China’s Ministry of Finance (MoF) and State Administration of Taxation (SAT) have released an update to the VAT reforms under the Shanghai pilot program. The announcement clarifies issues regarding the application of “zero VAT rate” and “VAT exemption”.

According to the guidance—Cai Shui [2011] No. 131 issued on Dec 20, 2011,the following VAT applicable services provided in pilot areas are subject to the zero VAT rate:

• International transport services (including cross-border and overseas transport of both passengers and cargo);
• Research and development services provided for overseas entities;
• Design services provided for overseas entities (excluding design services provided for domestic immovable property).

Notably, Circular No. 131 stated that only pilot enterprises and individuals that have obtained operation licenses will be eligible for zero rate preferential treatment.

Further, the zero VAT rate is applied on different types of taxpayers by different means. For taxpayers that employ the general tax payer VAT calculation method (GTP), allowing deduction of input VAT from output VAT, the zero VAT rate is implemented through the “exemption, deduction and refund” method, with the tax rebate rate the same as applicable to VAT rates stipulated in the “Implementation Details of VAT Reform in Transport Services and Certain Modern Services (Cai Shui [2011] No. 111).”

For taxpayers that employ the small tax payer VAT calculation method (STP), which does not allow the deduction of input VAT from output VAT, VAT exemption applies.

Both types of taxpayers mentioned above shall be required to conduct the tax exemption, deduction and refund procedures with the tax authorities in charge of tax rebates on a monthly basis.

Further, logistic auxiliary services (other than warehousing services), that are not provided by Pilot Enterprises and Individual to foreign entities, will be VAT exempt. Warehousing services rendered outside China will also be VAT which is better than the existing BT regime, which covers only international transportation services and not logistics auxiliary services.

Since the treatment under zero rated VAT provides greater potential rebate benefits than VAT exemption, eligible Pilot Enterprises and Individuals should ensure they have obtained the required qualifications and licenses for GTP status in order to apply and enjoy the zero rated treatment.

In summary, the VAT pilot program circulars provide for more favorable treatment for international transportation industry and export of services than provided under the current business tax system. It is hoped the latest circular will help improve the competitiveness of the Chinese pilot enterprises and individuals in the international market by bringing China’s VAT regime for these relevant industries at par with the international best practices.