Completion of the VAT Reform's Expansion
The value-added tax ("VAT") reform has been around for several years for the purposes of transforming business tax ("BT") into VAT with respect to sales of services, intangibles, and real property, since the State Council decided to kick it off with a pilot program in Shanghai on October 26, 2011. The pilot program officially got started on January 1, 2012. The Chinese central government clearly pushed a gradual expansion of the VAT reform over the years.
On March 23, 2016, the Ministry of Finance ("MOF") and the State Administration of Taxation ("SAT") took the final step to complete such gradual expansion by jointly issuing Caishui [2016] No. 36 ("Circular 36"). Circular 36 contains several attachments with detailed new rules, including the Trial Implementation Rules (Attachment One), the Supplemental Guidelines (Attachment Two), the Transitional Rules (Attachment Three), and the Zero-Rate and Exemption Rules on Cross-Border Transactions (Attachment Four). Circular 36 will take effect on May 1, 2016.
End of Business Tax
Circular 36 effectively ends the application of BT to sales of services, intangibles, and real property. This latest and final expansion covers construction, real property, financial services, and consumer services, thus leaving no territory for BT. Consumer services include cultural services, sports, education, medical services, travel, entertainment, lodging, catering, and so on. In other words, Circular 36, which was released by the MOF and the SAT, is able to supersede both the VAT Interim Regulations and the BT Interim Regulations, which were promulgated by the State Council. From a purely legal standpoint, the legal validity of Circular 36 is at least questionable, especially because the State Council is technically a higher governmental body than the MOF and the SAT.
Scope of Application
VAT only applies to actual or deemed sales of services, intangibles, and real property within the Chinese territory. In particular, VAT will be triggered, if one of the following conditions is met:
(i) Real property leased or sold is located in China;
(ii) Natural resource, of which use right is sold, is located in China; or
(iii) Either a purchaser or a seller of services (excluding real property) and intangibles (excluding natural resource use right) is in China.
Deemed sales of services, intangibles, and real property occur, when one of the following transaction takes places:
(i) Entities or individuals perform free services to other entities or individuals, but for public interest or general public; or
(ii) Entities or individuals sell intangibles or real property to other entities or individuals without a consideration, but for public interest or general public.
On the other hand, VAT will not be triggered in the following circumstances:
(i) Services sold by foreign entities or individuals to domestic entities or individuals are solely performed outside of China;
(ii) Sold by foreign entities or individuals to domestic entities or individuals are solely used outside of China; or
(iii) Personal property leased by foreign entities or individuals to domestic entities or individuals is solely used outside of China.
Tax Rates
The VAT rates are as follows:
- 6%, by default;
- 11%, applicable to transportation, postal services, basic telecommunications, construction, lease of real property, sales of real property, and sales of land use right;
- 17%, applicable to lease of personal property;
- 0%, applicable to cross-border transactions engaged by domestic entities and individuals; and
- 3%, applicable to small scale VAT taxpayers.
Transitional Rules
Issuance of Circular 36 obviously creates huge transitional problems for both taxpayers and tax bureaus. First, to the extent that taxpayers were previously entitled to BT exemptions or benefits, Circular 36 largely continues such exemptions or benefits under the VAT system. Second, for services or projects entered into before May 1, 2016, Circular 36 selectively grants transitional treatment. For instance, sales of real property acquired or built by general taxpayers prior to April 30, 2016 are still subject to VAT at a 5% rate. Given a lack of uniformity of the transitional treatment, however, Circular 36's impact on each individual sector or industry is worth of in-depth review on the case-by-case basis.
Our Observations
Circular 36 is clearly a great leap in the right direction. The essence of Circular 36 is to complete a years-long progress in replacing BT by VAT. The overall effect of Circular 36 would likely reduce tax burden of taxpayers involved, though this is not necessarily true to each single taxpayer. Further, allowance of input credits is expected to boost various industries of services, especially cross-border services.
On the other hand, it is unfortunate that neither the National People's Congress nor the State Council directly step into to complete this final and full expansion of the VAT reform from a rule of law perspective. Besides, as Circular 36 fails to contain even one single example illustration, the rule-making capability of the MOF and the SAT once again appears to be limited and primitive at best.
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