China economy

No ‘one size fits all’ solution as China’s asset managers prepare for new VAT regime in 2018

Levy not expected to trigger capital flight to bank savings despite higher costs

PUBLISHED : Sunday, 31 December, 2017, 12:19pm
UPDATED : Sunday, 31 December, 2017, 11:07pm

Asset managers in China will have one more box to tick on their compliance checklist from next year – gauging risks and costs associated with the new value-added tax regime.

Under the new regime, asset managers will have to pay a 3 per cent VAT on various eligible returns from assets under management, including fixed incomes and capital gains from financial transactions. They will have to strike a delicate balance to cope with the new levy, perhaps by trimming tax risks by carefully calculating the VAT and then sitting down with investors, the ultimate beneficiaries of investment products, on how to share the cost without driving them away.

“There is no simple ‘one size fits all’ solution,” said Kenneth Leung, the Greater China indirect tax leader at global accounting company EY.

“Asset managers have to go through every product carefully to gauge which products would be taxable, to manage the VAT risk when there are uncertainties, and to develop tax compliance processes for VAT purposes. They should also communicate with the investors on how to share the tax liabilities properly,” he said.

The implementation of VAT is complicated because a product could involve multiple investment portfolios – interest from most bonds is taxable but dividend from stocks is not.

Poor communication on tax issues could trigger misunderstandings between asset managers and investors. Some less risk-averse asset managers might distribute all the investment returns to investors without making enough provisions on the VAT due, exposing them to tax risks. Some conservative asset managers might make more than sufficient VAT provisions until they are sure the tax authorities will not come after them for any dues. This could lead to complaints or legal action if investors do not understand the practice and believe that asset managers are inappropriately reducing their earnings by withholding VAT unnecessarily.

Asset managers have to go through every product carefully to gauge which products would be taxable, to manage the VAT risk when there are uncertainties, and to develop tax compliance processes for VAT purposes
Kenneth Leung, Greater China indirect tax leader, EY

Stellar Fu, a tax partner at PwC, said it was inevitable that investors would bear the tax burden and that assets managers had legal support for passing on the levy to investors at least for mutual fund products. It is stipulated by China’s mutual fund law that investors should bear tax liabilities, not managers.

“One thing is for sure, assets managers have to change their mentality when designing products, factoring in the VAT issue, and properly communicate with investors on how to shoulder relevant costs and risks,” she said.

Despite the higher cost, market watchers said VAT might not trigger a capital exodus from the asset management sector to bank savings, as the levy is not enough to level the gap between returns from assets management products and deposits.

The one-year benchmark saving rate sits at 1.5 per cent, whereas wealth management products can often offer returns of more than 5 per cent, though it is not guaranteed.

China has already expanded its tax reform to all broad industries since May 1, 2016, requiring the remaining four sectors – finance, construction, property and consumer services – to pay VAT instead of a business tax.

The authorities have, however, postponed levying VAT on asset management products twice, granting asset managers a total grace period of 20 months to lay the ground for a smooth transition amid outcries of double taxation exposure and too complicated a system.

Market watchers say more specifics on the tax code needed to be spelt out in the rapidly evolving industry, estimated to be worth more than 100 trillion yuan (US$15 trillion).

The tax and finance authorities will closely monitor the implementation of the new tax regime and introduce new rules to tackle any problems identified, EY’s Leung said.