China expands VAT reform to new sectors: launch date – May 1

Новости в сфере налогового законодательства

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In the 2016 National People’s Congress this month, Li Keqiang, China’s Premier, announced in the Government Work Report that Value Added Tax (VAT) reforms will be fully implemented and expanded to the construction, real estate, financial and consumer services industries starting from May 1, 2016.  

As background, as part of the efforts to reform China’s state-centric fiscal system, VAT reform was first introduced in 2012 as a trial program in Shanghai. The goal was to replace the Business Tax (BT) with VAT.  Since 2013, the program has been expanded to several other municipalities and provinces and applied to various sectors, including railways, postal services, telecommunications and certain service industries.  

With the announcement by Premier Li, industry players are now looking forward to the long-awaited new VAT policies applying to the construction, real estate, financial and consumer services industries.  Once the VAT reform is fully implemented nationwide, China will be one of the world’s key countries with the most advanced VAT regime.  

1.         NEW REFORM SECTORS 

The four sectors subject to the last round of VAT reform and their applicable rates are as follows: 

Industry

Scope

Current BT Rate

Applicable VAT Rate

 

Construction services

  • Construction, installation, repairs, decoration and other construction projects

3%

11%

Real estate

  • Sales of buildings and other structures built on land
  • Assignment of land-use rights and natural resources use rights
  • real property leasing

5%

11%

Financial and insurance

 

5%

6%

Consumer services

hospitality, food and beverage, healthcare and entertainment

5%

(entertainment 5 - 20%)

6%

 

2.         TIMELINE AND ACTIONS

“The progress in the VAT reform last year was slower than was planned and efforts would be made to meet the May 1 deadline this year,” said Lou Jiwei, Minister of Finance on the sidelines of the legislature National People’s Congress. 

Wang Jun, Chief of the State Administration of Taxation (SAT), said in a press conference on March 13, 2016 that a detailed VAT reform scheme will be submitted to the State Council executive meeting for approval; thereafter, it is likely that the Ministry of Finance (MOF) and the SAT will jointly announce the detailed reform policy by April this year.  If everything stays on track, the launch date of the reform policy will be May 1, 2016.  As a transitional measure, it is also contemplated that taxpayers will be granted an additional 10-day period to complete VAT filings for May and June.  

Since this VAT reform will have a significant impact on at least 10 million taxpayers in China, and it is just a few weeks from now to the May 1 launch date, the SAT has issued an internal circular (Shuizongfa [2016] No. 32, hereinafter referred to as Circular 32) regarding the implementation plans and timetable to be followed by the local tax bureaus at different provincial and municipal levels.  

This Circular 32 sets out several milestones as key steps for achieving the target launch date.  The key steps include the following: 

  • Fix the working plans for each level of tax bureaus.
  • Transfer taxpayers from local tax bureaus to state tax bureaus (BT and VAT payers are under the administration of local tax bureaux and state tax bureaux respectively).
  • Complete preparation work for conversion of BT to VAT.[1]
  • Organize internal training for tax officers.
  • Organize external training for taxpayers.
  • Conduct trial run of VAT reform.

Circular 32 requires that all levels of tax bureaus shall make their best efforts to complete the above milestones, which, in turn, would make the launch date on May 1 achievable.  The Chief of the SAT, Wang Jun, also confirmed that all tax bureaux would provide green channels to new VAT taxpayers under this latest VAT reform to facilitate their tax filings. 

3.         WHAT'S NEXT? 

It is anticipated that the VAT reform will bring significant benefits to enterprises.  With VAT reform being extended to the new sectors including construction, real estate, finance and consumer services, the local tax burden of the millions of taxpayers engaged in these four industry sectors will be greatly reduced, as would that of the other industry sectors which are in the same supply chains as these four industry sectors.  

The Chief of SAT, Wang Jun, has also affirmed in the press that the government has formulated associated policies − such as continuing the tax preferential treatments originally provided for BT payers to VAT payers after the implementation of this new VAT policy − as well as providing transitional policies to support the smooth transition from BT to VAT.  Notwithstanding the above, Wang also assured taxpayers that tax authorities at all levels will be committed to continue the transition of the relevant tax preferential policies from their local implementation perspective.  

CONTRAST WITH EU VAT 

The Chinese proposals are very different from the VAT systems of the EU.  For example, in the financial and real estate sectors, most suppliers are exempt, though some are taxable while others carry the right to opt to tax.  Those supplying goods and services into China will need to be aware of the VAT implications as law and practice develops.  It is hoped that the SAT will learn from the European experience of VAT in formulating laws and practices, so that problems can be alleviated.  Financial services and real estate VAT are two of the most complex areas of EU VAT and much can be learned from European Court of Justice case law. 

4.         MORE WILL BE COMING

Before May 1, 2016, we expect that the SAT will issue more detailed rules to illustrate how the new VAT system will work.  The launch date on May 1, 2016 is pretty clear, but many issues remain to be settled and clarified.  

