SHANGHAI VAT PILOT PROGRAM

From 1 January 2012 qualified businesses in Shanghai will be required to charge VAT following approval by the local tax bureau;
Input VAT is creditable both for qualified pilot participants and their customers;
Generally, the program follows existing VAT mechanisms;
Two new VAT rates will be introduced, 6% and 11%, adding to the existing rates of 13% and 17%;
Treatment of exports is yet to be determined but likely 0% or tax exempt;
The first VAT return is due on 15 February 2012;
Companies should now prepare for compliance burdens.

Background

China’s State Council has approved a VAT reform pilot program to be conducted in Shanghai from January 1, 2012. The aim of the pilot is to replace Business Tax (BT) with Value Added Tax (VAT) for some businesses within Shanghai Municipality operating within designated service sectors.

The program is designed to eliminate the inefficiencies of the dual BT and VAT systems for business in China and is the first step in sweeping reform of China’s indirect tax system announced in the most recent five year plan. As BT is not a creditable tax, it is a cost that accumulates through the supply chain. Under the VAT system, VAT incurred by businesses along the supply chain can be credited as input VAT.

It is expected that the Shanghai pilot will provide the model for similar reforms to be rolled out across China in the near future. While there will be an adjustment period, we believe these reforms are overdue and recommend that you contact your SJ Grand advisor to discuss how the new measures will impact your business.

Local tax bureaus in China are currently contacting eligible businesses in Shanghai (including Shanghai branches of firms with headquarters in other cities) to notify them of the need to comply with the pilot program.

What are the relevant notices that outline the program?

Caishui [2011] No. 110 (Circular 110)) Notice for the Introduction of the Pilot Scheme to Convert Business Tax to VAT
Caishui [2011] No. 111 (Circular 111)) Notice for Converting from Business Tax to VAT in the Transportation Industry and Certain Modern Service Sectors in Shanghai
Circular 111 Appendix 1: Measures for Implementation of Converting Business Tax to VAT in the Transportation Industry and Certain Modern Service Sectors (Implementation Measures)
Circular 111 Appendix 2: Regulations on Relevant Issues for Converting Business Tax to VAT in the Transportation Industry and Certain Modern Service Sectors (Relevant Issues)
Circular 111 Appendix 3: Regulations for the Transitional Policy for Converting Business Tax to VAT in the Transportation Industry and Certain Modern Service Sectors (Transition Rules)

Pilot Program VAT Rates and Taxpayers

Two classes of VAT taxpayer exist under the pilot program:

General Tax Payer (GTP)	Tax payers providing VAT pilot services with annual turnover of RMB 5m and above; or tax payers providing VAT pilot services with annual turnover of less than RMB 5m but which voluntarily apply for GTP status.
Small Tax Payer (STP)	Tax payers providing VAT pilot services with annual turnover of less than RMB 5m

GTP Threshold Increase

Companies should note that the minimum annual sales revenue that requires compulsory VAT registration has been raised under the pilot program from its current levels of RMB 800,000 for trading companies or RMB 500,000 for manufacturing to a new threshold of RMB 5 million. This move is a positive step in reducing compliance issues and tax burden for smaller companies as most will be classified as STP.

What services are included in the program?

The following categories provide an overview of the services subject to the scheme and their corresponding rates. These categories describe only the broad overview. We recommend careful analysis of your business scope and discussion with your tax officer as the rules in Circular 111 provide more detailed definition of each service category:

General Tax Payer (GTP)	17%	Leasing (including operating and finance leasing) of moveable and tangible goods;
	11%	Transportation services: involving cargo or passengers by land (except by rail), water, air and pipeline;
	6%	Logistics and ancillary services; R&D and technology services: including technology transfers, technology consulting, feasibility studies, exploration services. 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: design, copyright and trademark transfers, services related to intellectual property rights, advertising, conference and exhibition services; Certification and consulting services, including accounting and legal services.
Small Tax Payer (STP)	3%	All VAT pilot program services

Are my services conducted “in Shanghai” for the purposes of the program?

In simplest interpretation, the place of supply for VAT pilot program purposes is determined with the same rules as the BT place of supply.

