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Implementing VAT reform in China

Sarah Chin & Li Qun Gao of Deloitte explore the evolving challenges of a single VAT system

China's tax landscape in 2012 was dominated by the VAT pilot reform programme. Launched in Shanghai on January 1, the pilot moved certain services (transportation and modern services) out of the scope of the business tax (BT) regime into the scope of the VAT regime. This was the first phase of an overall plan to replace the dual BT/VAT systems with a single system applying to the supply of both goods and services. The pilot was subsequently expanded to another eight cities/provinces. In April 2013, the government announced that the reform will be implemented nationwide as from August 1 2013, and on May 24 2013 the Ministry of Finance and the State Administration of Taxation issued a circular (Circular 37) that formalises the national implementation of the VAT reform from a legislative perspective and provides detailed – and positive – implementation rules on the national rollout.

The pilot reform has given rise to some issues, such as a distortion of competition between businesses within and outside pilot areas. By far the most controversial issue has been the practical implementation of Circulars 110 and 111, which detail the general guidelines for the VAT reform, including applicable rates and scope, provide detailed implementation rules for the Shanghai pilot and lay the foundation for other cities to join the VAT pilot.

The implementation rules in Circular 37 do address a number of issues that have arisen during the pilot reform (for example which treatment applies when both exemption and zero rated treatment apply, and the method to be used when accounting for zero rated services).

After 18 months of practical experience with the pilot reform, this article looks at the technical developments and the main challenges for implementation of the reform nationwide. We also comment on what we believe will be the approach over the next two years given that the reform will be completed by 2015. One thing is certain: major changes and refinements will continue to be part of the landscape as China learns, through practical implementation, what measures are needed to ensure an efficient and effective system.

Transition from pilot to full-fledged reform

The issuance of Circular 71 in July 2012, which set the formal timetable for, and scope of, the expansion of the pilot from Shanghai to eight cities/provinces, was the first indication that the pilot was entering a new phase. The transition from a pilot programme to a full-fledged reform became clear with the announcement by the State Council on April 10 2013 (and subsequent issuance of Circular 37) that the focus will move away from a city-by-city implementation to a national initiative.

Another change confirmed in Circular 37 is the nationwide implementation of the transportation and modern services sectors as from August 1 2013. Bringing the reform to a national level is the correct step given the distortion of competition initially created by the Shanghai pilot. Circular 37 also brings the production, broadcasting and distribution of TV and radio programmes and films into the model services sectors covered by the nationwide VAT reform. Railway transportation, postal and telecommunications services, which were mentioned in the April announcement (but no timeline for their inclusion) are not covered by Circular 37, so it is unclear when these sectors will join the VAT reform.

Technical possibility and practical reality

The most beneficial aspect of the reform clearly is the fact that no VAT is charged when covered services are supplied overseas; this is achieved either via a zero rating or, in most cases, an exemption. At the time this feature was announced at the end of 2011, it was met with immense excitement, especially as this had been broadly lobbied for in previous years. However, when taxpayers in Shanghai attempted to apply the exemption on January 1 2012, it became apparent that it could not be used because the local tax bureaus themselves were uncertain of the implementation rules. Today, some 18 months after the pilot was launched, Shanghai and Beijing have become slightly more relaxed and allow certain taxpayers to apply for the exemption at their own risk (if any inconsistences are found during an audit, for example, the taxpayer must repay the VAT). However, some local tax bureaus remain conservative and require VAT to be charged until they receive further clarifications from the central government.

Companies doing business in China always cite local variations and the VAT reform is no exception. In this case, the good news is that some cities, such as Shenzhen, have issued local guidance on how to apply for a VAT exemption, and we are aware that new guidance is being drafted by local tax authorities and being reviewed by the SAT, so there is reason to believe that some of the practical issues will be resolved soon.

VAT or BT: Which is more beneficial?

Being subject to VAT generally is beneficial for businesses because they are able to claim an input VAT credit charged on their purchases of goods/services against their own VAT liability. However, the definitions of pilot services in the current rules are broad and, in many cases, vague. As a result, some taxpayers have found themselves in a difficult situation when assessing whether they should continue to pay BT or start paying VAT after the pilot.

While the ambiguity of the scope of the pilot creates some uncertainty, taxpayers also have the opportunity to interpret the scope of included services to their benefit and argue for the desired treatment. For example, although market research services per se are not covered by the reform, it is possible that, where such services can be shown to include an advisory element because there are comments on how the marketing can be tailored to the Chinese market, market research services can be classified as a form of consulting, which is included in the reform, thus allowing VAT to be charged.

