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With the launch of a value-added-tax (VAT) reform pilot programme in Shanghai since the start of this year, multinational corporations with operations in the city can claim input VAT credits for many purchases of fixed assets, goods and services.
The new VAT regulations contain more favourable rules for cross-border transactions than the old business tax (BT) regime. This potentially benefits multinational companies seeking to provide services to, or from, their head offices, according to Lachlan Wolfers, a partner at KPMG China. 'The VAT reforms in Shanghai seek to replace the dual system of indirect taxes in China, being VAT [which applies to goods] and BT [which applies to services], with a single VAT across the goods and services sectors.'
Tax leader for China South at Ernst & Young, Clement Yuen says the transport services and certain modern services that were previously subject to BT are subject to VAT in Shanghai. 'Because two new VAT rates of 11 and 6 per cent have been introduced, there are three levels of VAT rates: 17 per cent, 11 per cent and 6 per cent applied to different services,' Yuen says. 'In addition, export of prescribed services is eligible for zero-rated treatment.'
Wolfers expects the pilot programme to be rolled out across the mainland over the next few years. 'The reforms are taking place because BT is an inefficient turnover tax which taxes business - it effectively cascades throughout a supply chain. More than 150 countries now have a VAT. Relative to other taxes, VAT is a more stable form of revenue in times of economic turbulence. It is also relatively inexpensive to collect and more readily accepted by consumers because it is embedded in the price of goods and services sold to consumers,' Wolfers adds. 'The adoption of a VAT in China reflects the government's desire to adopt world's best practices.'
Yuen says while services subject to VAT covered in Shanghai's VAT pilot scheme are outlined in Caishui 2011, No 111 Circular (Chinese abbreviation for finance and tax), and Caishui 2011, No 131 also lists services that qualify for zero-rated treatment, or VAT exempt, and there are still areas that are not specifically addressed. 'We know there are many situations where the taxpayer may need to seek guidance from the authorities on the treatment of certain services or issues, since the rules are still relatively new to all,' he adds.
He believes that multinational corporations with operations in Shanghai, that are registered as VAT general taxpayers, would face various issues under the Shanghai VAT pilot arrangements. These issues could affect their VAT/VAT cash-flow burden, revenue, operating costs, business and VAT compliance processes.
National indirect tax leader at PricewaterhouseCoopers China, Alan Wu says Circular 131 clarifies the principles of the preferential VAT treatments for the international transport industry and export of services. This will potentially improve the competitiveness of the Chinese enterprises and individuals that are covered in the pilot scheme, in the international markets.
'In the prevailing business tax regime, the tax-paying enterprises and individuals providing international transportation services are eligible for BT [business tax] exemption treatment in accordance with Caishui 2010, No 8 Circular jointly issued by the Ministry of Finance and State Administration of Taxation in April 2010 entitled: 'Notice Announcing BT Exemption for International Transportation Services'. However, the input VAT paid for purchasing equipment and VAT-able services is not creditable and has to be treated as cost,' Wu adds. 'As a comparison, Circular 131 provides more preferential indirect tax treatments to the international transportation industry.
'For pilot enterprises and individuals with the required qualifications and licences, they will enjoy a zero-rated VAT treatment on the international transportation income. Since the refund rate is the same as the applicable VAT rate, there would not be any non-creditable VAT. The input VAT costs paid can be used to offset against the output VAT arising from other VAT-able activities, or refunded.
'Where the pilot enterprises and individuals are either general VAT payers without the required international transportation qualifications and licences, or small-scale VAT payers, they can still enjoy a VAT exemption on the international transportation income, which is equivalent to the prevailing BT treatment.'
VAT general taxpayers will need to have good accounting records and invoice-management systems since their VAT liabilities will depend on the support of VAT special invoices, says Annie Lau, director for tax at Deloitte China. 'It is important for the taxpayer to formally confirm its general taxpayer status with the tax bureau in order to adopt the credit system. Taxpayers engaged in taxable services of different tax rates would need to separately account for the services, otherwise, the higher tax rate will apply.'
To alleviate tax burdens, it is important for the general taxpayers to obtain valid VAT invoices from suppliers to support input VAT credit. Otherwise they may need to adjust the pricing to pass on an increased tax burden to customers or suppliers via pricing negotiations, Lau says. 'Taxpayers may also need to be more selective in choosing suppliers to obtain valid VAT invoices. Some companies outside the pilot area cannot credit the Taxable Services VAT Special Invoices issued by Shanghai service providers due to system-recognition problems. It is important to resolve the issues with the tax bureau in charge.'
Deloitte China has received queries from some clients in Shanghai who do not know if their businesses are covered by this pilot scheme since their services are not specifically stated in Circular 111. 'Our advice is that the clients should confirm with the tax bureau in charge since the list of the circular is not exhaustive,' Lau says.
'However, some clients in logistics services and transportation complain that their tax burdens have increased under the pilot programme since they do not have much input VAT credit.'