Value-added tax fully implemented. So what does the change really do?
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AFTER about a half-year delay, China extended the value-added tax to all industries on May 1, replacing the business tax.
The last stage of the switch applies the VAT to real estate, construction, finance and consumer services industries.
Adoption of the VAT to replace the business tax is part of a national tax reform program.
The value-added tax applies only to new value created by a business, compared with the business tax that was levied on gross revenue.
In the first two weeks of the VAT expansion, local price authorities have been busy monitoring the market to ensure that businesses don’t overcharge customers in the name of VAT.
Travelers in hotels, diners in restaurants, students’ informal education and training classes and buyers of existing homes are now effectively subject to a 6 percent VAT instead of the 5 percent business tax.
Weeks before the implementation, international chain hotels such as Intercontinental, Marriott and Hyatt added 6 percentage points to services fee, citing the advent of VAT.
Some training organizations were also reported to have raised fees in the name of VAT reform.
Tax authorities have been quick to react, explaining that VAT should not be used as an excuse to raise prices.
Under the new regime, companies can claim tax deductions on their purchases of other goods and services. Tax authorities have estimated that the tax burden for hotels, restaurants, and training organizations will remain relatively unchanged because the tax deduction on purchases will effectively offset the extra percentage point in tax.
In addition, small businesses meeting certain criteria are eligible for a preferential 3 percent VAT rate.
Buyers of some existing homes that were previously subject to the 5 percent business tax are now subject to a 5 percent VAT rate. Official calculations show that the actual tax burden under VAT will be 4.76 percent of the price of a home because of various taxation methods under VAT and the old business tax.
Authorities said homebuyers can save some 2,000 yuan (US$306) on the purchase of a 1 million yuan apartment.
Although it may all be confusing at first to companies and individuals, the introduction of VAT is meant to streamline taxation in the business cycle. Of course, companies can decide whether to pass on savings or additional costs to consumers.
The tax reform started in Shanghai in 2012, applying VAT to manufacturing industries. Within three years, transportation, telecommunication, leasing, technology innovation, media and entertainment sectors were added to VAT, with tax rates of 6 percent, 11 percent and 17 percent, and a preferential rate of 3 percent for small businesses and some special operations.
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The more industries included in the VAT system, the more purchases companies can claim for tax deductions.
The latest inclusion of construction, real estate, finance and consumer services industries will give companies maximum benefit of VAT rules.
These four sectors involve nearly 10 million companies that formerly generated nearly 2 trillion yuan in business taxes annually, or about 80 percent of China’s business tax revenue.
Real estate and construction companies are subject to an 11 percent VAT rate, while finance and consumer services companies are subject to a rate of 6 percent.
The government has estimated that the shift to VAT will reduce the tax on newly included sectors by a combined 500 billion yuan this year, though the impact on a single company will vary depending on how much tax deduction it can get from purchases.
In the past four years, 640 billion yuan has been cut from taxes due to VAT reform, according to the State Administration of Taxation.
Because of the size and complexity of the last four industries, the extension of VAT missed its original deadline by about five months.
Premier Li Keqiang, in a March meeting of the State Council, China’s cabinet, ordered full implementation of VAT to be completed no later than May 1.
With that deadline met, regulators are now mending loopholes in the regulations and working with companies to apply the rules to actual operations.
“The VAT system for each company is very detailed and complex, requiring careful data input and classification,” said Robert Li, an indirect tax partner with PricewaterhouseCoopers. “Regulations are usually broad and vague in the early days of implementation, and from past experience, it requires intensive communication lasting months or years between companies and the regulator to improve VAT rules.”
For example, are food delivery services offered by hotels and restaurants a sales activity or a form of catering?
If considered a sales activity, revenue from food delivery would be subject to 17 percent VAT rate, compared with a 6 percent rate applied for food consumed within a restaurant.
The finance industry, including banking, insurance and funds sector, is grappling with the new system.
Banks cannot claim a tax deduction for the interest they pay, but it is still uncertain whether interbank lending is subject to taxation.
Insurance companies are working with the insurance regulator and tax authorities to determine how the rules apply to revenue and fees from reinsurance businesses. The fund management industry has issues to clarify related to dividends, ownership of assets and classification of handling fees that may occur in a single transaction but are often paid to various parties.
“One reason for the exceptional complexity we have in the VAT system is the many levels of VAT rates applied to different operations,” said Li. “We have more rates in China than in most countries using VAT. We will be happy one day if tax rates are simplified, but that will take a long time to realize.”
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