On 24 March 2016, the Ministry of Finance (“MOF”) and the State Administration of Taxation (“SAT”) issued Circular Caishui  36 (“Circular 36”). Circular 36 contains the VAT rates and rules applicable to all industries which thus far have not been affected by the transitioning from BT to VAT and which must now transition with effect from 1 May 2016. These industries are in particular:
- the construction service industry;
- real estate industry;
- financial services industry;
- lifestyle service industry (including hotel, catering, healthcare, education, cultural and entertainment services).
Circular 36 represents the final step of the BT-to-VAT-Reform which started in 2012 and has since been progressively expanded to fully replace BT with VAT.
While this final step is of particular importance to companies being engaged in the above listed industries, it also impacts companies of other industry sectors who retain services from companies ope- rating in the above listed industry sectors (e. g. by leasing property, acquiring land use rights, needing financial services, using trans- portation, telecommunication, hospitality services).
Hence, the impact of this final step of the BT to VAT transitioning will be felt across a wide range of enterprises who are all well advised to consider such impacts in their daily business and e. g. also when rendering quotations for services, entering into con- tracts, budgeting and having pricing discussions with customers and suppliers.
In the following, we will summarise some of the major changes brought about by Circular 36.
According to Circular 36, entities and individuals engaged in sales of services, intangible assets or real property (hereinafter referred to as the “taxable activities”) within the territory of the People’s Republic of China (hereinafter referred to as “PRC “) are value- added taxpayers (hereinafter referred to as the “VAT taxpayers”) and shall pay VAT rather than BT according to Circular 36.
“Entities” refer to enterprises, administrative authorities, public institutions, military units, social organisations and other entities and “individuals” refer to the individual businesses and other indi- viduals.
Under the VAT regime, taxpayers are divided into “general tax- payers” and “small-scale taxpayers”. A taxpayer under BT-to-VAT Reform Program whose annual VAT taxable sales amount of tax- able services exceeds a certain threshold (currently RMB 5 million or above) shall be deemed as a general taxpayer; otherwise, the taxpayer shall be deemed as a small-scale taxpayer. Other indivi- duals whose annual taxable sales amounts exceed the prescribed threshold shall not be deemed as general taxpayers.
Any entity or individual business whose annual taxable sales amount exceeds the prescribed threshold which does not provide taxable services on a recurring basis may choose to pay taxes as a small-scale taxpayer.
A taxpayer under BT-to-VAT Reform Program whose annual tax- able sales amount is less than the prescribed threshold (currently RMB five million) may become a general taxpayer by registering the eligibility as a general taxpayer with the competent tax autho- rity provided that it has sound accounting and is able to provide accurate tax information. “Sound accounting” means that a tax- payer maintains account books in accordance with the uniform accounting system of the State and conducts accounting based on lawful and valid tax vouchers. Taxpayers meeting the conditions set for general taxpayers shall apply to the competent tax autho- rities for registration of their eligibility as general taxpayers. Except as otherwise specified by the SAT, once a taxpayer is registered as a general taxpayer, the taxpayer may not be reidentified as a small-scale taxpayer.
For general taxpayers, the VAT rates under Circular 36 are the following:
- 11 per cent for the provision of transportation services (BT rate was 3 per cent), postal services (BT rate was 3 per cent), basic telecommunication services (BT rate was 3 per cent), construction services (BT rate was 3 per cent), real estate leasing services (BT rate was 5 per cent); sales of real estate (BT rate was 5 per cent); transfer of land use rights (BT rate was 5 per cent);
- 17 per cent for providing tangible movable leasing services (BT rate was 5 per cent);
- 6 per cent for other taxable behaviours including value-added telecommunication services (BT rate was 3 per cent), financial services (former BT rate was 5 per cent), lifestyle services (BT rate varies from 3 per cent - 20 per cent), etc.;
- A zero tax rate shall apply if an entity or individual inside China provides services to abroad, whereby the detailed scope shall be further defined by MOF and SAT.
When comparing these VAT rates with the BT rates, one will find that the general taxpayer VAT rates are higher than the prior BT rates. However, one has to keep in mind that general taxpayer VAT invoices (“Fapiao”) can be used to deduct input VAT from output VAT, as long as the taxpayers on both sides are general taxpayers and all other conditions for such deduction are met. BT on the other hand is cascading tax without the possibility of deduction/set-off.
Small-scale taxpayers must apply a “simplified taxation method” where VAT is levied at a flat rate of three per cent (irrespective of the industry sector) and for them input VAT is no deductible from output VAT.
