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FINANCE: Turnover Taxes reform
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Turnover Taxes reform

Analysis of current wave of tax reforms covering a few sectors

By Kelvin Lee, PwC Tianjin


In brief
On March 5th, Premier Li Keqiang indicated in the government work report that the pilot program for the transformation from Business Tax (BT) to Value-Added Tax (VAT) (the "B2V Reform") would be expanded to cover the construction sector, real estate sector, financial services and consumer services (the "Four Industries") from May 1st, 2016. On March 18th, the Executive Meeting of State Council officially approved the implementation measures for the B2V Reform. Almost a week later, the Ministry of Finance (MoF) and the State Administration of Taxation (SAT) jointly released Caishui [2016] No. 36 (Circular 36) on the Comprehensive Roll-out of the B2V Transformation Pilot Program, and the long-awaited expansion measures of the B2V Reform were officially released.


Circular 36 stipulates that the taxable scope of the B2V reform is "the sales of services, intangibles or immovable properties within China". In terms of the applicable VAT rate, the rate for transportation services, postal services, basic telecommunication services, construction services, immovable property leasing services, sales of immovable properties and transfer of land use right is 11%; the rate for tangible movable properties leasing services is 17%; the rate for other taxable activities (including financial services and consumer services, etc.) is 6%; and certain cross-border taxable activities within the service scope stipulated by the MoF and SAT provided by domestic taxpayers shall be zero-rated or exempted from VAT. In addition, taxpayers can claim input VAT credit on VAT incurred on the purchase of immovable properties with valid VAT invoices. By now, all industries under the BT regime have been transformed to the VAT regime; all VAT taxpayers are highly recommended to pay close attention to the significant impacts brought about by the B2V Reform.

BT 201605 19 Finance
In detail

Overall picture
Circular 36 comprises of general measures and four appendices, and the format is consistent with the previous B2V reform policies circulars. It clarifies the effective implementation date and the relevant work requirements. The four appendices are as follows:
-Appendix 1: which focuses on taxation elements, such as, scope of taxpayers, scope of taxable activities, tax rates, calculation of tax payable, etc.
-Appendix 2: which elaborates certain specific VAT polices for new B2V pilot taxpayers and existing VAT taxpayers respectively during the period of the B2V Pilot Program.
-Appendix 3: which stipulates that the original tax preferential treatments under BT are retained during the period of the B2V Pilot Program ;
-Appendix 4: which stipulates the scope of cross-border taxable activities eligible for VAT zero-rated or exemption treatment.


All B2V business is covered by Circular 36, and certain existing circulars relating to the earlier stages of the B2V Reform, such as Caishui [2013] No. 106 ("Circular 106"), etc. will be abolished simultaneously as Circular 36 comes into effect. Therefore, Circular 36 will have a profound impact on new VAT pilot taxpayers, existing VAT pilot taxpayers and non-VAT pilot taxpayers.


New and adjusted provisions


Adjustment of taxable scope
BT 201605 15 Finance HLCircular 36 stipulates that the taxable scope of the B2V pilot program is "the sales of services, intangibles or immovable properties within China". While construction services, financial services, consumer services, sales of land use right, sales and leasing of immovable properties are newly added into the taxable scope, the circular also adjusts and optimises the previous annotation of the scope of each item of service, for instance:
-Reclassifying "Technology Transfer and Technology Consulting" from "R&D and Technology Services" to "Sales of Intangibles" and "Identification and Consulting Services" respectively;
-Reclassifying "Freight Forwarding and Customs Agency" from "Logistics Auxiliary Services" to the new category named "Business Auxiliary Services" ;
-Moving "Value-added Information System Services" from "Business Process Management" to a separate new chapter;
-Reclassifying "Financial Sale and Leaseback Model" from "Tangible Movable Property Leasing Services" to "Financial Services";
-Re-defining some of the services in "Logistics Auxiliary Services" as "Non-carrier Transportation Services" and reclassifying them into "Transportation Services" ;


The above changes show that the taxable service scope is becoming more detailed and complete as the development of B2V pilot program progresses. Even if taxpayers have not changed their business, the change of the annotation on the tax categories could affect the taxpayers' applicable tax category, and even the tax rate. Taxpayers should get to know the annotation details and precisely determine the applicable taxable service category and tax rate.


Concurrent operation and mixed sales activity
Circular 36 contains provisions for both concurrent operation activities and mixed sales activities. Where a pilot enterprise provides VAT-able activities that are subject to different VAT rates or levy rates, the enterprise should separately account for the turnover of each activity. If the VAT-able activities are not separately accounted for, the highest VAT rate would apply to all VAT-able activities. Mixed sales refers to a sales transaction comprising of both services and goods, taxpayers engaging in the production, and the trading of goods would be subject to VAT on such mixed sales under the category of sales of goods, while other taxpayers would be subject to VAT under the category of sales of services. Meanwhile, the concept of "mixed operation" in Circular 106 is abolished.


