China has completed the conversion of business tax (“BT”) to value-added-tax (“VAT”) (“B2V-Reform”) as required by the 13th Five-year Plan that has been approved by the 12th National People’s Congress on March 16, 2016.

According to a news report by Xinhua Agency, China’s official news agency, on April 13, 2016, the completion of the B2V-Reform will result in a total tax reduction of RMB 500 billion in China in 2016. It is expressly promised by Premier Li Keqiang that for all related industries overall tax burden will decrease and no tax increase will occur due to the B2V-Reform.

Although this might be positive news, it is still too early to cheer. Taxpayers should check out carefully the possible reactions of local tax authorities and their implementation of the new tax regime, since the interests of central government may not always be consistent with that of local authorities.

1. BT is local government’s money

According to the Decision of the State Council on Implementation of Tax Sharing Administration System promulgated on December 15, 1993 (“Tax-Sharing Decision”), income from the collection of BT belongs to the local government, whereas VAT is shared between central (75%) and local government (25%).

Due to the B2V-Reform local governments are now losing their biggest source of tax income from the previous collection of BT.

If the sharing rate for VAT set out by the Tax-Sharing Decision will not change fundamentally (although during a transition period of 2-3 years the sharing rate of tax income from the collection ofVAT is set at 50:50 between central and local government, which will still increase the overall tax income of the central government as implied by the transitional plan issued by the State Council), as a consequece from the B2V-Reform the central government will grab a further share of the biggest piece of cake from the local government’s plate.

2. More responsibilities for local governments with less money to spend?

Since 1992 until now local governments have borne major parts of the state’s expenditures.

Since many years now there is also a tendency of the central government to push tasks/duties/expenditure obligations down to the local governments. Such two trends are crushing the local level governments, especially the bottom level which bear the most implementation tasks whereas being confronted with the least financial support or power.

China’s policy of “simplification and delegation” (简政放权) provided under the 13th Five-Year-Plan may have an impact on such trend – but the question is, to which direction?

Simplification may result in less work, however delegation will increase the workload of local governments which has led to numerous complaints by local governments already.

3. Local governments being urged to find alternative financing means

When the central government is squeezing money from local governments, but pushing on the other hand more tasks to them, local governments will need to identify alternative means of getting financed.

Consequently, the following changes are expected with regard to the financing of local governments:

  • Increase of direct taxes

The 13th Five-Year-Plan implies an increase in many direct taxes, such as individual income tax, consumption tax, real estate tax, environmental protection tax.

The upcoming individual income tax reform, which will most likely include a reclassification of income items being subject to individual income tax as well as an adjustment of the current tax rates, will play a big role in this regard. The least one could expect in the future is, that local tax bureaus will increase their audit and collection efforts in relation to high-income earners in China.

  • Squeezing more profit from State-owned enterprises (“SOE”)

As provided under the 13th Five-Year-Plan, central government intends to gradually increase the proportion of profits to be collected from investment of state-owned capital. According to theDecisions on Several Key Questions on Comprehensively Deepening Reform (in Chinese中共中央关于全面深化改革若干重大问题的决定) issued by the Central Committee of China Communist Party on November 12, 2013, by 2020, such proportion shall be raised to 30%.

Such “profit squeezing” may lead to chain reactions among SOEs. One may expect SOEs to push for more business profits so as to make up for the lost part.

  • Other options?

Finally the B2V-Reform causing a gap in local governments’ funds could easily result in other effects, such as an increase in local government debts, the increased selling of land use rights or the imposing of more severer fines (e.g. the most recent draft revision to the PRC Anti-Unfair Competition Law has substantially increased the fines and penalties for violations of anti-unfair competition rules).