In contrast, some taxpayers may prefer to continue to pay BT because, for example, they have negotiated financial subsidies based on the BT paid. A move to VAT liability would result in a reduction or loss of such subsidies and the creation of a VAT cost. For example, take the case of a Chinese company that is located in a special trade zone, such as an export processing zone, because the company's main business is the manufacturing of goods for export. The Chinese company must pay a royalty to its overseas related parties for licensed technology used in the manufacturing process. Under the pilot, the company is required to withhold VAT instead of BT from the royalty payment. Unless the financial subsidy is still available and can effectively offset any VAT in excess of the BT, the company will incur a cost because, as a company registered in an export processing zone, it does not suffer VAT and, thus, cannot credit input VAT.

Future rollout of industries

There is considerable interest in whether the real estate and construction sectors and financial services will transition from BT to VAT rules and, if so, when. The strategic economic importance of these industries in China means that the government will need to consider many issues and competing interests before converting them to VAT to ensure both sectors continue to thrive. The April 2013 announcement was silent on this issue.

If real estate services ultimately will be covered under the VAT regime, the question is how they will be subject to VAT, that is under the simplified taxation method where a flat rate applies with no input VAT credit or under the normal input and output mechanism. If the simplified taxation method is chosen, real estate businesses would be taxed in substantially the same way as they are now, the only difference being the name of the tax and possibly the rate. If the normal mechanism is adopted, however, many issues will need to be addressed, including the rate (and any exemptions), eligibility to claim input VAT credits and the administration of VAT invoices. The potential impact on real estate prices in China is an issue of interest to both the government and the public. Construction is closely linked to real estate development as the main service purchased by real estate developers so these two industries are likely to be considered together.

Circular 110 stated that, in principle, financial services should be taxed using the simplified taxation method. Financial service institutions would prefer zero-rating or exemption, though signals are that neither is likely to be adopted because the government is not ready to relinquish the BT revenue from financial services. If neither of these treatments is available, a rate lower than the 5% BT rate may be the best a financial service institution can hope for.

What to expect over the next two years

The Chinese government has confirmed that the reform will be finalised by the end of 2015 – an ambitious deadline. There is still a lot of work to do, such as defining VATable services, rolling out the reform to more industries and balancing the impact on the economy. The government has been looking at other VAT systems and has been consulting with foreign tax authorities to formulate an appropriate system for China. The issuance of Circular 37 demonstrates that the government has taken into consideration experience gained from the pilot programme and introduced some positive changes, which should be welcomed by businesses.

However, since there generally is no public consultation when issuing new tax rules in China, the challenge is whether the new rules can be implemented by businesses. For the VAT reform to be a success, the legislators need to understand the real life transactions affected and what changes innovations bring to such transactions. The VAT reform has broad implications for companies doing business in China, and all companies need to monitor developments carefully – despite the demanding deadline of 2015 for full VAT implementation, experience has shown that this deadline will be met.




Sarah Pui Pui Chin

Deloitte China

30/F Bund Center

222 Yan An Road East

Shanghai 200002


Tel: +86 21 6141 1218



Sarah Chin is the national indirect tax and customs Leader for Deloitte China and the tax managing partner for Deloitte Hong Kong. She focuses on working with multinational companies, assisting them to identify, plan, and implement solutions for their local operations from PRC VAT and customs points of view.

Sarah began her career as an inspector with the UK's HMRC before moving into VAT consultancy. She spent seven years in the UK primarily advising on governmental issues and international VAT before relocating to Zurich where she established an EU VAT centre of excellence before building and heading up a VAT team in Switzerland. Sarah is the global indirect tax leader for several of Deloitte's strategic accounts.

Sarah is a frequent speaker and has authored numerous articles. Since 2008, Sarah has worked with Chinese governmental bodies on the approach and design of Chinese VAT reform. She is also an associate of the Chartered Institute of Taxation of England and Wales.




Liqun Gao

Deloitte China

30/F Bund Center

222 Yan An Road East

Shanghai 200002


Tel: +86 21 6141 1053



Liqun Gao is an indirect tax partner of the Deloitte China member firm and is based in Shanghai. She focuses on providing advisory and compliance services to multinational companies in relation to their operations or transactions from PRC VAT, customs, business tax and consumption tax perspectives.

Professional Experience

Liqun's professional experience includes general PRC tax and regulatory advisory, tax aligned supply chain management, VAT and customs issues in processing trade, mitigation of export VAT refund costs, foreign exchange issues, operating in special zones like free trade zones, export processing zones and bonded logistics parks. She has assisted clients in retail business to review and restructure their discount programs to achieve tax efficiency. From 2006 to 2007, Liqun took a secondment in the indirect tax group of the London office of Deloitte UK.

Liqun provides China tax training at various institutions and is a frequent speaker at seminars and conferences. She also worked as a domestic expert with the National People's Congress and the Ministry of Finance in the drafting of the new VAT Law.

Liqun is a key member of Deloitte's Asia Pacific indirect tax team, a highly specialised, experienced and integrated group bringing global and Asia Pacific expertise to clients. The Deloitte Asia Pacific indirect tax team has a singular focus on dealing with clients' compliance, advisory and consultancy needs regardless of geography, and has built a reputation in the marketplace for its practical, efficient and effective approach.

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