After the Enterprise Income Tax of the People’s Republic of China on 1 January 2008 unified China’s corporate income tax system, China has since the start of this year implemented a second wave of tax reforms, this time involving the three types of turnover taxes:
- BT (business tax) – levied on service income, the transfer of intangible assets, and the sale of real estate;
- VAT (value added tax) – levied on the sale of tangible goods, on processing, repair and replacement services, and on the import of goods;
- CT (consumption tax) – levied on a selected list of luxurious and hazardous consumption products.
The regulations and implementing rules that became effective on 1 January 2009 are of an interim nature, with further changes expected within 2-3 years. However the current, interim changes especially to the BT and VAT systems are having a huge impact; companies in China and abroad should take careful note. Major changes in Business tax will affect foreign enterprises, and not always in a positive way.
The scope of the BT taxable services
According to Article 4 of the new BT Implementation Rules, where either the service recipient or service provider is located in China, China shall levy BT on any income derived from such service. Thus BT is charged in China based on the place where the service recipient or provider is located, rather than where the taxable service is rendered. This not only broadens the scope of the BT taxable services, but can also result in double-taxation: most jurisdictions impose BT on services performed within their territory, and international tax treaties do not usually include provisions on prevent double-taxation of BT. Some examples of who may be affected:
- A logistics company of country A holds the inventory of a Chinese customer in the warehouse in county A, i.e. the logistics company provides warehousing service to the Chinese company outside China. The logistics company shall pay BT in China (withheld by the Chinese customer) and in country A.
- A foreign company lends money to its Chinese subsidiary. BT shall be levied on any interest payments.
- The Chinese subsidiary of a foreign company is charged costs for marketing and management services performed outside China. BT shall be levied and withheld by the Chinese subsidiary.
- A Chinese company retains an international law firm to represent it in a dispute in country A. BT shall be levied on the fees, to be withheld by the Chinese company.
New provisions on withholding agent
In accordance with Article 11 the new Business Tax Regulations, where a foreign company or individual with no operating organization in China provides taxable services, transfers intangible assets or sells real estate in China, either the foreign company’s agent, the purchaser of the services or the transferee of the intangible assets or real estate will be the withholding agent.
The withholding agent should file the tax return and pay the BT payables withheld in a timely manner. Otherwise the withholding agent, and the foreign taxpayer, will be subject to considerable risk. Under the Law of the People’s Republic of China Concerning the Administration of Tax Collection, where it concerns a foreign company, the withholding agent in China shall withhold the payable BT, and may be liable for any delay. However the liability for paying BT remains with the taxpayer, a principle which has been re-confirmed in a recent circular issued by the State Administration for Taxation, Guoshuifa  No. 3. If the withholding does not or is unable to discharge of tits withholding obligations, the foreign taxpayer should directly declare BT to the tax authority. If the taxpayer fails to settle, the tax authority may pursue the payment from the taxpayer directly, and even collect overdue tax from the taxpayer’s other projects in China. Under Article 68 of the aforesaid law, the tax authority could also impose a fine of 50-500%.
Note that it is advisable to include a provision in the service (or loan) contract that the contract price includes BT, and that the Chinese party is responsible to pay such taxes. However the foreign taxpayer remains liable, and the only way to minimize risk is to ensure that taxes are paid.
Place of tax return filings
One final change regards the place where the tax return filing should be made. Under the old regime, BT should be filed where the services are rendered. This has been changed to the domicile of the taxpayer, or in the case of a foreign taxpayer, the domicile of its withholding agent.
Start of the reform of the VAT system
The old VAT system was production-based, meaning thatVAT general tax payers were not permitted any deduction of VAT against output VAT for purchased capital equipment, resulting in a degree of double taxation. From 1 July 2004, several regions experimented with a consumption-based VAT system; the new system was implemented nationally, and for all industries, on 1 January 2009.
From production-based to consumption-based
In accordance with Article 21 of the PRC VAT Implementation Rules, fixed assets that may be deducted from output VAT include machinery, means of transportation, equipments and tools that are related to production and business operations, whose service life exceeds 12 months. On the other hand, real estate such as buildings and constructions, and vehicles, motorcycles and yachts for personal consumption, are excluded.
The change will make investment in capital equipment cheaper for VAT general taxpayers such as manufacturing companies and trading companies. Capital-intensive industries are set to benefit the most, especially if they sell their products domestically. Foreign-invested enterprises (FIE’s) in encouraged industries, who were previously VAT exempt for the import or purchase of capital equipment, will lose their advantage, and the fact that they can now only credit their purchases against VAT paid on domestically-sold goods may add to their pressures. Other companies that will not benefit are companies, including FIE’s, that engage in service activities and are subject to BT rather than VAT, and VAT small-scale taxpayers.
Thresholds and rates for VAT smallscale taxpayer
Under China’s tax system, small-scale taxpayer are not entitled to input VAT credits, but rather pay VAT based on the sales revenue. To relieve their tax burden, the thresholdsfor annual sales revenue of VAT general taxpayers in manufacturing and commercial activities (i.e. trading, distribution) has been reduced from RMB 1 million and RMB 1.8 million to RMB 0.5 million and RMB 0.8 million respectively, enabling more small taxpayers to qualify for general taxpayer status. Also, the VAT rate for small-scale taxpayers has been reduced from 6% for manufacturing and 4% for commercial activities, to a uniform rate of 3%.
The costs and benefits of the new systems for BT and VAT will vary across industries and between companies. Most manufacturing and trading companies in China stand to benefit to different degrees, by eliminating for the possibility of double-taxation of VAT. Companies that purchase few fixed assets (low input VAT), or those that export all their products (no output VAT), will hardly be effected, while Capital-intensive industries (high input VAT) and companies that sell domestically (high output VAT) will reap the biggest advantages. Small-scale tax payers, especially manufacturers, will see the greatest impact, with across the board cuts.
While the VAT reforms provide a more level playing field and remove double-taxation, the BT reforms have the opposite effect, creating new burdens for foreign companies providing services to Chinese companies, and making these services more expensive by creating an extra level of taxation. It also remains to be seen how easy it will be to levy these taxes efficiently, especially when it concerns relatively small amounts. In any case, foreign companies providing services and financing to Chinese companies should take appropriate steps to mitigate any risks.