The Value-Added Tax (“VAT”) and Business Tax (“BT”) have been the two most important turnover taxes in China. BT is imposed on business activities without any deduction of costs whilst VAT taxes the value added at each stage of sale of goods or services. However, the parallel operation of VAT and BT has long led to unfair double taxation as well as administrative difficulties for the authorities.
Following the “Outline of the Twelfth Five-Year Plan for National Economic and Social Development of PRC” adopted by the National People’s Congress on 14 March 2011, it was decided that the VAT should replace the BT entirely. The Ministry of Finance (“MOF”) and the State Administration of Taxation (“SAT”) therefore jointly issued a Circular on the Pilot Plan for the Imposition of Value Added Tax to Replace Business Tax (Cai Shui [2011] No. 110, “Circular 110”) on 16 November 2011. Based on the Circular 110, the Pilot Reform was first implemented in Shanghai through the Circular on Implementation of the Pilot Program for Replacing Business Tax with Value Added Tax in the Transportation Industry and Some Modern Service Industries in Shanghai (Cai Shui [2011] No. 111, “Circular 111”) (“Pilot Program”), which was also issued on 16 November 2011.
Pursuant to the above Circulars, the Pilot Program began on 1 January 2012. Upon successful implementation of the program in Shanghai, the reform will be extended to other cities. The ultimate aim is to replace BT entirely with VAT in China, eliminating the problem of double taxation.
Under the Pilot Program, taxpayers will receive a special VAT invoice to credit input VAT (charged on their payment of services) against output VAT for services provided in Shanghai by other Shanghai service providers registered in Shanghai. Taxes will therefore only be paid on the amount of value added at their respective stages.
In relation to services that are provided by Shanghai service providers registered in other parts of China, the old BT scheme will apply, but they may be able to deduct the BT against the VAT payable in Shanghai. According to the Circular on Zero VAT Rate and Tax Exemption Policy Applicable to Taxable Services (Cai Shui [2011] No.131), exports of services to customers outside mainland China may be treated as zero rated or be exempted from VAT.
Some Major Provisions of the Pilot Program
Scope of Pilot Industries
The Circulars provide that the pilot services to which VAT is applicable include the transportation industry (comprising land transport services, water transport services, air transport services and pipeline transport services) and some of the modern services (comprising research and development and technical services, information technology services, cultural and creative services, logistics support services, professional verification and consultancy services etc).
Recognition of VAT General Taxpayer Qualification
Under the VAT system, different tax rates and methods of tax computation are applicable to general taxpayers and small-scale taxpayers. For a VAT taxpayer participating in the Pilot Program whose annual sales volume or taxable services exceeds RMB 5 million, the taxpayer will be required to qualify as the VAT general taxpayer. Otherwise, the taxpayer will be classified as a small-scale taxpayer (though he may still apply for the status of general taxpayer upon fulfilling certain requirements).
Tax Rate and Method of Tax Calculation
Other than the standard rate of 13% or 17% for the existing VAT, two new lower rates of 11% and 6% have been added. Further details are as below :-
| Type of the tax payer | Pilot industries | BT rate | VAT rate |
| General Taxpayer | Tangible property lease | 5% | 17% |
| Transportation industries | 3% | 11% | |
| Selected modern service industries excluding the above | 5% | 6% | |
| Small-scale Taxpayer | Same as general tax payer | Same as general taxpayer | 3%* |
* Input VAT cannot be credited against output VAT.
For the general VAT taxpayer, although the VAT tax rate is higher than the prevailing BT rate (of between 3% and 5% for certain services), it will not, in many cases, result in higher tax payable since the tax base and method of tax calculation are different from the BT.
Preliminary Effect of the Pilot Reform in Shanghai
It was reported that from January until the end of June 2012, the tax amount collected by the Shanghai Tax Office was reduced by around RMB 4.45 billion. It appears that the tax burden of taxpayers is lower due to the Pilot Reform. The reform should stimulate the domestic economy since it provides incentives to pilot taxpayers to upgrade their equipment or purchase outsourcing services as such costs can be deducted for tax purposes.
The Expanded Pilot Area
After implementing the Pilot Program in Shanghai for 8 months, MOF and SAT jointly issued the Circular on Implementation of the Pilot Program for Replacing Business Tax with Value Added Tax in respect of the Transportation Industry and Some of the Modern Services in Eight Provinces or Cities Including Beijing (Cai Shui [2012] No. 71, “Circular 71”) on 31 July 2012. According to Circular 71, the Pilot Program has since been expanded to eight provinces or cities, including Beijing City, Tianjin City, Jiangsu Province, Anhui Province, Zhejiang Province (Ningbo City included), Fujian Province (Xiamen City included), Hebei Province and Guangdong Province (Shenzhen City included). It is anticipated that more policy guidance for such tax reform will be issued, and more industries and areas will join the reform.
If you have any questions on the above or other issues on doing business in Mainland China, experienced lawyers in our China Business Department will be happy to assist you.