel, The Hobbit and Jack the Giant Slayer; Sony is due roughly US$23 million for Skyfall and After Earth; Disney is owed US$35 million from Oz and Iron Man 3; and Paramount is owed around US$30 million for Star Trek Into Darkness, GI Joe and Jack Reacher. Universal and Fox also have outstanding payments for hit films such as Oblivion and Life of Pi, and MGM will be due its share of profits from co-productions The Hobbit and Skyfall.

The new WTO agreement on China-U.S. movies signed in 2012 also made it more complicated in terms of profit distribution. The agreement increased the profit shares of U.S. studios to 25 percent of the total box office, however it appears that due to the new VAT reform, CFGC is claiming that U.S. studios should bear about 2 percent of their VAT expense, therefore meaning the U.S. studios can now only receive 23 percent of the total box office profits.

After China’s nationwide VAT regulatory change on August 1st, the new rules subject enterprises providing broadcasting, film, and television services to a 6 percent VAT rate. It also means that these enterprises will be able to use their input VAT obtained from buying equipment or other sources to deduct their 6 percent output VAT, and only pay the difference when the output VAT is more than input VAT.

The 2 percent tax mentioned by the studios could be caused by this new policy, however some Chinese media have phrased this as an “approximate 2 percent.” China Briefing’s own research revealed that there is no such thing as an “extra 2 percent VAT” specifically imposed on box office profits that should be borne by the foreign studios, and there is currently no clear rule that specifically addresses the problem caused by the recalculation of input and output VAT as defined in the August 1st regulations.

Some experts are speculating that the 2 percent is the difference between the pre-VAT reform comprehensive tax rate of roughly 4 percent, and the post-VAT reform rate of 6 percent. What may also be happening is that this so-called “2 percent VAT rate” is a rough calculation resulting from different opinions on splitting box office proceeds from imported movies in China.

However, this is an issue for CFGC as well as for the Hollywood studios, since without clarification from Beijing they too could be held liable if they refund the entire 25 percent back to the United States. Hollywood is wary of rocking the boat because China’s film market – already the second largest in the world – is due to overtake that of the United States by 2020. China is also set to build 25,000 cinema screens over the next five years, many with the latest 4k digital technology to cope with demand from an increasingly wealthy population. The government’s recent decision to relax the numbers of foreign films allowed to be shown in China each year from 20 to 34 should also boost profits for U.S. studios.

Nonetheless, the debate does show that when it comes to China, understanding the full implications of its taxes – VAT in particular – attention to detail when assessing the amount of profits expected in any deals is paramount, as is keeping abreast of how regulatory changes may impact upon your business model and revenue streams.

“The Chinese position over structuring the VAT input-output status is not an uncommon tax procedure. However, it does have a negative impact upon overseas studios with no expenses in China to offset VAT,” comments Chris Devonshire-Ellis, Founding Partner of Dezan Shira & Associates. “The debate could be viewed as a tax stick to encourage American studios to invest more in production facilities in China. If their China VAT expenses matched their China VAT income the problem would go away. But to do that they need to have a full scale presence in China.”

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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