BT 201605 18 FinanceReasonable commercial purpose
According to Circular 36, tax authorities have the right to determine the sales amount of taxable activities provided by a taxpayer where it is obviously high or low and without reasonable commercial purpose. Reasonable commercial purpose is a standard used by tax authorities to assess the legal form and economic substance of taxpayers or transactions and has been widely adopted in the Corporate Income Tax (CIT) regime. Although Circular 106 has already introduced the reasonable commercial purpose principle, it is still unclear as to how to determine reasonable commercial purpose in the turnover tax regime. In this regard, Circular 36 defines the term "without reasonable commercial purpose" to refer to the seeking of tax benefits as the main purpose and through the use of artificial arrangements to reduce, exempt, defer VAT payments or increase VAT refund.


Net basis method
According to the VAT general principle, VAT payable shall be the balance of output VAT less input VAT, which means VAT only taxes the value-added portion. However, considering that, in practice, valid VAT invoices may not be able to be obtained for certain special businesses which makes it impossible to accurately calculate the "value added amount", Circular 36 introduces the net basis method which allows industries, such as, financial leasing, air transportation, brokerage and agency, tourism business, etc. to calculate the VAT payable amount by deducting certain prescribed expenditures from the gross VAT-able sales amount.


Circular 36 also requires valid invoices to support the deduction of the prescribed expenditures above mentioned. Meanwhile, Circular 36 also stipulates that even when the invoices mentioned above are also eligible for claiming input VAT credit, taxpayers can only use the net basis method to calculate the VAT payable and cannot choose to claim input VAT credit.


Immovable property are included in input VAT credit scope
Circular 36 stipulates that VAT incurred on the purchase of immovable property is creditable provided that valid VAT invoices are obtained. China has allowed VAT incurred on the purchase of fixed assets to be creditable since 2009. By adding VAT incurred on the purchase of immovable properties to the creditable scope in this round of reform, China has now fully implemented a consumption-based VAT regime, which is important in perfecting the VAT credit chain and mitigating the multiple taxation issue. Taxpayers should pay attention to the methods of claiming input VAT credit and the administrative requirements stipulated in Circular 36, timely obtain the VAT invoices and complete the input VAT invoice verification within 180 days to ensure that the input VAT amount can be fully credited.


According to Circular 36, except for immovable properties under finance lease and temporary building and facilities in construction sites, input VAT incurred on the purchase of immovable properties can be credited over two years with 60% in the first year and 40% in the second year. As the current VAT credit mechanism adopts the principle of allowing input VAT credit to be claimed for purchases in the current period, taxpayers can claim the full input VAT credit in the period the VAT invoice is obtained. Claiming the credit in instalments will bring some practical problems in accounting and tax filing which taxpayers have to be aware.

BT 201605 14 Finance HLVAT on lending services is not creditable
According to Circular 36, input VAT on lending services such as interest payment as well as advisory fees, commission charges, consulting fees, etc. paid by the borrower that are directly related to the lending services received by the borrower are not creditable. As a result, interest payment, which is the most common financial service charge, is not included in the input VAT credit scope. Circular 36 has not explained whether it is because of fiscal revenue consideration or tax administration reason. Taxpayers should pay closely attention to the official policy interpretation and subsequent circulars.


In addition, Circular 36 also stipulates that VAT on passenger transportation services, catering services, resident daily services and entertainment services is not creditable. These services are generally for collective benefits or individual consumption, which are always not creditable even if the taxpayers have obtained the relevant valid invoices. However, as input VAT in relation to self-used vehicles and yachts has already been included in the VAT credit scope since 2013, taxpayers should keep an eye on the further policy development of these items.


BT 201605 17 FinanceUsing net value in calculating input VAT credit
Circular 36 stipulates that where there is a change in the use of fixed assets, intangibles and immovable properties of which the input VAT incurred was not credited because of the use of simplified method, VAT exemption, being used in collective benefits or for individual consumption and these assets are now used in activities where input VAT credit is allowed, the taxpayer can claim input VAT credit based on "the net value" with the support of valid invoices in the month following the change. As the former VAT Law and regulations did not have any provision addressing this specific situation, therefore taxpayers may likely not be able to claim input VAT credit in the past. On the other hand, where taxpayers have changed the use of assets and the VAT is no longer creditable, the non-creditable input VAT has to be transferred out. Circular 36 now makes the input VAT credit rules more practical and reasonable, taxpayers should pay attention to the procedures for claiming such input VAT credit, particularly how to resolve the situation where the VAT invoice verification period has expired.


New policy on cross-border taxable activities
Circular 36 has zero-rated or exempted certain cross-border taxable activities of the Four Industries, such as overseas construction services, provision of direct fee paying financial services related to monetary financing and other financial services carried out among foreign entities. VAT pilot taxpayers should understand the relevant administrative measures to ensure they can fully enjoy the preferential treatments.