Supplier (Pilot Industry)	Customer	Applicable Tax	Input VAT recoverable?
Shanghai	Shanghai	VAT	Yes
Shanghai	Rest of China	VAT	Yes, if customer is GTP
Rest of China	Shanghai	BT	N/A
Rest of China	Rest of China	BT	N/A
Outside China	Shanghai	VAT (withholding)	Yes

VAT on Exports

Circular 110 outlines that services covered under the pilot provided to an overseas customer are without VAT but do not clarify whether these will be charged at 0% or are tax exempt. The difference will impact business as a 0% rate will mean that input VAT on costs associated with the transaction will be recoverable. We will monitor announcements for further clarification of this issue.

How are BT/VAT calculated?

For information purposes only

Item	Business tax		Small tax payer		General tax payer
Item	Calculation	Example	Calculation	Example	Calculation	Example
Revenue inc. tax	A	10000	A	10000	A	10000
Tax rate	B	5%	B	3%	B	6%
Tax to be paid	C=A*B	500	C=A/(1+B)*B	291.26	C=A/(1+B)*B	566.04
Net revenue	D=A-C	9500	D=A-C	9708.74	D=A-C	9433.96
Purchase with VAT	E	90	E	90	E	90
Input VAT rate	F	17%	F	17%	F	17%
Deductible VAT	G		G		G=E/(1+F)*F	13.08
Cost of purchase	H=E-G	90	H=E-G	90	H=E-G	76.92
CIT rate	I	25%	I	25%	I	25%
CIT to be paid	J=(D-H)*I	2352.5	J=(D-H)*I	2404.685	J=(D-H)*I	2339.26
Net profit after CIT	K=D-H-J	7057.5	K=D-H-J	7214.055	K=D-H-J	7017.78

TRANSITIONAL RULES

The rules also clarify some of the issues that will arise during the transitional period, including:

Input VAT outstanding as at 31 December cannot be offset against output VAT generated from services covered by the pilot program
Businesses currently registered as GTP do not need to register again for services now covered under the Shanghai pilot program
Leases entered into prior to 1st January 2012 will continue in the BT system until their completion date unless renegotiated.

OUR RECOMMENDATIONS

Eligible Shanghai companies:

Determine your applicable rate and filing procedure
Conduct an impact study to locate any input credits that are available for your company, customers or suppliers
Assess the price implications for your business and whether you can pass on any VAT cost
Consider the operational impact on your accounting software and ERP
Look at existing contracts and asses the need to adjust or renegotiate
Begin staff training for implementation

For those companies changing to GTP status:

You are required to attend tax bureau for input VAT verifications within 180 days from the input VAT fapiao issuing date
You will need to purchase VAT fapiao issuance equipment (see below) and attend issuance training;
Your staff will need to carefully assess which input fapiao can be offset against output VAT
Currently, the tax bureau does not require documentary evidence to prove the provision of services falls under the pilot program categories. However, businesses are required to submit an application that addresses their scope of services. Your management team and accountant should carefully evaluate their business scope during this process.
Note that STP businesses that voluntarily change to GTP status are not permitted to change back to STP

VAT invoicing

Eligible businesses must record VAT transactions and issue invoices through the so-called “Golden Tax” System, which consists of software and printers obtained from the tax bureau. Through this system, the tax bureau monitors and cross-checks VAT transactions and credits for fraud.
Input VAT claims must also be processed through this system. VAT invoices must be verified by the tax bureau for approval before any offset. Businesses are advised to implement rigorous procedures for the handling of VAT invoices as lost or damaged invoices can delay or prevent VAT input claims.

Non-Shanghai companies:

Companies that are not currently affected by the Shanghai program should consider that it is likely that similar reforms will be rolled out across China in the near future. We advise that while reviewing the impact on your existing relationships with Shanghai-based suppliers and customers, you also analyze the future impact of similar reforms on your tax jurisdiction. In addition:

Identify any changes to the status of any key customers or suppliers in Shanghai
Review all contracts for VAT implications
Conduct analysis on increased/reduced VAT costs
Consider changing suppliers to those with lower VAT costs
Discuss the changes with your tax advisor or agent
Monitor government announcements for changes to the Shanghai program or expansions to other jurisdictions

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