Specifically, for the finance and insurance sectors, the common issues that all business sectors would encounter in switching from the BT system to VAT system include how to effectively claim input VAT credit and pass on output VAT to customers, and  the continuity of the existing tax exemption/reduction treatments under BT system.  In addition, a key challenge faced by the business operators in sectors, including financial institutions, insurance companies, security companies and asset management companies, would be the upgrading of each company’s current IT system to cope with the change.  It is anticipated that such upgrade will be quite time consuming. Thus, there have been news reports suggesting a possible delay in the VAT reform timeline for certain enterprises in these sectors.      

As for the construction and real property sectors, which are two pillars of China's economy, below is an overview of some of the major issues concerning these two sectors to help address the new VAT reform.  
 

 

Issues

Observation/Challenges

 

Real Estate 

1.  Cost deduction/input VAT credit 

  • VAT is not charged on the initial grant of land use rights by the government; therefore, property developers would not be able to claim any input VAT deduction on the initial land acquisition. Given that land is the main cost of developers, the proposal of a notional deduction was raised and discussed but MOF did not seem to favour this option.    
  • Previously, real property enterprises might not be able to obtain official VAT invoices from their vendors (such as head contractors, financial institutions, or equipment suppliers) for input VAT credit because the vendors were not general VAT payers.  With BT being replaced by VAT, the above should become less of an issue. 
  • VAT on labour costs is still not creditable.

2.  Sales revenue/output VAT

  • VAT is payable in full for presale revenue, given that a VAT invoice in the full amount is issued to customers. If no VAT invoice is issued for presale, MOF may consider a prepayment of VAT, calculated using a reduced levy rate (or other method) to be confirmed by the SAT.
  • Free area, parking lot, renovation, etc. sold together with a property are currently not required to be separately accounted for or treated as a deemed sale for VAT purposes.  However, while household electrical appliances are provided when the properties are sold, the sale price would need to be clearly split between appliances and real property, which are subject to different VAT rates.

3.  Transitional rules

  • For construction of properties that have been commenced but not sold, there should be transitional rules in place to ensure the overall tax burden of the real properties enterprises will not be significantly affected due to the new VAT reform.[2]

4.  Sale of second-hand properties

  • In the residential property market, sellers of second-hand properties are mostly individuals. To better manage VAT credit and collection in the supply chain, China for the first time is planning to formulate tax administration rules on such individual sellers.

5.  Real property leasing

  • Real property leasing is subject to VAT applying the same rate as real property sale (i.e., 11%).  There is a discussion to distinguish the sales/service nature between real property leasing and short-term service apartment leasing.  For short-term service apartment leasing, a lower VAT rate of 6% will be levied if it is considered as a type of customer service.  MOF is considering income derived from leasing service apartments for a term of less than four weeks (or any term to be determined) as a type of customer service income which is subject to 6% VAT.

Construction 

1.  Cost deduction/Input VAT credit

  • Since raw materials used for construction work are usually sourced from domestic individuals or small business operators who do not issue VAT invoices to their business partners, the head constructor and/or sub-contractors may not be able to obtain valid VAT invoices in respect of the domestic purchases from their individual or local vendors for input VAT credit purposes.
  • Similar to the real estate sector, in that VAT on labour costs is still not creditable.

2.  Transitional rules

  • For ongoing construction projects, there should be transitional rules in place to ensure the overall tax burden of the construction enterprises will not be adversely affected due to the new VAT reform. Reduced VAT levy rate or immediate VAT refund are proposals being considered among others.

 

3.  Offshore construction services

  • Provision of offshore construction services may be exempted from VAT with the relevant materials VAT costs incurred in China being refunded upon export.

 

As you can see, the real property and construction sectors are closely linked and always encounter similar problems in the VAT system (such as the input VAT deduction, transitional issues, and mismatch of income and costs due to the long lifecycle of projects).  With the new VAT reform coming into effect soon, we expect we will have a much clearer direction to deal with the above key issues that are in debate.  

Last but not least, in order to better prepare for the coming new VAT reform, enterprises − particularly in the real property and construction sectors − should review the status of their current projects and contracts with vendors and customers, not only from a tax perspective, but also more widely from a cash-flow management perspective, considering the possibilities around such issues as potential pricing adjustment.  Also, even though the policy makers affirmed that the new VAT reform should reduce the VAT burden on all industries, it does not necessarily mean this will apply to each and every enterprise. Individual cases may vary. For enterprises having a reduced tax burden after the VAT reform, their profit levels may not be increased as compared with the BT regime, since VAT and BT are structured differently, which may impact profit levels in different ways.  Therefore, a proper consideration of the transfer prices between vendors and customers is vital to ensure that an enterprise maintains its profit level while reducing its VAT burden.     

Find out more about the implications of China’s VAT reform by contacting Daniel Chan.



[1] Preparation work include recognition and certification of general VAT payers status; setup of tripartite automatic tax deduction agreements with the state tax bureaux; testing of hardware and software for online tax filings and tax control systems; estimation of the volume of VAT invoices based on the new VAT payers' revenue and printing of VAT invoices, etc.

[2] By reference to the transition rules on finance lease industry, MOF is considering offer a reduced levy rate on sales revenue but with no input credit.  For real property industry, it is expected that the transitional period will be longer given its unique business model.  The projects that are eligible for the transitional rules would also be subject to discussion.