The VAT reform project, officially launched as a trial programme in Shanghai in 2012, aims to consolidate the longstanding dual indirect tax system: VAT historically was levied on the supply of goods and the provision of repair, processing and replacement services at a rate of 13% or 17%, and business tax (BT) was levied on the provision of other services and the transfer of intangibles and real property at rates of 3% to 20%. The coexistence of the VAT and BT systems created a number of issues, such as double (or multiple) taxation because an input tax credit was available for VAT payers, while no such mechanism was available for BT payers. The reform aims to resolve the double taxation issue and to foster the development of specified modern service industries by gradually transitioning these industries from BT liability to VAT liability.
The government has issued a series of circulars and bulletins over the past four years which have gradually expanded the reform, both in scope and geography (and, more recently, guidance that simplifies the input VAT verification process). To date, transportation, postal services, telecommunications and certain modern service sectors such as information technology (IT), and film and television have transitioned from BT to VAT. The only sectors that remain subject to BT are property developers and the construction, financial and consumer services sectors.
Next steps
The Ministry of Finance and the State Administration of Taxation (SAT) are expected to issue comprehensive rules on property developers, and the construction, financial and consumer services sectors in the near future. Although details have not been made public, the following comments made by Premier Li Keqiang are relevant:
· The inclusion of property developers and construction, financial and consumer services in the VAT reform on May 1 2016 should mean that VAT will apply to these sectors as from that date. There had been considerable speculation about the effective date for these sectors, in particular, in light of guidance issued by the Ministry of Housing and Urban-Rural Development on February 19 2016 urging local construction authorities to complete all construction project pricing adjustments before the end of April 2016.
· Input VAT incurred by general taxpayers on newly acquired immovable property will be fully deductible, which should be welcomed by real estate enterprises that have been concerned about their ability to pass VAT on to their business customers.
· The new rules aim to ensure that there is no increase of the VAT burden for taxpayers.
Since the VAT reform efforts were launched in 2012, there have been many debates and discussions on technical issues relating to the design of the reform, especially with respect to the real estate and financial services sectors. Since the goal is to reduce the tax burden on businesses, it is possible that the BT treatment will be transitioned into the VAT rules, at least initially, so that a service that is now exempt from BT may be exempt from VAT under the new rules. The applicable VAT rates likely will be 11% for the construction sector and 6% for the other sectors.
Review processes
The sweeping VAT reform will have an impact on many aspects of affected businesses, including IT systems, contracts, supplier-customer relations, pricing, among others, and with detailed rules likely to be forthcoming, businesses may have a very short timeframe to fully prepare for implementation. With the premier’s announcement, businesses should focus on prioritising actions and testing so VAT can be passed on to the consumer. Businesses should communicate with their customers to ensure that, commercially, VAT can be charged, and contracts should be reviewed to ensure this is technically allowed. IT systems should be tested and internal controls reviewed to ensure they can handle the issuance of VAT invoices and management of VAT. Although recent guidance issued by the SAT allows a simplification of the input VAT verification, businesses will need to plan ahead in relation to their internal management and understanding of their data.
Contributed by Sarah Chin and Li Qun Gao, Deloitte Hong Kong and China.
