Recap of China’s Key 2013 Value-Added Tax and Legal Regulatory Updates

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Key Value-Added Tax Regulatory Updates:

Caishui [2013] No. 106 – VAT Pilot Reform Expansion

On August 1, 2013, the value-added tax (VAT) pilot reform was implemented nationwide, as formalized by the promulgation of the Notice Concerning the Nationwide Adoption of VAT in lieu of BT Pilot Tax Collection Policy in the Transportation Industry and Certain Modern Service Industries (Caishui [2013] No. 37, Circular 37) by China’s Ministry of Finance (MOF) and the State Administration of Taxation (SAT) on May 24, 2013. In early December 2013, China’s State Council revealed the further expansion of the VAT reform to the railway transportation and postal service industries, and the MOF and the 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, Circular 106), which came into effect on January 1, 2014, abolishing Circular 37.

Circular 106 specifies that an 11 percent VAT will be applied to railway transportation and postal service industries nationwide. Note that postal service industry refers to postal services provided by the wholly state-owned China Post Group. In addition, Circular 106 added space transportation service under transportation services, as well as included mail and package pickup and delivery services to the scope of logistics auxiliary service. Translation service is also newly specified as a type of consulting service.

The new regulation also altered the rules on leaseback services, providing relief to the financial leasing industry. Leaseback service, or sales-and-leaseback, refers to financial transactions where one party sells an asset to a financial leasing company and leases the asset back for long-term use. This arrangement helps improve the company’s cash flow and financial performance. According to SAT Announcement [2010] No. 13 (Announcement 13), the lessee in a leaseback service is not subject to VAT or business tax (BT). However, Circular 37 released earlier this year stipulates a 17 percent VAT charge on the entire leasing fee received by the providers of tangible property leasing services, which significantly raised the tax burden for financial leasing companies. Circular 106 relieves this burden by allowing financial leasing companies to deduct the cost of the tangible movable asset from the leasing fee before calculating tax.

Circular 37 allowed VAT exemption for offshore outsourcing services provided by companies located in certain cities of China and scheduled for this exemption to expire at the end of this year. Circular 106 extends the validity period to December 30, 2018, and expands it to include all pilot taxpayers. It also provides the detailed scope of eligible services.

Furthermore, Circular 106 removes the prejudicial tax treatment of foreign shipping companies that existed under Circular 37. 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 was not permitted. Instead, freight forwarders were 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 meant the foreign shipping companies ended up bearing a higher tax burden than Chinese shipping companies. In Circular 106, the deduction of international freight from the taxable income of freight forwarders is once again allowed, which brings the cost of foreign shipping companies back to the same level as domestic shipping companies.

Other Legal and Regulatory Alerts

Consumer Rights Protection Law

The new Consumer Rights Protection Law provides more protection for consumers. Previously, consumers had the burden of proof to show the defects of the products or services purchased. The new law shifts the burden of proof from the consumer to the seller for six months after the products or services are provided (the privilege expires after six months). It also confirms the right of rescission for consumers on products purchased via internet, television, phone or mail, which means the customers have the right to return most products without any specific reasons within 7 days of receiving them. Additionally, the new law adds heavier obligations for online transaction platform providers. They will be held liable in a dispute if they cannot provide the real name, address and effective contact information of a seller to consumers of online purchases. It also increases the punitive damages for conducting fraudulent acts in a transaction at three times the original price. The new law will come into effect on March 15, 2014.

Business Transactions Reporting Requirement

China’s State Council amended the Measures on the Report of Statistics of Balance of International Payment (State Council Order 642) in November 2013, which entered into force on January 1, 2014. The Measures require individuals and entities including FIEs and ROs in China to report not only all economic transactions (including the purchase and sale of commodities and services, giving and receiving endowments, and making and receiving investments) they conduct with non-residents in China, but also all of their foreign financial assets and liabilities under the supervision of SAFE. The new Measures also impose new obligations on non-residents of China, including foreign individuals and entities, to report to SAFE through the processing bank about their economic transactions with Chinese individuals and entities, including FIEs and ROs, in China. Detailed requirements are expected to be released in 2014.

Amendment of Company Law

In October 2013, China’s State Council decided to ease company registration requirements by lowering registered capital requirements, reducing costs of incorporation, and loosening registration principles. In the following month, the State Administration of Industry and Commerce confirmed that the new policies also apply to FIEs in China. On December 28, 2013, the Standing Committees of the National People’s Congress, the legislative organ of China, passed the decision to revise the Company Law. The new law will come into effect on March 1, 2014. We highlight some of the key revisions below:

  • The minimum registration capital of RMB30,000 for limited liability companies, as well as the RMB100,000 minimum for single shareholder companies and the RMB5 million minimum for joint stock companies will be cancelled;
  • There will be no mandatory ratio of the initial payment and deadline for full payment of registered capital;
  • The actual capital contributions of the company will no longer be required for incorporation. The current Company Law requires 20 percent of the registered capital to be paid in full upon company registration;
  • Company registration based on actual capital contributions will be replaced by company registration based on subscribed capital contributions, which means it will be unnecessary to actually have the funds at the time of registration. The shareholders of the company (the founders) will decide on the amount, method, and deadline for subscription of contributions at their discretion, and will be responsible for the authenticity and legitimacy of the contribution.

Additionally, the requirements for location of the business upon company registration will also be lowered. For example, Zhejiang AIC introduced in late November that in e-commerce, an independent “secretary company” may be used as a virtual business location for the purpose of business registration and administration.

Other Updates

China’s Minister of Finance Lou Jiwei introduced the plan for further fiscal and tax reform of China in an interview in November 2013, commenting that the initial reform of the consumption tax system will include adjustment of its scope and tax rate. The reforms aim to make consumption tax more functional with respect to adjusting high energy-consumption, high pollution products and certain luxury goods.

Another important act that could affect foreign investors is the cleaning up of existing preferential tax policies. Minister Lou expressed that regional tax incentives that have been proven to have positive effects will be applied nationwide and all preferential tax policies will be enacted through a unified system constituted by specialized tax laws and regulations instead of local government. These changes raise the question over whether existing regional development zones will lose their competitiveness in attracting investments, since they may no longer be able to offer special tax treatments.

This article is an excerpt from the January and February 2014 issue of China Briefing Magazine, titled “Annual Audit and Compliance in China.” In this issue of China Briefing, we discuss annual compliance requirements for foreign-invested enterprises, including wholly-foreign owned enterprises, joint ventures and foreign-invested commercial enterprises, as well as the less demanding requirements for representative offices. We also highlight the most recent tax and legal changes that will significantly influence the way companies do business in China in 2014.

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