Adjustment of the industry categories
Circular 36 adjusts the categorization of various industries, e. g. “technology transfer and technology consulting” is now subsumed under a newly added category of “sales of intangible assets” (including transfers of patented and non-patented technology, of trademarks, of copyrights, of goodwill, of exploitation right for natural resources, etc.) and the “transfer of trademarks and copy- rights” has been moved from “cultural and creative services” to “sales of intangible assets”. It is crucial for taxpayers to familiarise themselves with Circular 36 to determine under which particular industry category they fall because only then they will be able to determine the applicable VAT rate for their particular taxable activities.
Reasonable Business Purpose
Circular 36 provides that if a taxpayer has set the price for tax- able service/goods that is obviously too high or too low and lacks “a reasonable business purpose”, the tax bureau has the right to adjust the services/sales amount for taxation purposes. This is the first time the “reasonable business purpose”-rule has been introduced for the VAT regime. The term “without reasonable busi- ness purpose” is defined as a behaviour of taxpayer who – with the main purpose of achieving a tax benefit through artificial arrange- ments – seeks to reduce, defer or being exempt from VAT pay- ments or to increase VAT refunds.
Real estate purchases now included in deduction scope
Circular 36 provides that the input VAT for real estate purchased by taxpayers may be credited against output VAT. The input VAT for the purchased real estate bought by a taxpayer can be deducted for two years, with up to 60 per cent being deductible in the first- year and up to 40 per cent being deductible in the second year (however, real estate acquired under finance-lease models as well as temporary buildings or structures erected on construction sites do not fall under the realm of such two-year rule).
Under the current Chinese VAT regime, once the input VAT Fapiao (tax invoice) has been properly certified and filed, the input VAT can be carried forward without limit to time. Hence, how the above two-year-deduction mechanism will work, remains to be seen and depends on further explanations to be issued by the SAT.
No VAT Deduction for Input VAT Concerning Loan-Related Costs
Circular 36 provides that input VAT levied in relation to expenses for loans/financing (e. g. interest, consulting fee for financial ser- vices, handling fees payable to lenders) cannot be deducted from output VAT.
Zero-rate VAT, VAT Exemptions and new policy on cross-border services
Circular 36 adds certain cross-border taxable transactions to the list of transactions for which the zero VAT rate or VAT exemption can be applied for.
The zero-rate VAT shall e. g. apply to the sale of the following ser- vices and intangible assets sold by entities and individuals within China:
- International transportation services: transportation of passen- gers or cargo from within China to abroad or from outside China into China or occurring entirely outside China.
- The following services provided to offshore entities for con- sumption exclusively outside China: R&D services; energy performance contracting services; design services; production and distribution services for radio, film and television programs; software services; circuit design and testing services; informa- tion system services; business process management services; offshore service outsourcing business.
- Certain business activities involved in offshore (= outside China) service outsourcing business, including information technology outsourcing (ITO), technical business process out- sourcing (BPO), and technical knowledge process outsourcing (KPO), shall be subject to the Explanatory Notes on Sales of Services, Intangible Assets, and Real Property in terms of the corresponding business activities.
Sales of the following services and intangible assets by entities and individuals within China shall be VAT-exempt (except where the zero-rate VAT applies): construction services for engineering projects outside China; engineering supervision services for engi- neering projects outside China; engineering survey and explora- tion services for engineering and mineral resources outside China; convention and exhibition services for conventions and exhibitions outside China; warehousing services with storage places China; tangible personal property leasing services with the subject matter used outside China; broadcasting services for radio, film, and tele- vision programs (works) provided outside China; cultural, sports, education, medical and tourism services provided outside China; international transportation services provided by non-transport operating carriers; direct chargeable financial services provided for the monetary financing between entities outside China and other financial business operations, which are not related to any goods, intangible assets, or real property within China.
Construction and Real Estate Industry
Circular 36 defines “real estate” and “construction services” in the same way as the BT regulations thus far. Hence, “real estate” continues to be understood to include both the sale and lease of real estate and governs all major real estate categories (residen- tial, retail, office, industrial, commercial property, etc.) and will be subject to a VAT rate of 11 per cent.
Business activities of service providers such as real estate agents, property managers, architects, surveyors etc. are not understood to fall under the category of “real estate and construction” ser- vices qualify as “other services” and are hence subject to a VAT of a six per cent.
- Transition Period Policy (“Grandfathering”) for Construction Industry
For construction services the transition period policy stipulates that for services provided under “old construction projects”, tax payers may opt to apply the “simplified taxation method” (i. e. VAT = sales volume x three per cent but without the opportu- nity to deduct input VAT).
