China: Bye-bye business tax

On March 5, 2016 the long awaited last stage of the sales tax (VAT, value added tax) reform was passed. The Chinese Premier Li Keqiang has made clear that the sales tax reform will be effective from May 1, 2016 in China. This means that the pilot reform of the sales tax in operation since January 2012 in Shanghai will be introduced across the country and the business tax will be completely removed from the Chinese tax system. As a result, China will be the country with the most extensive tax base for sales tax.
 

The business tax which had been applicable for many years previously had to be collected at every stage of the supply chain which led to double taxation and an enormous additional cost burden for taxpayers. These costs should usually be passed on to the business partners in order to distribute the tax burden to the individual business parties.

 
In particular at an international level the Chinese business tax system caused much consternation. For cross-border transactions/business the company was open to a loss of price competitiveness and the total tax burden of the company group was also negatively affected and increased considerably.

 
According to the previously submitted draft law and other information sources, however, no fundamental changes were expected for the last stage of the sales tax/VAT reform. The sole core issue of the reform is the enforcement system which has not yet been adopted. A number of the details could still be changed (please compare with our China Newsletter Issue 2 of June 2015). In this respect we will keep you informed of the current situation.

The 4 remaining sectors where business tax is still applicable are financial services, real estate, construction services and personalised services. However, as from May 1, 2017 they will also be subject to the new sales tax. Foreign companies with investments in China in other sectors and their foreign headquarters, however, must also consider the general problems in business operations which can occur with the full implementation of the sales tax reform:

• For tax assessments of the cross-border service contracts the local tax authorities in practice have different specifications and assessment criteria which can lead to different tax burdens for contracts with a similar design. After the complete implementation of the sales tax reform this situation will be corrected. As a result, when cross-border services within the company group are subject to tax in China, sales tax is collected at a uniform rate. The paid tax is considered as an input tax of the Chinese subsidiary company.
• Should taxpayers with foreign loans have to withhold the sales tax and can they offset the sales tax as an input tax against sales tax which has to be paid? Is it vice versa for the taxpayer in accordance with the provision of foreign services possible to realise exemption from the sales tax when they grant a loan to a foreign company? Can standard commercial loans due to the sales tax reform be claimed by companies as an input tax? Does the sales tax reform include reference values for company groups which influence the planning or decisions relating to their financing methods?
• Can the input tax for necessary accommodation and catering costs for employees be taken into account with the reimbursement of travel costs? In principle, in the course of the sales tax reform companies have the possibility to use, asses and correct existing internal regulations for personalised services in relation to cost control.
• If current office rental contracts expire in the financial year for 2016, companies are instructed to consider the possible changed tax burden. The negotiation of new contracts requires an exact examination of the tax burden and preparations for the negotiations.
• The inclusion of construction services in the sales tax reform will have an effect on the equipping of factories, plant assembly, selection of suppliers and contract negotiations.
• Regarding current contracts and transaction which are still subject to business tax, the regulations for the transition period must be observed.
• For current transactions not yet summarised by different tax authorities, companies are instructed to make timely adjustments and to reassess the total tax burden.
• The current business model and the type of transactions have to be internally reassessed by companies in order to then adapt to the tax structure. Particular attention must be given to the applicability of exemption to sales tax.

As the finalisation of the sales tax reform can have effects on daily business operations of the company and on transactions within the company group, we recommend that already now companies should begin with review, assessment and preparation activities.

  
The specialists at our Chinese offices will continue to observe the current developments of the implementation rules still to be finalised and the practical application through the tax authorities. We will keep you informed here in our newsletter comprehensively and in detail.