Highlights of Notice for Converting from Business Tax to VAT in the Transportation Industry and Certain Modern Service Sectors in Shanghai

On 16 November 2011, the Chinese Ministry of Finance and the State Administration of Taxation (SAT) jointly issued Caishui [2011] No. 110 (Circular 110) and Caishui [2011] No. 111 (Circular) which set out the details of the Shanghai VAT pilot scheme. Circular 110 contains the general framework of the VAT pilot scheme while Circular 111 set out the detailed implementation rules that are specifically applicable to Shanghai. The main content of Circular 111 and it appendices are highlighted below.

Highlights of Circular 111 - Notice for Converting from Business Tax to VAT in the Transportation Industry and Certain Modern Service Sectors in Shanghai

Circular 111 sets out detailed implementation rules for the initial pilot in Shanghai and these rules generally follow the principles set out in Circular 110. Some of the principles in Circular 110 (such as the taxing method for construction, telecommunication, financial and insurance services) will not be implemented in the initial pilot in Shanghai, but may be implemented at a later stage.

Circular 111 addresses the Shanghai pilot ?specifically, the application of VAT in the transport and certain modern services sectors. The appendices primarily provide details on three main topics: the scope and application of VAT, the right to deduct input VAT and preservation of the current BT incentives. Circular 111 is drafted to follow the current VAT rules, so the mechanisms for an input VAT credit or simplified taxing method, the point of taxation, classification of taxpayers and administrative measures, remain unchanged.

Appendix 1 ?Implementation measures

This Appendix aims to clarify the scope of the charge to VAT. The Implementation Measures are applicable to entities and individuals located in the pilot region (i.e. Shanghai) and foreign entities and individuals that provide taxable services to entities and individuals located in the pilot region. The Implementation Measures address the relevant issues within eight chapters, including the definition of taxpayers and withholding agents, the definition of VAT taxable services, applicable tax rates, calculation of VAT liabilities, the point of tax and location of the tax payment, tax reduction and exemption, tax collection and administration and supplementary articles.

Scope of service sectors selected for the pilot program

• Transportation services involving cargo or passengers, including transportation by land (excluding railway transportation), water, air and pipeline;
• R&D and technology services, such as transfers of technology and technology consulting;
  Information and technology services, including software related services, circuit design and testing services, IT system services and process and procedure management services;
• Creative cultural services, including design, transfers of copyrights and trademarks, services related to intellectual property rights, advertising, and conference and exhibition services;
• Logistics and ancillary services;
• Leasing (including operating and finance leasing) of moveable and tangible goods; and
• Attestation and consulting services.

An attachment to Appendix 1, referred to as “Annotations to the VAT Items,?provides detailed explanations of the scope of each service category.

Treatment of provision and receipt of services within and outside China

• If either the service provider or the service recipient is located in China, the provision of the relevant services will be considered to be provided in China and, thus, subject to VAT. The following services, however, will not be deemed to be provided in China, so no VAT will be due:
• The provision of the relevant services by overseas companies or individuals to Chinese companies or individuals and the services are used entirely outside China;
• The leasing of moveable and tangible goods by overseas companies or individuals to Chinese companies or individuals and the goods are used entirely outside China; and
• Other situations as stipulated by the MOF and the SAT.

Services within the scope of VAT

The provision of transportation and certain modern services free of charge, except those provided for the benefit of public welfare, will fall within the scope of VAT, as will other situations stipulated by the MOF and the SAT.

Applicable VAT rates

The following VAT rates will apply:

• Leasing of moveable and tangible goods: 17%
• Transportation services: 11%
• Certain modern service sectors (excluding the leasing of moveable and tangible goods): 6%
• Other taxable services stipulated by the MOF and the SAT: 0%
• VAT levying rate used under the simplified taxing method: 3% (as is currently the case).

