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Taxing times for China's tax reformers

China Daily

Publication Date : 20-08-2012


Changes in VAT will benefit some companies but hurt others: Experts

It has been quite a busy month for Su Chenhui, financial manager at LabCorp Clinical Trials, but more challenges seem to lie in the months ahead.

To prepare his company for the value-added tax (VAT) reform that will become effective on Sept. 1, Su has been sent to two training sessions organised by the local tax bureau and his tax adviser.

What Su has learned was that there might be more paperwork to deal with, tougher supervision from authorities and the possibility of renegotiating contracts with clients of his company, a Beijing-based US medical test service provider.

Fortunately, however, all the hard work will pay off once his company adopts VAT instead of business tax.

"Under the new system, the company will be eligible for a deduction of 17 per cent VAT in our material costs, mainly reagent in our case, which accounted for about 40 per cent of our revenue.

"That will translate to a saving in taxation equivalent to 6.8 per cent of our revenue, which is even more than the 6 per cent VAT we are required to pay," Su said.

LabCorp's case is not unique, as the policy will also benefit 138,000 other corporate taxpayers in modern-service and transportation sectors that will be involved in the tax reform in the capital city.

Instead of paying business tax on all transactions in the industrial chain, modern service providers will pay 6 per cent VAT. Transporters will be charged 11 per cent VAT. Both levies are deductible with the input tax receipt from their suppliers.

According to a statement from the local tax authorities, the programme is expected to save Beijing's businesses 16.5 billion yuan (US$2.6 billion) a year.

"As for our company, it is reflected in a lower break-even point," Su said.

"We would have to achieve at least 24 million yuan annual sales before starting to make profits if still paying business tax but, under VAT, the company could start making money at 20 million yuan sales."

Backed by the favourable conditions, LabCorp Clinical Trials Beijing is expecting a 15 per cent growth in annual revenue, according to the financial manager.

This is exactly the result policy makers want to see when they pushed forward VAT reform in the first place. Later it will be expanded across eight other provinces.

Booster of confidence

Business tax applies to a production process, with the tax rates varying from 3 to 15 per cent according to different sectors, while VAT is deduced from the difference between a commodity's price before taxes and its cost of production.

VAT and business tax together accounted for more than 50 per cent of China's tax revenue in 2011.

Following Beijing on Sept. 1, VAT will be further applied to the transport sector and some modern service industries, replacing business tax, in the provinces of Jiangsu and Anhui on Oct. 1, Fujian and Guangdong on Nov. 1 and Tianjin, Zhejiang, and Hubei on Dec. 1.

The ambitious expansion was based on the positive results seen in the trial programme that started in Shanghai on Jan. 1.

A total of 135,000 enterprises had been included in the programme and a tax reduction of about 4.4 billion yuan was recorded during the first half, according to the city's taxation authorities.

Jiang Zhuoqing, director of the Finance Bureau of Shanghai, said 90,000 small enterprises in the city, which is 66.5 per cent of the pilot taxpayers, enjoyed tax cuts of around 40 per cent.

"At a time of an intensifying economic downturn, the tax reform has forcefully promoted the healthy development of small and micro businesses," Jiang said.

"The structural tax cut is a major part of the proactive fiscal policies promised to relieve the increasing downturn pressure facing the Chinese economy," said Zhang Bin, a director of the tax research department with the National Academy of Economic Strategy at the Chinese Academy of Social Sciences.

A series of measures adopted by Chinese authorities seems to have had little positive effect on the world's second largest economy, which was expanding at its slowest pace in three years in the second quarter at 7.6 per cent.

Amid a declining marginal effect of easing monetary policies, as well as concerns of a possible rebound in inflation and especially housing prices, experts are calling for more in-depth solutions to revitalise the economy, and many appeals have been made for tax cuts to play a major role.

Gao Peiyong, head of the Finance and Trade Economics Institute under the Chinese Academy of Social Sciences, predicted China has the room for a maximum of 600 billion yuan in tax cuts this year.

According to a calculation by the Research and Development Centre affiliated to the Shanghai municipal government, the municipality's total tax revenue would decline 10 billion yuan in 2012 because of the pilot programme, which is equivalent to 3 per cent of the local government's total tax revenue.

In the Shanghai pilot programme, the reform brought down the tax burden for 75 per cent of IT and financial service companies and 80 per cent of taxpayers in creative industries, said Xiao Jie, minister of the State Administration of Taxation, at a forum in Guangzhou.

Moreover, "the reform could lead to a reduction in tax revenue of more than 100 billion yuan once expanded nationwide," he added.

