China’s rise as an economic superpower is undeniable, and the opportunities this presents for companies to compete in the world’s most populous market are well documented. Entering or expanding business operations in China creates new challenges, whether the plan involves setting up regional headquarters, opening new research and development (R&D) centers, adopting tax-efficient supply chains, or evolving the business presence from a representative office to a Chinese legal entity. China’s tax environment is similarly challenging, with rules that may seem opaque, rapidly changing, or implemented differently from province to province. The evolution of China’s tax environment, however, is less documented.
Historically, tax regulations in China have been more general in application than in many Western countries. While regulations are supplemented by a significant amount of interpretive material, such as Circulars, this guidance can still leave broad discretion to tax administrators. As a result, businesses often encounter obstacles in achieving desired levels of certainty, consistency and effective risk management in applying tax regulations to relatively routine transactions.
China’s VAT reform pilot program
The Chinese government has recently commenced one of the most ambitious reform programs in recent history. The reforms seek to replace the Business Tax (BT), which was historically paid by the services sector, with a VAT on both the goods and services sectors. The pilot program’s first stage commenced in Shanghai on 1 January 2012 for the transportation, asset leasing and modern services sectors, and then expanded to several other major commercial centers throughout mainland China. The next stage, expected to be implemented over the next 18 months or so, should see VAT replace BT for the telecommunications, construction, real estate, financial services, insurance and entertainment services industries. These changes, which aim to promote the development of China’s services sector as part of the government’s 12th Five-Year Plan, have significant ramifications for multinational companies doing business in or with China. Put simply, the reforms modernize and apply global best practices of the VAT systems now operational in over 150 countries across the world.
While China’s VAT reforms are welcome, the short timeframes for implementation of just 6 weeks in Shanghai and 4 weeks in Beijing proved challenging. Local tax authorities and business have faced complexities arising from multiple VAT rates, strict invoicing processes and the interaction of VAT and BT in different cities and provinces during the transition.
Following the VAT reforms, there is significant potential for errors and anomalies as the new rules are tested, systems changes are implemented, interpretative differences and administrative variations are resolved, and compliance errors are overcome. Companies undergoing the transition from BT to VAT should consider undertaking a 'health check' to identify and correct errors before they are replicated across China as the reforms expand to other cities and provinces and to new services industries.
With the aim of improving and modernizing taxpayer services, China is seeking to align tax authority interpretations by improving consistency across regions and encouraging businesses to enhance their levels of voluntary compliance. One such initiative is a proposal by the State Administration of Taxation (SAT) to introduce a system of advance rulings for enterprise taxpayers in China. Apart from China’s existing advance pricing arrangement (APA) program, taxpayers in China currently have no way to achieve the certainty that advance tax rulings can provide. The system of binding public rulings now being considered would greatly improve the uniformity of tax law interpretation across the different tax authorities in China. In addition, to promote collaboration and consistency among tax authorities and other government departments, the SAT is encouraging joint audits by state and local tax bureaus and more cooperation between tax collection and administrative departments. The SAT is also encouraging interaction with other government branches, such as those responsible for public security, customs and financial institutions.
While the SAT is making good progress in its endeavors to improve China’s tax environment, new policies and procedures will take time to be fully implemented. Given the fast-paced evolution of China’s business and regulatory environment, local variations are likely to remain for the foreseeable future.
- plan ahead
- be aware of local differences
- make sure your arrangements are sound and well documented
- monitor and adapt as tax authorities evolve
- seek local knowledge, supported by a global network
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