- 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.
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  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  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  No. 43 has included several clarifications on the VAT implication for common marketing models for telecoms companies:
- 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%).
- 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  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.
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.