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LEGAL ASSISTANCE: Chinese VAT Reform to Pilot in Tianjin
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Introduction
In August 2012, China’s Ministry of Finance (MOF) and State Administration of Taxation (SAT) announced that the pilot program in relation to the Chinese indirect tax system, concretely concerning the Value Added Tax (the VAT pilot program), which was formerly launched for Shanghai only, would be effective to another eight cities/provinces, including Tianjin. This VAT pilot program would certainly have significant tax implications in Tianjin’s service industries. 
 
The VAT pilot program seeks to progressively substitute the Business Tax (BT) currently applicable to taxable services in China, for the VAT. BT, a tax currently levied on the revenue derived from rendering services or transfer/rental of real estate, amongst other items, has been considered as a local tax with Chinese characteristics- since the main indirect tax system adopted by most jurisdictions worldwide is VAT (both on the revenues derived from sales of goods and services). It is observed that this recent VAT reform implemented by the Chinese government reveals the trend and intention of China on the globalisation of its indirect tax regime.
 
The VAT pilot program will be carried out in several phases. The first phase has already been carried out only in Shanghai and applied to specific sectors in Shanghai, namely transportation and ‘modern’ services. The following phases will consist of applying the VAT pilot program to specific sectors in other regions of the country and eventually, if the program is successful, it will be applied nationwide and to all service sectors. Now, Tianjin has become the second pilot area.
 
The new VAT pilot program has come into effect in Tianjin as of 1 August, 2012. In this newsletter, we will provide a preliminary and brief analysis of the VAT pilot program and offer some comments to enterprises that will be impacted by such change.
 
Outline of the VAT reform
Circular 1101 and  Circular 1112  , jointly issued by the MOF and SAT, mainly set out the legal framework of the VAT reform.  
 
Circular 111 sets forth the specific services which are subject to the VAT pilot program (’Pilot Industries’) and the applicable VAT rates respectively. According to Circular 111, enterprises chosen as pilot enterprises shall file VAT instead of BT on the service revenues derived from services of Pilot Industries. Detailed scope and clear definition of each Pilot Industry has been provided in Circular 111. In addition to the current VAT rates of 13% and 17%, another two VAT rates, 11% and 6% will be adopted.
Below is a table of the current BT rates and applicable pilot VAT rates under each category of industries.
 
Compliance rules
In respect to the calculation of the payable VAT, if the taxpayer qualifies as a general VAT payer and is approved by the tax authority, the general VAT mechanism shall apply (i.e. output VAT – input VAT). However, if the taxpayer does not reach the threshold to become a general VAT payer, it will be considered a small scale VAT payer, subject to a 3% VAT rate, and whose input VAT will not be deductible.
Pilot Enterprises will soon be required to set up systems regarding the issuance, management and submission of special VAT invoices. In addition, service contracts would become essential under the VAT pilot program and will be required by SAT for VAT deduction purposes or be considered as evidentiary documents in determining the due date of payable VAT.
 
Zero rate and exemption for services provided to overseas companies
Circular 131 was issued by the MOF and SAT, specifically addressing taxable services supplied by a Pilot Enterprise to an overseas company eligible for both VAT zero-rate and exceptions.
 
According to Circular 131, services taxable at zero-rate will be subject to VAT but at 0% and, thus, the relevant input VAT associated with the services provided to overseas clients will be fully recoverable. Such services include research and development services, design services provided to overseas entities and international transportation services relating to the transport of cargo and passengers from China to overseas, from overseas to China and those services provided outside of China. 
 
VAT exempted services rendered will imply that the input VAT associated with the services provided to the customer is not recoverable. Industries subject to such exemption include, amongst others: certification, attestation and consulting services; technology consulting services; leasing of tangible and moveable goods when such goods are located overseas; advertising for ads published outside China and international transportation not supported by an international transportation operation license.
 
Our observation
Enterprises in Tianjin which are engaged in Pilot Industries shall first confirm with the in-charge tax authority whether they have been falling into the pilot scheme. Overseas enterprises which provide relevant services to clients in Tianjin shall also confirm the tax position of such clients since the latter might have to withhold relevant VAT (6% or 11%) on the service income.
 
In addition, enterprises subject to BT may bear a heavier tax burden when purchasing services from enterprises which are subject to VAT, since such payable VAT might eventually be reverted into purchase price for such services. On the other hand, those VAT taxpayers could benefit from the VAT transformation as they may apply VAT deduction under the general VAT mechanism. Therefore, it is advisable for all enterprises to go through and review contracts already executed or under negotiation and reconsider the relevant prices.
 
For the above reasons, we strongly recommend that enterprises rendering or receiving services from Pilot Industries shall be familiar with the VAT pilot program and learn how the system will adapt to their specific services in a detailed perspective.

By Manuel Torres and Diego D'Alma
 
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