China’s State Council decided that the Value Added Tax (VAT) pilot program, which replaces Business Tax with VAT, currently in force in Shanghai, will be expanded progressively from 1 August 2012 until the end of 2012 to 10 cities/provinces. Those 10 cities/provinces represent many of the major commercial centres in China, namely: Beijing, Tianjin, Jiangsu, Zhejiang, Anhui, Fujian, Hubei, Guangdong, Xiamen and Shenzhen. The precise date for implementation in each city or province has not been specified.
The decision by the State Council has confirmed that the industries subject to the pilot program in the 10 cities/provinces named will be the transportation and modern services industries. The State Council decision also indicated that the pilot program will be expanded to other cities and provinces, as well as to other industries, during 2013.
The VAT pilot program is designed to enhance the growth and development of the services sector in mainland China, which is consistent with the Government’s 12th Five Year Plan. Foreign companies who either do business in China, or who buy services from China, will benefit from this pilot program. Previously a 5% Business Tax liability generally applied whenever services were exported from China, or imported to China. Now, in many cases those services should be free of any real VAT cost.
The VAT pilot program benefits manufacturers in China – they can now claim VAT credits for the costs of the services they purchase, whereas previously there was a 5% Business Tax cost on those services.
The VAT rates selected by the Government, being 6% for the modern services industry, and 11% for the transportation sector, are well below the international average VAT rate that now exceeds 15%. This policy is intended to reaffirm China’s commitment to being an internationally competitive place in which to do business.
The State Council’s decision to expand the pilot program to major commercial centres around mainland China during 2012 is testament to the early success of the Shanghai pilot program, and reflects a commitment to achieving substantial reform of the indirect tax system in China. In its simplest form, the VAT reforms seek to replace Business Tax (BT) with a VAT. The replacement of BT, (a tax on business) with a VAT (a tax collected by business, but effectively borne by the end consumer) is an important change for business. With over 150 countries around the world having now implemented a VAT, these reforms should also more closely align China’s system of indirect taxes with world’s best practice.
Early statistics from Shanghai (as reported by the Shanghai Tax Bureau) show that approximately 90% of businesses have benefited from a reduction in their tax burden as a result of the pilot program. If this trend continues on a national basis, then these changes will be welcomed by the business community, particularly during this period of global economic instability.
The changes to China’s VAT regime more closely aligns its system of indirect taxes with those applicable internationally, including the EU, Canada, Australia, South Africa and Singapore. This will ease some of the challenges for multinational companies looking to set up in China.