Noteworthy: Changes Brought by the Draft Chinese Value Added Tax Law

The Draft stipulates, unless otherwise stipulated by the competent departments for finance and taxation under the State Council, concerning the taxable transactions within the Chinese territory conducted by entities and individuals outside China, purchasers are parties who have the obligation to withhold VAT.

According to the prevailing stipulations, foreign companies provide services within the territory of China, i.e. cross-border services as commonly seen, foreign companies can engage a tax agent in China by themselves to withhold VAT from the service payment, or have the VAT withheld by the service purchaser in China. In practice, such VAT withholding obligation may not be certain due to probable communication problems, which leads to disputes among the parties. The Draft determines the service purchaser as the withholding agent explicitly, which makes tax compliance easier in practice.

For the sales of services and intangible assets, under the current regulations, the transactions shall be subject to the Chinese VAT, if the seller or the purchaser is located in China. The Draft explicitly proposes to replace "the purchaser is located in China" with "consumption in China" as the precondition. We understand that the Draft also emphasizes that even if both the seller and the purchaser are outside of China, the tax obligation will still arise in the special case that the purchased service is consumed in China. To measure the tax burden of the cross-border services in China under the Draft as a common non-trading transaction, the Corporate Income Tax (“CIT”) shall be assessed in conjunction with the “place of the service provision”, while the VAT needs to be analyzed separately with full consideration of the principle of the “place of consumption”.

In addition, the Draft stipulates, if the party who has the obligation of withholding VAT is located outside China, it shall file tax returns for the withheld VAT with the competent tax authority at the place where the taxable transaction occurs. That implies foreign companies shall also be obliged to withhold VAT if they are the purchaser of the services rendered in China. However, in practice, in the case that both buyers and sellers are located outside of China, if taxable, the actual taxation may be more complicated, and it is expected that further implementation rules to be issued by the tax authority.

However, the definition of "actual place of consumption" is yet to be defined by a series of guiding rules. For example, whether the determination of "domestic consumption" in the case of cross-border subcontracting services may cause double taxation is yet to be clarified.

It is noted that the following deemed taxable transactions are deleted in the Draft:

• Consignment of goods to other units or individuals for sale; Sales of goods by agency; Transfer of goods from one establishment to another establishment for sale by a taxpayer that maintains two or more establishments and adopts consolidated accounting, unless the relevant establishments are maintained in the same county (or city).
  
• Provision of goods self-produced, processed on a commission basis, or purchased to other units or individual business operators as investments; Distribution of goods self-produced, processed on a commission basis, or purchased to shareholders or investors.
• Service provided free of charge.
• Sales of consignment goods.

However, it is still to be discussed whether the above deletion in the Draft means that such situations are no longer deemed as taxable income under the VAT, as some of them may lead to potential tax avoidance and a break in the VAT chain (e.g. VAT input on assets acquired by the enterprise as shareholders' contribution). Further clarification is expected in the implementation details to be issued by the tax authority.

The Draft did not list loan service as non-creditable for input VAT, which implies that the VAT included in the loan interest charges can be credited as input VAT. This is certainly good news to many taxpayers who have loans and meaning that the Chinese government aims to support enterprise financing further by reducing the financing costs.

According to the Draft, where one taxable transaction of a taxpayer involves two or more tax rates or levying rates, the tax rate or levying rate applicable to the main business of the taxable transaction shall apply. While based on the prevailing regulations, except for machines and equipment sales with installation and commissioning services, etc., which were additionally regulated, in general, mixed sales activities are subject to VAT according to the main business of the company. But the case can be that a company is involved in several kinds of main business subject to different VAT rates. The Draft determines the applicable VAT rate purely based on the transaction itself is more reasonable and transparent.

Since years, there have been numerous VAT regulations in China, and especially the regulations introduced since the VAT reform have further complicated the fragmented VAT regulatory system. Moreover, since the Chinese VAT system is not linked to the overseas VAT system, taxpayers need to carefully consider their tax costs of providing cross-border services. We are looking forward to the speeding up of the legislation for VAT in China as well as the issuance of relevant detailed rules to provide transparent and effective guideline to assist in the implementation of VAT law.