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Why China is extending its VAT pilot

China piloted a new VAT regime in Shanghai in January. It now plans to expand the programme to Beijing on July 1.

The measures saw VAT and business tax merged into a single tax, shifting the burden of taxation from businesses to consumers.

Lachlan Wolfers, a tax partner at KPMG China, points out that the expansion of the pilot program geographically throughout mainland China was part of the government's original plan.

“However, the pace of the expansion looks likely to occur quicker than many anticipated,” said Wolfers. “This may be partly due to the fact that the reforms, in most cases, reduces the tax burden for business, which assists business during this period of global economic instability.”

Christina Liu, finance controller at recruitment firm Hays, agrees that the reforms are beneficial for her company.

“Given the current business tax born by our company, VAT would significantly lighten our load in terms of tax burden,” said Liu.

Liu wants to see the programme extended nationwide.

“I believe China will effectively improve the VAT system by replacing current business tax for a more straightforward control throughout the country,” she said.

Wolfers reports client feedback of the pilot has so far been extremely positive.

“For most taxpayers, the shift from business tax to a more modern and internationally recognised tax, like a VAT, is clearly welcomed,” he said. “It's also important to recognise that the pilot program benefits many businesses in the manufacturing and retail trading sectors too, because they can now claim input VAT credits for the services they acquire.”

He notes that the head offices of many multinational companies are pleased to see the reforms occurring, particularly because the treatment of cross-border transactions is much more internationally competitive than under the old business tax system. The VAT is also more familiar to them, even though it does have many uniquely Chinese characteristics.

“This is not to suggest that all businesses in Shanghai have had their tax burden reduced,” said Wolfers. “Certain businesses in the transportation and logistics sector may have had their tax burden increased, but the government is responding to this with various assistance measures. The key message is that the government has been prepared to listen and respond - this has been critical to the early success of the pilot program.”

After Beijing, Chongqing, Tianjin, Shenzhen and Jiangsu are the most likely locations to receive the pilot programme, with other provinces also likely to join. If the local governments in those provinces have seen businesses in Shanghai benefiting from the pilot program, then it is logical that they will want to ensure their own businesses remain as competitive.

Wolfers believes that once the reforms have been expanded across all of mainland China, then the scope may be expanded to cover other areas such as financial and insurance services, real estate and construction, entertainment, post and telecommunications, until business tax has been phased out entirely.

“The experience and pace of the reform in Shanghai has been frenetic,” said Wolfers. “When other countries such as Australia implemented similar reforms, they gave businesses 18 months to prepare, but in Shanghai businesses were given a little over six weeks.”

“It was difficult for traditional business taxpayers, and even for tax bureaus, to adjust to VAT within one and a half months,” confirmed Liqun Geo of Deloitte. “The rules came out on November 16 2011 and were effective on January 1 2012. But generally speaking, businesses found the pilot a good move because they have more input VAT credit and reduced cost for services.”

Wolfers points out that the key is to maintain the perspective that the long-term benefits for business outweigh some of the short-term challenges.

“The tax authorities in Shanghai also worked very hard to assist business with implementation, which has been critical to the success of the pilot program,” he said.

Wolfers reports that many larger businesses have put together project teams to implement the reforms – bringing staff from sales, marketing, procurement, IT, legal and finance functions to enable them to break down a large change into smaller more manageable processes.

“I have been really impressed with the extent to which businesses in China have adapted to, and embraced these reforms,” he said.

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