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FINANCE: New opportunities arising from expanded scope of zero-rated VAT preferential treatment to certain exported services
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New opportunities arising from expanded scope of zero-rated VAT preferential treatment to certain exported services

By Kelvin Lee, PwC Tianjin


In brief

Recently, the Ministry of Finance (MOF) and the State Administration of Taxation (SAT) jointly issued Circular Caishui [2015] No.118 (Circular 118) to expand the zero-rated VAT preferential treatment to certain eligible exported services, including cinema/television, technology transfer, software and offshore outsourcing. Meanwhile, Circular 118 also clarifies the measures for manufacturing enterprises and trading enterprises to apply for the VAT exemption/refund treatment.

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Circular 118 expands the scope of zero-rated VAT services, which should reduce the VAT effective tax burden and cost for the relevant enterprises. However, enterprises should also pay attention to the compliance requirement, calculation and filing requirement of the zero-rated VAT policy. Relevant enterprises engaging in the export of services with small amounts of input VAT would need to assess whether or not to apply for the zero-rated VAT preferential treatment, by taking into account the future changes in their operations as well as the development of the Business Tax (BT) to Value Added Tax (VAT) Transformation Pilot Program (B2V reform).


In detail
Newly-added exported services eligible for zero-rated VAT preferential treatment


Currently the ongoing B2V reform in China provides two types of VAT preferential treatments for certain cross-border services -- i.e. zero-rated and VAT exemption. Based on the existing Caishui [2013] No.106 (Circular 106), zero-rated treatment is only limited to international transportation services rendered by domestic entities and individuals, research and development (R&D) services, and design services to overseas entities. In order to further encourage the export of services, Circular 118 expands the more favourable zero-rated VAT preferential treatment to certain exported services currently eligible for exemption from VAT. According to Circular 118 - effective from December 1st, 2015 - domestic entities and individuals providing the following taxable services to overseas entities are eligible for the zero-rated VAT preferential treatment:


- Production and distribution of broadcasting, films and television programmes (works)
- Technology transfer, software, circuit design and testing, information system and business services
- Process management and contracted energy management services, with subject matter located overseas
- Offshore service outsourcing business, including information technology outsourcing (ITO), technical business process outsourcing (BPO), and technical knowledge process outsourcing (KPO).


The applicable VAT refund (exemption) method


Moreover, Circular 118 clarifies the specific VAT refund (exemption) method applicable to enterprises providing zero-rated services, which is, in general, consistent with the one stipulated in the existing Circular 106. Please refer to the Appendix for details.


VAT refund rate of taxable services


The VAT refund rate of taxable exported services remains the same as the applicable VAT rate for corresponding domestic services - i.e. six percent for modern services. There is no difference between the applicable VAT rate and refund rate for the same service. Applicants are required to provide valid proof of export and receipts in filing for the tax refund.

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The takeaway


Under the zero-rated VAT preferential treatment, enterprises are exempt from VAT for exported services and the corresponding input VAT paid can be used to offset against the output VAT arising from other domestic VAT taxable activities or can even obtain a VAT refund; while under the VAT exemption treatment, services are only exempt from VAT upon exports and the corresponding input VAT incurred are treated as cost. Obviously the zero-rated VAT preferential treatment is more favourable than the VAT exemption treatment. Circular 118 expands the scope of zero-rated VAT services and is expected to be welcomed by enterprises engaging in the export of services. Especially for certain exported services with large investments in equipment and materials, the effective VAT burden may be substantially reduced upon claiming the zero-rated VAT preferential treatment.


Although the zero-rated VAT preferential treatment is more favourable than the VAT exemption treatment, its calculation and filing procedure are much more complicated than the latter one. How to accurately calculate and file VAT under the Exempt, Credit and Refund (ECR) method for exported services would become a huge challenge to enterprises which were previously applicable to the VAT exemption treatment. Moreover, invoices supporting the input VAT credit are not required under the VAT exemption policy, but enterprises - upon claiming zero-rated VAT preferential treatment - should take stock of their business process and make sure they will obtain invoices supporting the input VAT credit in a timely manner so as to fully enjoy the VAT ECR treatment (or VAT Exempted and Refund treatment). Meanwhile, enterprises shall also keep an eye on how to manage the input VAT and prevent the tax-related risks, such as the timely uploading and verification of the VAT invoices, segregating the input VAT that could not be credited, etc.


For service items with a smaller amount of input VAT incurred, enterprises shall choose an optimal treatment between the zero-rated VAT preferential treatment and VAT exemption treatment by making an assessment of the potential reduced VAT cost and additional administrative compliance cost. According to the existing VAT regulations in China, taxpayers may choose to enjoy VAT exemption treatment - or pay VAT - by giving up the zero-rated VAT preferential treatment. However, taxpayers are not allowed to change to zero-rated VAT preferential treatment within 36 months after making the choice. It means that enterprises have to take into account the future changes in their operation as well as the development of the tax policy. Particularly, once the B2V reform is extended to cover all of the remaining sectors in the near future, the input VAT incurred for certain exported services - e.g. industry sectors which incurred relatively large amounts of rental payments for immovable properties -- may be significantly increased.

BT 201602 110 43 Finance 001
Under the existing Circular 106, trading companies exporting self-developed R&D services and design services would be regarded as manufacturing enterprises and are applicable to the VAT ECR treatment in the same manner as their exported goods. Circular 118 has extended the eligible scope of this preferential treatment to cover all taxable services under the zero-rated VAT preferential treatment, which will allow more trading enterprises to enjoy the preferential treatment.


It is anticipated that the administrative measures of Circular 118 will be released soon to clarify the detailed scope, requirements on approval or record-filing, as well as the specific administrative procedures for enterprises with exported services to enjoy the zero-rated VAT preferential treatment. Enterprises engaging in the newly-added exported services eligible for zero-rated VAT preferential treatment should pay close attention to the following key points:


- Assess whether their exported services are eligible for zero-rated VAT services
- Choose the optimal treatment among zero-rated VAT preferential treatment, VAT exemption and paying VAT after making a self-assessment
- Once the zero-rated VAT preferential treatment is adopted, enterprises should take stock of their current business process; improve the internal control system; establish an administrative mechanism on input VAT; review their current business arrangements; and formulate a new pricing strategy
- Trading enterprises can actively explore practical ways to enjoy the preferential treatment of the "VAT ECR treatment method of regarding them as manufacturing enterprises for exported services in the same manner as the exported goods".




Appendix:

The applicable VAT refund (exemption) method for enterprises engaging in exported services eligible for zero-rated VAT preferential treatment001


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