By Dezan Shira & Associates
China’s value-added tax (VAT) reform, which replaces business tax (BT), began May 1 and will be expanded to include the real estate/construction, finance, and life services sectors.
The reform could fundamentally alter the accounting systems of small and medium enterprises in China, and should reduce companies’ tax burdens by eliminating duplicate taxation from the current coexistence of the BT and VAT systems.
Life services, which is vague in scope and definition, is one of many industries heavily affected by the reform. Life services will receive substantial tax benefits during the transition period to VAT.The notice explicitly clarifies that the life services industry covers various services that satisfy day-to-day living needs of urban and rural residents, including:
- Cultural and sports services Cultural services are services provided to satisfy cultural needs, such as literature, arts, culture, ancient heritage, religion, and sightseeing. Sports services are business activities of organizing and hosting competitions, activities, training, and management pertaining to sports.
- Education and medical services Education services are business activities providing academic and non-academic education services, and educational support services. Medical services are the provision of services in medical examination, diagnosis, treatment, rehabilitation, prevention, healthcare, midwifery, family planning, and vaccination services, as well as provision of drugs, medical materials and appliances, ambulances, ward accommodation, and meals in relation to these services.
- Tourism and entertainment services Tourism services are the business activities of organizing and arranging transportation, tour accommodation, food and beverage, shopping, and entertainment. Entertainment services are the business of providing premises and services concurrently for entertainment activities.
- Food and beverage and accommodation services Food and beverage services supply consumption services for consumers through production of food and beverages and provision of premises. Accommodation services provide accommodation premises and support services, including hotels, motels, hostels, and resorts.
- Resident day-to-day services Resident day-to-day services satisfy the day-to-day living needs of residents and their families, including services such as funeral services, nursery care services, and spa and bathhouse services.
BT program vs. VAT program
Under the current BT program, most services are subject to a 5 percent tax rate, whereas under the new VAT program, general VAT taxpayers are subject to a 6 percent tax rate. For small-scale taxpayers, a 3 percent VAT levy rate applies. While the new VAT rates relieve a huge tax burden on small-scale taxpayers, they might place additional stress upon general VAT taxpayers.
There are two methods of VAT calculation: general and simplified. Generally, the former applies to general taxpayers and the latter applies to small-scale taxpayers. Here are two examples of how the new rates affect former BT taxpayers depending on annual income and taxpayer status:
Example 1: Restaurant A is a business taxpayer with an annual income of RMB 500,000 (BT payable = RMB 500,000 × 5% = RMB 25,000). After the VAT reform, Restaurant A will become a small-scale taxpayer, and is thus subject to the 3percent VAT rate and a simplified tax calculation method:
VAT payable = RMB 500,000 × 3% = RMB 15,000
Example 2: Company B’s annual taxable income (RMB 10 million) exceeds the ceiling for small-scale taxpayers and therefore is a general VAT taxpayer. Company B’s taxes are calculated with the general calculation method and result in a larger tax payments. The comparison of their tax amount payable is listed below:
BT payable = RMB 10 million × 5% = RMB 500,000
VAT payable = (RMB 10 million ÷ (1+6%) x 6%) = RMB 566,037
Note: assuming that there is no deduction to the input VAT amount
Exceptions and VAT-exempted Services
As part of the Chinese government’s policy to boost its service sector, certain life services will be exempt from VAT payment within the transition period. These include:
- Child daycare services
- Nursery care services
- Retirement services
- Disability welfare institutions
- Services provided by disabled persons
- Matchmaking services
- Funeral services
- Medical services
- Academic and educational services
- Services provided by student work-study programs
- Income derived from housekeeping services by personnel of a housekeeping services enterprise.
Although it introduces some tax reductions, VAT reform might impair the competitiveness of small companies. Larger companies engaged in the life services sector who that are currently BT taxpayers can issue “special VAT invoices“, but smaller companies can not. Buyers tend to prefer companies that offer these invoices because it allows them to deduct input VAT and reduce tax payments. This indicates less room for the future development of small-scale companies in the life services industry. According to the new notice, these small companies may seek help from the tax bureau to issue special VAT invoices, but the procedure and time requirements are unclear.
This article was first published on China Briefing. Since its establishment in 1992, Dezan Shira & Associates has been guiding foreign clients through Asia’s complex regulatory environment and assisting them with all aspects of legal, accounting, tax, internal control, HR, payroll and audit matters. As a full-service consultancy with operational offices across China, Hong Kong, India and emerging ASEAN, we are your reliable partner for business expansion in this region and beyond. For inquiries, please email [email protected]