Amid complexity, VAT reform grinds onward
Print Edition
China is expected to replace the business tax with a value-added tax (“VAT”) for financial services and real estate sectors this year in the final stages of a major overhaul of the indirect tax structure.
Unlike the business tax, which is levied on the total revenue of a company, the VAT assesses only increments of new value created by a company. Under the VAT, certain costs of purchasing goods and services can be deducted.
According to a Chinese government blueprint released in 2010, the business tax will be completely replaced by the VAT by the end of this year.
The tax shift was first implemented in sectors such as transportation, leasing, telecommunications and modern services. The financial services and real estate sectors were left to last because of their complexity and their wide-ranging impact on the economy.
Construction and consumer service industry are also scheduled to be participating into the VAT system this year.
Shanghai Daily sat down with Robert Li, an indirect tax partner with PricewaterhouseCoopers China, to discuss how the new tax structure may affect companies and consumers.
Q: Do you think VAT reform will really be completed this year?
A: Currently, only four sectors are still to be put under the VAT system: construction, real estate, financial services, and consumer services such as hotels and restaurants. This is the last year of the 12th Five-Year Plan, and the blueprint VAT reform should be completed this year. We expect this to happen, but we can’t rule out the possibility that the authorities may require more time in some aspects.
We think the rules for the VAT in real estate and construction may be implemented first while the financial sectors could be the last to join. Those rules may be released as soon as May, leaving financial institutions only three or four months to prepare. Consumer services may be included somewhere in between.
Q: What are the some of the complexities involved?
A: For property developers, it has not been decided whether and how they can claim VAT credits from land purchases in cases where developers are unable to acquire VAT invoices. If they cannot deduct the costs of land, they will face elevated tax pressure when they shift to the VAT system. Some have proposed a deemed input VAT on land purchases, and some have said they can pay the tax and claim refunds later. Property developers and tax authorities have not agreed on a solution to the issue yet.
Another big problem is on policies during a transitional period. For example, how to tax a real estate project that was completed before the VAT policies take effect. The tax burden of such older projects could be higher than new ones because developers were previously unable to claim VAT credits on goods and services. Rules need to be settled on issues such as whether there will be a transitional period, how long it will be, whether the government will refund excess taxes to a company, or if a flat-rate scheme will be used during the transitional period. These are some of the many questions waiting to be resolved.
The financial sectors are even more complicated. Operations in banking, insurance, and securities industries vary greatly as to what can be claimed under VAT credits and what rate will be applied. For example, for banks, can deposit interest be considered as a VAT credit? How can banks acquire invoices from individual consumers and actually claim tax deductions?
The process of VAT reform is a prolonged journey where companies need to be ever alert for new questions arising even after policies are released. The freight forwarder sector, for instance, was among the first services industries under the VAT system in 2012, but it was not until September 2014 that detailed rules were settled on some specific operations.
Q: What are the benefits of VAT reform for companies and consumers?
A: People talked a lot about structural tax cuts when VAT reform was first introduced, but that is not much a priority for the government now. The government wants to eliminate duplicate taxation and integrate the services and manufacturing industries into a single system. A company will be able to deduct credit on more costs and probably will save money as the VAT system expands to cover service industries.
The impact will be sweeping when financial and real estate sectors are added this year. If the companies will be able to get a tax credit from the interest they pay on loans or on a property they buy or rent from a developer, the savings could be shared by the company, the bank and the developer.
If the tax paid ends up being higher, the interested parties are likely be engage in fierce negotiations concerning the breakdown.
For consumers, the impact is not so direct because companies may or may not pass on saving or additional costs to end users. There are some industries, such as marine transportation, where prices did go up after the VAT reform, partly due to higher tax pressure.
But in the real estate sector, arguably the most sensitive industry to be included, the results are not quite as obvious.
Residential property is a special industry where the price is decided more by market demand than by real cost. As home prices remain under government oversight, property developers will be cautious in transferring any additional tax cost to consumers. It’s likely that developers will take time to analyze the impact of the tax reform, observe market prices and look for cost savings elsewhere if needed.
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