Key Points

  • State Administration of Tax to formally include telecoms services into the VAT system as of June 1.
  • Different VAT rate will apply to telecoms services, depending on how they are categorized.
  • Once included into the regime, several VAT rules will become applicable to telecoms companies.

Background

China State Administration of Tax (“SAT”) recently released the Notice  on Including Telecom Industry into the Pilot Scheme on Switching from  Business Tax to VAT (“Cai Shui [2014] No.43”) at end of April, which  will become effective on June 1, 2014. After the telecommunications  industry has been formally included in the VAT system, it is expected  that the VAT reform will be expanded further to cover financial services,  construction services, real estates and consumer services. We would  keep monitoring the VAT reform progress.

Summary of the VAT Rule for Telecom Industry

In the newly issued Cai Shui [2014] No.43, the telecom sector is  defined as the business activities of providing voice communication  services by phone, transmitting, sending, receiving or applying  images, text messages and other electronic data and information  by using the wired/wireless electromagnetic system or photovoltaic  system and other communication network resources. Telecoms  services are further divided into two sub-categories and subject to  different VAT rate:

Click here to view table.

The telecoms services provided by entities and individuals in China to  overseas clients are exempted from VAT.

When included into the VAT regime, several VAT rules will become  applicable to telecoms companies. One typical VAT rule is when  the taxpayer sends out free gifts during its business operation, that  taxpayer shall recognize deemed sales revenue for the free gifts  based on the market value of the gift for VAT purpose. When it is  common marketing strategies for telecoms companies to present  gifts and bonuses to consumers, Cai Shui [2014] No. 43 has included  several clarifications on the VAT implication for common marketing  models for telecoms companies:

  1. According to previous rules applicable to telecoms companies,  neither Business Tax nor VAT should be triggered for free gifts  of telephone sets, as such gifts are regarded as being sent out  for free. Under the VAT regime, if the telecom company provides  free gifts such as phone cards, mobile phones or telephone  sets, the total money and out-of-pocket expenses charged by  the telecom company shall be accounted at its applicable tax  rates respectively. The new VAT rule requires that total revenue  received by telecoms companies should be allocated among the  sales and services, and be subject to different VAT rate (i.e. 6%,  11% or 17%).
  2. The telecom service provided upon claiming of bonus points by  customer (where customer will be granted with certain value of  free telecom service based on the bonus points they have saved  up in their accounts, such as exchange of the bonus points into  prepaid telephone card) is not subject to VAT. 

Following Cai Shui [2014] No.43, SAT has further promulgated the  Notice No. 26 on Interim Measures for Telecom Enterprise on Levying  of VAT. Notice No. 26 has been promulgated to specifically regulate  the VAT filing and payment measures applicable to China Mobile,  China Unicom and China Telecom, the three state-owned telecoms  companies. According to Notice No. 26, the lower tier branches of  the three state-owned telecoms companies will conduct a monthly  provisional filing at a levying rate determined by provincial tax  authorities on the overall collected revenue for the taxable services.  The provincial branches of the three telecoms companies are required  to conduct a consolidated VAT filing on quarterly basis for the telecoms  services carried out in that province based on the data reported by  its lower tier branches. All off-set of the VAT input will be realized on  provincial level, the purpose of which, as we speculate, is to allow  more consistent control on the VAT filing process by provincial tax  authorities and to eliminate local branches’ compliance burden.

Expected Impact

The telecoms companies may consider adjusting their current  marketing strategies by reevaluating the turnover tax liabilities in  each current type of their marketing campaign. Furthermore, as a  strategic plan, telecoms companies may possibly start to focus on  their value-added services in the future and lower the proportion of  their basic services, which is also consistent with government’s policy  in the telecom industry’s restructuring.

Before the VAT reform, telecoms companies are subject to 3% Business  Tax. In the short-term, the profits of telecoms companies (mainly the  three gigantic China market players: China Unicom, China Mobile and  China Telecom) may notice a substantial impact due to their drastic  rise of turnover tax liabilities under the VAT regime. However, in the  long-run, telecoms companies will see benefits from their high capital  investment in base station construction and equipment procurement.  Vendors to those companies shall consider possible adjustment to their  current price strategies for the relevant products.

In addition, there is also news about the central government  considering setting up another state-owned entity to hold and  operate all the base stations and relevant assets. As such, the VAT  reform for the telecom industry seems to occupy only a very small  part of the whole industry reform, and we would expect to see what  regulatory changes and reforms the telecom industry would embark  upon in the future.