Implications of the VAT Reform in China

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Dec. 11 – The VAT pilot reform represents tax saving opportunities for many taxpayers, but increased tax burdens for others. For service providers in China who are now registered as general VAT taxpayers, they can claim input VAT credits for the purchase of goods, fixed assets and services used in their business. It is therefore more advantageous for these service providers to contract with other providers who are also VAT payers so that they can recover VAT incurred on costs, as compared to contracting with a business tax (BT) payer since BT is not deductible. For businesses selling and importing goods, it is now possible to claim input VAT credits for the purchase of services that fall under the pilot reform.

On a broad scale, with the radio, television and film industry being included in the pilot, enterprises will be able to deduct tax from the purchase of fixed assets. This encourages enterprises to actively promote new transmission technologies such as a ground digital television network and live satellite so as to drive new industries such as digital audio broadcasting, 3D movies and TV, and IMAX, etc.

On the other hand, the tax burden of logistics enterprises have nearly doubled since the implementation of the pilot reform. The 11 percent VAT rate for transportation industries replaced the previous 3 percent BT; while storage, delivery and cargo forwarding services adopt 6 percent VAT, replacing the previous 5 percent BT. The main items for deduction are expenses for gas, fixed asset purchase and vehicle repair. However, the enterprise may not purchase vehicles every year, and it is difficult to obtain a VAT invoice for vehicle repairs. While it is relatively easy to obtain a VAT invoice for gas, this expense only occupies about 15 to 20 percent of the operation’s costs. The relatively few deductible items and strict deduction conditions have caused the costs to nearly double.

Before the end of the Twelfth Five Year Plan period (2011-2015), the VAT reform is expected to expand to cover all other sectors currently still subject to BT. These include rail transportation, financial services and insurance, real estate and construction, post and telecommunications, and entertainment services. The tax reform for these industries is more complex and therefore requires more planning. It is anticipated that rail transportation, construction, and post and telecommunications will be subject to an 11 percent VAT rate. Once the VAT pilot reform is fully implemented, some speculate that local tax bureaus, the main function of which are to collect BT, will be converted to state tax bureaus.

For businesses previously subject to BT and which now fall under the pilot, the VAT declaration procedures will become more complex, and higher demands will be placed on their financial management. This is also a good opportunity for companies to review their tax planning arrangements to maximize tax savings. In estimating changes in their tax burden, businesses can consider the following factors:

• The proportion of expense that is input VAT deductible against the income;
• Ability to obtain certificates for claiming input VAT;
• Composition of suppliers;
• Composition of customers; and
• Ability to conduct separate accounting for the sales volume or service income for different operations subject to different tax rates.

This article is an excerpt from the December 2013 issue of China Briefing Magazine, titled “Revisiting China’s Value-Added Tax Reform.” In this issue of China Briefing Magazine, we review recent steps taken by the Chinese government to reform its value-added tax policy. Specifically, we examine the sectors covered by the new Pilot Reform program with a focus on tax rates, taxpayer status and the calculation of VAT. We also include a VAT Pilot Reform Rates Chart, which overviews each affected industry’s tax rate and VAT exempted services.

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