Input VAT

• The input VAT that can be recovered is as follows:
• Input VAT amount stated on the special VAT invoice;
• Import VAT amount stated on the Import VAT Payment Certificate issued by Customs;
• 13% on the purchase voucher for agricultural products;
• The recipient of transportation services can deduct input VAT based on the special VAT invoice obtained for transportation services purchased. In cases where no VAT special invoice is obtained, the recipient of the services can claim an input VAT deduction at the deduction rate of 7% based on the transportation fee specified in the transportation fee receipt;
• Where services are provided by overseas entities or individuals and received in China, the VAT withheld by the recipient in Shanghai will be eligible for recovery if supported by a tax payment clearance certificate. Written contracts, payment certificates and debit notes, or invoices issued by the overseas entities must be provided to support the claim.

Appendix 2 ?Relevant issues

Appendix 2 aims to clarify certain issues with regard to pilot taxpayers, withholding agents and current VAT payers.

Right to deduct payments to non-pilot companies

• For industries that are allowed to be taxed on a net income basis under the current BT rules, if the taxpayer under the pilot program makes a payment to a non-pilot company that qualified for deduction under current BT rules, in calculating the VAT output for the taxpayer, the payment still could be deducted from the income for VAT purpose to achieve consistent treatment.

Clarification of right to deduct for current general VAT payers

• Input VAT incurred for VAT taxable services provided by taxpayers in the pilot program is creditable. The creditable amount is the input VAT amount shown on the special VAT invoice.
• Input VAT incurred for transportation services provided by small-scale taxpayers in the pilot program is creditable (7% on the invoice amount).
• Input VAT incurred for VAT taxable services provided by overseas suppliers is recoverable by current VAT payers participating in the pilot region. The creditable amount is the input VAT amount shown on the tax payment certificate.
• Input VAT that is not eligible for deduction includes the receipt of passenger transportation services, transportation services related to purchased goods, works-in-progress and finished goods that are in an abnormal loss situation.
• Transportation fee settlement receipts issued in Shanghai on and after 1 January 2012 cannot be used to claim an input VAT credit because a special VAT invoice must be issued for the provision of transportation services in Shanghai.
• Input VAT incurred through 31 December 2011 that is associated with the original VAT taxable activities cannot be credited against the output VAT associated with new taxable services after 1 January 2012.

VAT registration threshold for the pilot

• The annual service revenue threshold for general VAT payers is CNY 5 million (inclusive).
• Small-scale VAT payers that have sound accounting systems and are able to provide accurate documentation for tax filing purposes can apply for general VAT payer status even if their sales revenue does not reach CNY 5 million; this is consistent with current VAT rules.
• It will not be necessary to reapply for recognition of general VAT payer status if a current general VAT payer also engages in VAT taxable services and meets the CNY 5 million threshold.
• General VAT payers may not convert to small-scale taxpayer status unless so stipulated by the SAT.

Appendix 3 ?Transitional rules

Appendix 3 mainly aims to provide VAT incentives, by introducing a VAT exemption or VAT collection with an immediate refund mechanism, to preserve the BT incentives currently enjoyed on certain services.

Exemption from VAT

• Technology transfers, technology development and related technology consulting and technical services provided by taxpayers in the pilot program;
• Qualified offshore outsourcing services provided by companies established in Shanghai during the period 1 January 2012 to 31 December 2013; and
• Ship inspection services provided by the Shipping Classification Society, direct flights between Taiwan and the Mainland and other miscellaneous items.

VAT collection with an immediate refund

• Domestic cargo transportation services, warehousing services and loading and unloading services provided by taxpayers in the pilot program and registered in the Yangshan Free Trade Port Area;
• Taxpayers that hire a specified number of handicapped persons and provide VAT taxable services;
• Pilot general VAT payers that provide pipeline transportation services (eligible for a VAT refund in excess of 3% of their actual VAT burden); and
• Authorized finance leasing companies included in the pilot program (eligible for a VAT refund in excess of 3% of their actual tax burden for the provision of finance leasing services of moveable and tangible goods).