Starting from 1 January 2012, China has launched a pilot business tax (“BT”) / value added tax (“VAT”) reform with Shanghai as the first pilot area. The purpose of such reform is to shift certain types of services from the BT system to the VAT system. The main difference between the two tax systems is that the VAT system has an input-output credit mechanism while the BT system does not. This means that BT is generally not recoverable while VAT is. Over the past year, the BT/VAT reform has been gradually extended to more regions such as Beijing, Tianjin, Anhui Province, Zhejiang Province, Fujian Province, Hubei Province and Guangdong Province.
On 27 May 2013, the PRC Ministry of Finance (“MoF”) and the State Administration of Taxation (“SAT”) issued the Tax Circular Caishui  No. 37 (“Circular 37”) to extend the BT/VAT reform to all over the country starting from 1 August 2013. This Tax Circular incorporates and replaces the past circulars issued for the purpose of the pilot reform and also brings some additional amendments.
Main content of Circular 37
The main content of Circular 37 is as follows:
- Scope of services shifted from BT to VAT
Under the original pilot BT/VAT reform, VAT taxable services included transportation services, R&D and technology services, IT services, design services, transfer of trademark, goodwill and copy rights, intellectual property related services, advertisement, conference and exhibition services, logistics-related services, lease of movable tangible assets as well as certification, authentication and consulting services (“Taxable Services”).
Circular 37 further added “radio, film and television services” to the above scope of Taxable Services. Such services include producing, releasing and broadcasting of radio, film and television programs or works.
Starting from 1 August 2013, all Taxable Services provided by or provided to tax payers located in China shall be subject to VAT and no longer BT.
In practice, it is not unusual that disputes arise between tax payers and tax authorities regarding the applicability of BT/VAT to specific services. E.g. in some cases, it is unclear whether certain services qualify as “consulting services” for BT/VAT purposes, If the services are indeed “consulting services”, VAT shall apply, otherwise BT will apply. To avoid uncertainties and risks, it is advisable for tax payers to discuss in advance with the competent Chinese tax authority on whether BT or VAT will apply to specific services.
- Small-scale VAT payers, general VAT payers and applicable tax rates
A general VAT payer can issue VAT invoices and credit its input VAT against its output VAT. The applicable VAT rates for calculating output VAT of Taxable Services are as follows:
- 17% for lease of movable tangible assets;
- 11% for transportation services; and
- 6% for other Taxable Services
A small-scale VAT payer shall pay VAT at 3% on the gross amount for its Taxable Services and is not able to credit any input VAT. A small-scale VAT payer also cannot issue VAT invoices (增值税专用发票) by itself, but can ask the tax authority to issue VAT invoices for it.
A tax payer providing Taxable Services with an annual transaction value of above RMB 5 million is required to apply for the general VAT payer status. Small-scale enterprises with a transaction value below this threshold can also become general VAT payer upon application, if they keep proper accounting records.
- Exportation of Taxable Services
VAT at 0% applies for international transportation services, R&D services and design services provided to foreign customers.
To achieve the effect of 0% tax rate for the above Taxable Services, Circular 37 provides the applicable VAT treatments for different types of VAT payers.
Same as in the pilot reform, Circular 37 also provides for VAT exemption for exportation of certain Taxable Services, e.g. consulting services. However, Circular 37 does not provide guidance on the procedural and document requirements for enjoying such VAT exemption. In practice, some pilot area tax authorities are still requesting VAT payment for exportation of Taxable Services which should be exempted from VAT. So also in this case it is recommendable for tax payers to check in advance with the competent tax authority about its practice.
- VAT payable by foreign tax payers
Foreign tax payers providing Taxable Services to their Chinese customers are also subject to VAT. In such case, the Chinese customers shall normally act as the tax withholding agent. Such VAT paid by the foreign tax payers can be recovered by the Chinese customers by crediting as input VAT against their output VAT, provided that they are general VAT payers. Therefore, it is commercially reasonable for foreign tax payers to charge the relevant VAT costs to their Chinese customers.
- Input VAT creditability for purchase of motorcycles, cars and yachts for self-use
Under the current VAT system, if a tax payer purchases motorcycles, cars and yachts for self-use, the input VAT related to such purchase is not creditable. Starting from 1 August 2013, such VAT will be creditable for general VAT payers. This will effectively reduce their purchase costs.
- Old Contracts
Circular 37 does not provide any transitional arrangements for old contracts concluded before 1 August 2013. I.e. generally speaking, BT/VAT applicability shall be assessed based on the date when the tax payment liabilities arise. If the tax payment liabilities arise after 1 August 2013, the new rules shall apply, even though the relevant contracts have already been concluded before 1 August 2013.
However, as an exception, outstanding contracts for lease of movable tangible assets concluded before 1 August 2013 continue to be covered by the BT system until the termination of such contracts.
- Same as under the pilot reform, Circular 37 also covers various other topics such as mixed sales, consolidated VAT declaration, deemed sales of Taxable Services, conditions for creditable input VAT, non-creditable input VAT, consequence of not applying for the general VAT payer status, exchange rate, timing of VAT liability, tax declaration deadline, tax payment location, value threshold for individuals, issuance of VAT invoices, and a detailed explanation of the scope of Taxable Services, etc.
- It is advisable for Chinese tax payers affected by Circular 37 to prepare themselves for the new VAT regime and start discussing with their tax authorities regarding BT/VAT applicability on their business and prepare for the general VAT payer status (where possible);
- Commercial wise, it is important to make an in-depth analysis of the changes in the tax burden brought by Circular 37 to adjust pricing where necessary and to restructure business models where advisable;
- Foreign companies providing Taxable Services to customers in China shall also take the BT/VAT issue into consideration when concluding the relevant contracts. In particular, the relevant tax clauses may need to be changed in view of the BT/VAT reform.