“Old construction project” refers to:
- a construction project with the contractual commencing date before 30 April 2016 as stated in the “construction project construction permit”;
- in case that the “construction project construction permit” is not issued, the construction project with the contractual commencing date before 30 April 2016 as stated in the construction project contract.
Circular 36 made it clear that the adoption of “simplified taxation method” for “old construction project” is a “choice” of the general VAT tax payer, but it is not a requirement. It also appears to be a choice which can be made on a project-by-project basis. Impor- tantly though, once the choice is made, it cannot be retracted by the tax payer for a period of 36 months. If the general VAT tax payer does not make such choice, then the general taxation method will be applied which means that the 11 per cent tax rate will apply while the input VAT can be deductible.
- Transition Period Policy for Real Estate Industry
Circular 36 also provides a transition policy for real estate indus- try. General VAT payers selling real estate before 30 April 2016 may choose to apply for the simplified taxation method and the VAT rate will be five per cent but without the opportunity to deduct input VAT.
The most crucial point for VAT for the financial industry sector is the determination of “sales volume”. Circular 36 provides to that end the following:
- Loan services: all interest and revenue of an interest nature received under loan service will be considered “sales volume”;
- Transfer of financial products: “Sales volume” will be the dif- ference between the sales price and the initial price of acquir- ing the financial product; if the balance is negative, it can be carried forward to the next tax paying period (but not to the next accounting year);
Once the sales volume is determined, one can easily calculate the output VAT which shall be the sales volume multiplied by six per cent VAT rate under financial industry.
While the construction industry will benefit from relatively gen- erous transitional or grandfathering relief under Circular 36, not so the financial services sector. In fact, there is no relief from existing contracts or commercial undertakings agreed before 1 May 2016. They become subject to six per cent VAT with effect from 1 May 2016.
The lifestyle industry sector includes e. g. hotel and catering ser- vices, healthcare industry, cultural and sports industry, entertain- ment industry, etc.
- Circular 36 provides that under the catering services category, output VAT paid for regular daily services for individuals and for entertainment services will not qualify for input VAT deduction. However, input VAT related to purchases in the cultural, sports, education, medical, travel and accommodation industry service is deductible for VAT purposes.
Hotels services are often actually manifold and comprise not only the mere accommodation but often also ancillary services such as food & beverage, entertainment, fitness and SPA, conferencing and meeting services. Hence, depending on the actual circumstances you may be well advised to request the service providers to issue separate invoices for the various services. If this is not possible, the whole range of services will be likely subject to the highest VAT rate among the various items of the service package.
Also, even more than in the past it will be of heightened impor- tance that all bookings/payments for business trip expenses (travel, accommodation etc.) are made in the name of the entity which eventually bears the cost and wishes to deduct the relevant VAT and that Fapiao are issued in the exact name of the company who will bear the related costs to ensure such entity can use the input VAT for VAT deduction purposes.
Healthcare industry: Under the BT system, there was a broad blanket tax exemption for “medical services”. Under the new VAT system, medical services will continue to be tax exempted, but only insofar as the medical service fee does not exceed the government-set thresholds. Thus, while many healthcare services provided by public hospitals and other similar service providers will continue to enjoy tax exemption, health services provided by (often more costly) private clinics and service pro- viders may become subject to VAT at a rate of six per cent.
The lifestyle services sector will not benefit from any form of transitional or grandfathering relief under the new rules. This means that a six per cent VAT rate potentially applies to all sup- plies invoiced from 1 May 2016, even if a booking or reservation was made prior to that time.
First filing due date under the new VAT Regime:
In order to allow for certain expected delays during the infancy period of the VAT regime’s last transitioning step, the first filing due date for VAT has been extended from 15 June 2016 to 25 June 2016.
What taxpayers that now transition from the BT to VAT regime need to consider now:
- Taxpayers have to prepare for tax training of their staff, in par- ticular finance, accounting and sales staff;
- Taxpayers need to register for VAT purposes with their in- charge local tax authority and attend the statutory trainings;
- Taxpayers must purchase VAT invoicing machines from desig- nated suppliers as notified by the tax authorities;
- Taxpayers may in in the early stages sometimes only be allo- cated a certain number of Fapiao per month which may impact invoicing and cash flow of the affected companies and hence a more “generous” financial planning and additional reserves may be required during the transition phase;
- Taxpayers must carefully understand the financial impact of the VAT to BT transition on their business, pricing structures and internal processes and ERP systems;
- Taxpayers must consider if the new tax regime will require them to adjust any of their standard order forms, contract templates, general terms and conditions and other legal docu- mentation;
- General taxpayers should always request general taxpayer Fapiao from their suppliers and service providers.