To that end, the tax cut could help fuel the country's GDP growth by 0.5 per cent, increase service sector output by 0.3 per cent, raise domestic consumption by 1 per cent and create 700,000 new jobs, said the minister.

Meanwhile, the VAT pilot programme will provide a timely boost to China's exporters, who are struggling amid sluggish demand from overseas and rising costs domestically, said Lachlan Wolfers, a tax partner at KPMG China.

The VAT pilot programme benefits exporters in two main ways. First, services provided to overseas entities will typically qualify for exemption from VAT, which compares favourably with the previous position where 5 per cent business tax was payable, Wolfers said.

"This is consistent with the central government's strategy to promote the development of the service industry in China and to make it more internationally competitive.

"Businesses in the consulting, IT and logistics sectors are major beneficiaries of this change, which also serves to encourage the development of outsourced service centres in China," he said.

Second, manufacturers based in China who export goods to overseas will now be eligible to claim VAT credits for the services they purchase as inputs to their business.

"Previously, 5 per cent of business tax was usually payable on those services. This reduces costs for the export industry, which is particularly welcome given current levels of global economic uncertainty," Wolfers said.

Challenges ahead

"The planned expansion of the VAT pilot reform to 10 provinces, autonomous regions and municipalities suggested that the authorities are expecting the VAT reform to be completed by 2015," said Kenneth Leung, a partner of Tax & Business Advisory Services at Ernst & Young.

"However, some of the regions may not be ready for the reform, thus a rush out may lead to chaos," Leung said.

Meanwhile, the expansion still has to deal with issues such as some sectors complaining of a heavier tax burden even when authorities face declining tax revenues.

A survey of 65 logistic companies by the China Federation of Logistics & Purchasing has shown results that are not so promising.

For transportation companies, the average tax burden was twice as much as before under the pilot reform because the tax rate was raised to 11 per cent from the previous 3 per cent and there weren't many items eligible for deduction.

One out every 12 companies came from the transportation sector, while companies in cultural and creative industries accounted for nearly a quarter of the total. One fifth were technology innovators and service providers.

Two-thirds of the logistics companies involved in the VAT reform have seen their tax rising by an average of 50,000 yuan, according to the federation.

"Authorities need to work more on these problems found in the Shanghai pilot. A rushed expansion of the pilot will cause shocks," the federation stated.

Meanwhile, what is beneficial for Shanghai businesses might cause a crisis for companies in surrounding areas.

"The pilot preferential policies in one region will pose a 'depression effect' drawing in capital from surrounding areas, which is de facto discrimination against outsider companies," said Sun Gang, a researcher with the fiscal science research centre affiliated to the Ministry of Finance.

Besides geographical expansion, China may select certain industries to roll out VAT reform nationwide in 2013, Leung said. Such industries include transportation, building installation and post and telecommunications, he said.

Transportation is likely to take the lead as the first sector in the reform to see the application of VAT nationally, according to Wolfers of KPMG China.

Although the scope of the reform is expected to extend across the country, tax reform in certain sectors such as finance and property seems unlikely in the short term, according to Alan Wu, China indirect tax leader with PricewaterhouseCoopers.

The reform may not spread to the central and western areas of China either at present because the number of businesses in service sectors is not big enough to make a big difference.

The biggest difficulty for the tax reform, experts say, is that it touches on the country's fiscal system.

Under China's current tax regime, VAT is collected by the State taxation authorities, with 75 per cent going to the State coffers and the rest to local governments. Revenues from business tax belong to local governments and account for more than one-third of local government incomes.

In Shanghai, the national and local taxation authorities are one and the same, which means that the pilot programme would not face many institutional problems.

However, the expansion of the reform will inevitably force the repositioning of the local taxation departments in the governments of the involved cities and provinces.

In the tax reform in Beijing, local tax authorities get to retain all the new VAT revenues, but Wolfers said authorities still need to work out a plan for the long term if the reform is implemented in more provinces and sectors.

Beijing municipality's fiscal revenue, for example, grew 5.3 per cent year-on-year in the first half, which is far below the 10 per cent annual target set for this year.

Slower growth in fiscal revenue is sparking concerns that the cash-starved authorities may impose tougher enforcement during tax collection, resulting in a rise in the burden for taxpayers.

Bai Jingming, deputy director of the fiscal science research centre with the Ministry of Finance, said that with the expansion of the tax reform, the country will see a reduction of its tax revenue for the time being and, in the long run, it will promote the development of related industries, which will lay a solid foundation for the country's taxation system.

US$1 = 6.3 Chinese yuan


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