The takeaway


As an important measures to deepen the fiscal and taxation reform and supply-side structural reform, this round of B2V Reform will accomplish the completion of the VAT chain covering all industries including sales of goods, provision of services, sale of intangibles and immovable properties. Besides minimising double taxation, the B2V Reform also facilitates the social division of labour and industrial upgrading and gradually improves the VAT regime to lay foundation for the enactment of the VAT law.


Circular 36 covers all industries and businesses under the B2V Reform. Apart from continuing with the previous B2V measures and adding applicable B2V policies for the remaining Four Industries, it also refines and adjusts the existing B2V pilot policies after considering the result of the previous pilot runs and the features of the remaining Four Industries. Meanwhile, it also provides certain new regulations such as adding immovable property into the scope of creditable VAT item for non-pilot B2V taxpayers (sales of goods, provision of labour services). Therefore, both pilot and non-pilot taxpayers should proactively prepare for the implementation of this final round of B2V reform.

BT 201605 13 Finance HLNew pilot B2V taxpayers


VAT is much more complicated than BT, in terms of either tax treatment or tax administration, where taxpayers need to master the requirement of the tax filing mechanism, the VAT return form and VAT invoice management to ensure tax compliance and mitigate the tax risk. Meanwhile, as an important part of the structural tax reduction measures, B2V Reform will play a prominent role in reducing the tax burden of all industries through meticulous policy arrangements. Taxpayers should understand the VAT principles and relevant policies in order to fully enjoy the benefits from the B2V Reform and avoid tax increases that are self-inflicted. As the comprehensive implementation of the B2V Reform will be effective from May 1st, new pilot B2V taxpayers have a very short preparation period. In this regards, we suggest:

-Taxpayers should actively cooperate with the in-charge State Tax Bureau (STB) and prepare for extra work before the B2V Reform, including providing supplementary tax registration information, performing general VAT taxpayer registration, applying for VAT invoices, obtaining appliance for issuing VAT invoices, attending training, record filing for various tax incentives, record filing for export tax rebate eligibility, obtaining access right to online filing system, etc., and ensuring that the VAT return will be filed on time in June.
-Taxpayers should conduct a comprehensive assessment on the impacts to profit, revenue and cost/expenses brought by the B2V Reform, and analyse the effect of input VAT to cash flow and financing cost. Taxpayers should also adjust the pricing mechanism for products or services, study supplier's profile and improve supplier management.
-Taxpayers should study the transitional measures and assess the impact on its tax burden. Taxpayers should also adjust the relevant clauses in commercial contracts based on the detailed B2V Reform policies and consider upgrading the business model accordingly.
-Taxpayers should adjust the work procedure and refine the system, revamp the system to separate price and VAT to meet the accounting requirements under the VAT regime. Taxpayers should also focus on VAT risk control management, adjust the system for matters such as, interconnection between the accounting system and the tax filing and upgraded invoice system, reasonable allocating non-creditable input VAT, etc.
-Taxpayers should modify the turnover tax management procedure, and compile a VAT operating manual brochure to ensure compliance. Taxpayers should also be familiar with the requirement of the upgraded VAT invoice system and properly issue VAT invoices, understand the requirement in obtaining and storing VAT invoices and the time period for claiming input VAT credit so as to ensure that the full amount of input VAT can be claimed.
-Taxpayers should pay close attention to any follow-up measures of the B2V Reform, study the various policy interpretation and detailed implementation rules, and timely analyse the relevant impact and act accordingly.

Existing pilot B2V taxpayers and non-pilot VAT taxpayers

BT 201605 16 Finance-Pay attention to the adjusted taxable scope of certain services. Taxpayers should precisely determine the taxable service category to ensure the applicable VAT rate is correct and issue the invoices correctly. Meanwhile, taxpayers should estimate the impact of the change in the VAT rate, adjust pricing strategy and business negotiation accordingly and reasonably transfer the VAT burden to its customers.
-Pay attention to concurrent operation and mixed sales. Taxpayers concurrently operating businesses with different tax rates should separately account for each business in each stage of the business cycle, such as, signing of contracts, bookkeeping and issuing of invoices, etc. so as to avoid the application of the higher tax rate to all businesses. Where a sales transaction involves both the sales of goods and provision of services, VAT would be levied on the full amount either under the tax category of 'sales of goods' or 'provision of services' according to business nature of the taxpayers.
-Claiming of input VAT credit. Taxpayers should be familiar with the new taxable services which are included in the input VAT creditable scope after this round of B2V Reform, understand the creditable purchase items and review the general VAT taxpayer qualification of suppliers. Following that, taxpayers should obtain the valid invoices in a timely manner to claim input VAT credit on time. When purchasing and leasing immovable properties, or receiving construction services at the beginning stage of this final round of B2V Reform, taxpayers should find out in advance whether the suppliers will elect the transitional policy and estimate the impact to the input VAT amount accordingly. If the suppliers are small scale taxpayers, taxpayers should also adjust the relevant pricing strategy. Taxpayers should also keep an eye on any subsequent detailed implementation rules and filing requirement on claiming input VAT credit for immovable properties in instalments.


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