On March 5, 2016, on delivering the Government’s Work Report, Premier Li Keqiang announced that the value-added tax (“VAT”) reform will be fully implemented in China from May 1, 2016, extending to all industries, including real estate, construction, finance and consumer services. On March 23, 2016, the Ministry of Finance (“MOF”) and the State Administration of Taxation (“SAT”) jointly released Cai Shui [2016] No. 36 (“Circular 36”) on detailed implementing measures for full expansion of the VAT reform.1

The full expansion of the VAT reform marks the start of a new era for China’s taxation system and the end of business tax.

The highlights of Circular 36:

  1. Definition of VAT payer and taxable activities

VAT payers are defined as enterprises and individuals carrying out taxable activities, i.e., providing taxable services, transferring intangible assets and selling real estate in China.

In turn, taxable activities include:

  1. services (except for real estate leasing) whose provider or recipient is located in China, and intangible assets (except for natural resources use rights) whose transferor or transferee is located in China;
  2. sale or lease of real estate located in China;
  3. transfer of use rights of natural resources located in China; and
  4. other activities specified by the MOF and the SAT.

Taxable activities do not include:

  1. overseas providers rendering entirely overseas services to domestic recipients;
  2. overseas  transfers  of  intangible  assets  entirely  used  overseas  to  domestic transferees;
  3. overseas providers leasing tangible moveable assets entirely used overseas to domestic recipients; and
  4. other activities specified by the MOF and the SAT.

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  1. Taxable activities and applicable VAT rates

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  1. VAT-taxable turnover

Turnover refers to the full price and other charges that taxpayers obtain as consideration for taxable activities, except:

  1. qualified government funds and administrative fees received on behalf of the authorities; and
  2. payments received on behalf of an entrusting party for invoices issued in the entrusting party’s name.

Circular 36 also introduces balance taxation (VAT payable on net revenue minus qualified deduction based on cost instead of effective input VAT) for certain taxable activities, including financial leasing, transfer of financial commodities, brokerage and agency services, air transportation and tourism.

As set out in previous regulations, if taxpayers charge obviously low or high prices without reasonable commercial purpose, the tax authorities are entitled to adjust the turnover.

Circular 36 defines these situations for the first time as taxpayers making artificial arrangements whose main purpose is to obtain tax benefits and reduce, exempt or postpone VAT payment or increase VAT refund.

  1. Input VAT credit

In addition to previous rules on the offset of input VAT, Circular 36 specifies that:

  1. Input VAT on passenger transportation services, loan services (including interest and other direct financing consultancy fees and charges), catering services, individual and family-oriented services and entertainment services cannot be deducted from output VAT.
  2. General VAT payers can deduct input VAT on real estate and construction in progress obtained and accounted for after May 1, 2016, from their output VAT in the next two years: 60% in the first year and 40% in the second.

This policy does not apply to finance lease real estate or temporary structures built on construction sites.

  1. Zero-rated VAT activities

Zero VAT rate applies to domestic taxpayers on:

  1. international transportation;
  2. space transportation; and
  3. services to overseas companies that are entirely consumed overseas, including R&D services, contract energy management, design services, radio and television show production and releasing, software services, circuit design and testing, information system services, business process management services, offshore services, outsourcing business and technology transfer.
  1. VAT-exempt activities

VAT exemption applies to domestic taxpayers that conduct the following crossborder activities:

  1. providing the following services overseas:
  • Construction services for engineering projects
  • Engineering supervision services for engineering projects
  • Engineering survey and exploration for projects and mineral resources
  • Conference and exhibition services
  • Warehousing - Leasing of tangible moveable assets used overseas
  • Radio and television broadcasting
  • Cultural, sports, education, medical and tourist services 
  1. postal, delivery and insurance services provided to export goods;
  2. services or transfer of intangible assets entirely consumed overseas to other overseas companies, including telecommunications, IP services, supplementary logistics (except for warehousing and delivery), attestation and consultancy, special technical services, business support and advertising when circulated overseas;
  3. international transportation services provided without conveyance;
  4. directly-charged financial services and other finance business; and
  5. any other services specified by the MOF and the SAT.

Under Circular 36, “entirely consumed overseas” means that the actual service recipient is located overseas and the service is not related to any domestic goods or real estate, and that the intangible assets are used overseas and are not related to any domestic goods or real estate.

  1.  Construction and real estate industry

To ensure a smooth transition, Circular 36 provides taxpayers in the construction and real estate industries with transition policies, allowing them to apply simplified methods to calculate VAT payable on old projects with a start date before April 30, 2016.

Date of issue: March 23, 2016. Effective date: May 1, 2016