Beijing is likely to expand a trial reform of value-added tax (VAT) to more cities this year as it seeks to increase tax revenues from the service sector.
Shenzhen, Beijing and Anhui province are expected to try out the reform by October, following the trail blazed by Shanghai, which started the pilot programme in January, according to Lachlan Wolfers, a tax partner at KPMG China.
The change, which covers the transport and 'modern service' sectors, replaces the dual system of indirect taxes on the mainland - VAT, which applies to goods, and business tax, which applies to services - with a single VAT for goods and services.
In the Shanghai scheme, VAT rates of 11 per cent and 6 per cent were introduced in addition to existing rates of 17 per cent and 13 per cent, for a total of four VAT rates.
After the change, some logistics and warehouse companies that had enjoyed a business tax rate of 3 per cent or 5 per cent were required to pay a higher rate.
Wolfers said it would take time for the new VAT system to prove itself.
'In the case of Shanghai, some transportation and logistics firms have incurred increased tax liabilities, particularly during the initial period, when they pay VAT at a higher rate on their services but do not get the benefit of VAT credit until they replace major items of capital equipment, such as vehicles,' he said.
'Once the pilot scheme is expanded to the whole nation, many of the short-term problems in paying VAT in some cities and business tax in others will be solved.'
According to the Shanghai Taxation Bureau, the reform, affecting 129,000 companies at the end of March, saved taxpayers a total of 2 billion yuan (HK$2.45 billion) in the first quarter. Small firms, accounting for 70 per cent of the affected businesses, were the biggest winners, as their taxes fell by 40 per cent.
The central government launched the reform partly because it gets 75 per cent of VAT proceeds but zero from business tax, which flows into local government coffers. The State Administration of Taxation said 10 cities and provinces had applied to take part in the pilot scheme so as to avoid local companies migrating to cities and provinces in the trial.
Wolfers said firms needed to prepare themselves for the new regime.
'The VAT reforms affect a broad range of aspects of a business. For example, companies may need to make changes to their information technology and accounting systems, ensure their key suppliers pass on cost savings, and review their contracts,' he said.
'For Hong Kong companies that purchase services from mainland China, the former 5 per cent business tax is saved, because under the new VAT rules, the export of many services is exempted from the liability.
'In addition, Hong Kong companies should be able to provide services to many businesses in the mainland without any real VAT cost.'