China Tax/Business News Flash 

• The Amended VAT DIR provides for the scope of "fixed assets" which are eligible for creditable input VAT: "...fixed assets are referred to machinery, mechanism, transport vehicles, and other equipment, tool, apparatus, etc. in relation to the production and operation, which has a useful life of more than 12 months".  This is generally in line with the definition of fixed assets in the Corporate Income Tax Law ("CIT Law").  In other words, both VAT and CIT Law are now aligned with the China Accounting Standards in this respect.
   
• Immovable properties such as building and structure do not fall into this scope.  In addition, the Amended VAT DIR now confirms that input VAT recovery is specifically disallowed for the purchase of small motor cars, motor cycles and yachts that are subject to consumption tax and may be used for private purposes.
   
• Input VAT for fixed assets with mixed use for VATable projects, and non-VATable projects / VAT-exempt projects / collective welfare / personal consumption shall be fully creditable if the taxpayer is a General-VAT taxpayer and satisfies other administrative requirements.
   
• The detailed rules in respect of cancellation of import VAT exemption treatment for imported equipment and cancellation of VAT refund treatment of "domestically-made" equipment purchased by foreign invested enterprises have not been released.  We believe that there will be separate circulars to address this.

• The concept of using "principle business" to determine whether a taxpayer shall be subject to VAT or BT in a "mixed sale" remains unchanged.  Meanwhile, special rule for taxpayers in the construction business which was addressed in a former tax circular is now introduced into the Amended VAT DIR.
   
• For enterprises concurrently engaged in VATable and BTable businesses, the onus of separately accounting for the taxable turnover for VAT and BT still lies with the taxpayer.  The former VAT DIR provides that where the taxpayer fails to segregate the turnover for the two businesses, it could end up in the whole turnover being subject to VAT.  However, the Amended VAT DIR gives the in-charge state tax bureau the authority to deem the amount of turnover subject to VAT.
   
• Where a General-VAT taxpayer is concurrently engaged in VAT activities, and VAT exempt projects or BT-able services, then it has to identify the input VAT (including that on fixed assets) in relation to the VAT exempt projects or BT-able services which shall be non-creditable.  If the taxpayer cannot identify specifically the relevant non-creditable input VAT portion, then it shall need to apply a prescribed apportionment formula to compute a deemed non-creditable input VAT.  However, the formula in the Amended VAT DIR will change the calculation base from the "total amount of input VAT of the month" (in the former DIR) to the "amount of input VAT that cannot be correctly identified for VAT activities, and VAT exempt projects or BT-able services".  This offers a more favourable policy change on non-creditable input VAT for taxpayers.

• The threshold for a General-VAT Taxpayer is reduced from RMB 1 million to RMB 0.5 million for industrial taxpayers and from RMB 1.8 million to RMB 0.8 million for retail / trading taxpayer.
   
• This is aimed to allow more small-scale taxpayers to be qualified as General-VAT Taxpayers which may make use of creditable system for merchandises, raw materials, and fixed assets, export refunds, etc. to pass on the tax burden to the next party in the supply chain.

• The Amended VAT DIR narrows down the scope of goods suffering from abnormal losses and deletes the ambiguous term called "other abnormal losses" in the former DIR.  The purpose is obviously to avoid unnecessary disputes between taxpayers and tax bureaus.  Moreover, loss from natural disaster is also eliminated from the scope of abnormal losses.

• There is a totally unexpected change in the Amended BT DIR concerning the definition of "provision of labour services within China".  The former BT DIR provides that as far as the labour services are rendered within China, the service income shall be subject to BT, whereas the Amended BT DIR refers it to the place where the service recipient or service provider is located. In other words, where either the service recipient or service provider is located in China, then the BT will be imposed on the service income, regardless of where is the service is rendered.  As a consequence, the whole concept of determining the source of BT-able labour service income will change starting from 1 January 2009.
   
• Through our understanding from the Chinese authorities, the objective of the change is to prepare for the merging of BT regime with the VAT regime in future.  Before the merging, the Chinese authorities are considering granting BT exemption to Chinese service provider who provides services to ex-China service recipient.  Their rationale behind is that such service should be seen as export of labour service.

• The concept of "mixed sales" is similar to that of the Amended VAT DIR.
   
• Similarly, for enterprises concurrently engaged in BTable and VATable businesses, the onus of separately accounting for the taxable turnover for BT and VAT still lies with the taxpayer.  The former BT DIR also provides that where the taxpayer fails to segregate the turnover for the two businesses, it may end up in the whole turnover being subject to VAT entirely.  However, the Amended BT DIR gives the in-charge local tax bureau the authority to deem the amount of turnover subject to BT.

• It is clarified that under the "consumption-based VAT Transformation", input VAT incurred for fixed assets should firstly be treated as creditable similar to raw materials or purchased inventory, and then any specifically non-creditable items should be excluded.  More importantly, so far, it seems there may not be any special procedures to be put in place for obtaining approvals from the tax authorities before the taxpayers can utilize the input VAT for fixed assets.  This should be welcome by the General-VAT taxpayers who will have significant investments in fixed assets for their production and operation.
   
• Since the input VAT for fixed assets will become creditable for VAT purpose, companies may carry out "fixed asset study" to re-examine their expenditures on immovable properties which are non-creditable for VAT, with an aim to identify the creditable input VAT of qualified fixed assets.  In some cases, we anticipate that planning or restructuring of a turnkey (all-in-one) contract with the building / structure constructors may be worth-considering to achieve better VAT efficiency and cost savings.
   
• There are still some uncertainties in relation to the VAT regime.  For instance, it is unclear whether the input VAT incurred for fixed assets can be refunded to export enterprises upon export.  Our informal discussion with the Chinese authorities suggests that, for contract manufacturing enterprises, such input VAT can be dealt with through the "Exempt, Credit, Refund" method.  Hence, cash refund should be possible.  However, this does not apply to export toll processors as they are not subject to any VAT (their export toll processing fee is VAT exempt).  Consequently, the cancellation of the VAT exemption in respect of the import equipment for toll processing arrangement would cause negative impact to these toll processors.  We have reflected this to the Chinese authorities, and hopefully they would provide some concessionary policy in the near future in order to alleviate the negative impact, especially in recent economic downturn.
   
• The rules for determining taxable turnover under "concurrently engaging in VATable and BTable businesses" have been changed in both the Amended VAT DIR and Amended BT DIR.  Apparent, the objective is to avoid the entire turnover being subject to VAT in case of uncertainty or disputes between taxpayers and tax bureaus.  However, both the two Amended DIRs have respectively authorized the state tax bureau in charge of VAT and the local tax bureau in charge of BT to make their determination in respect of the VAT-able turnover and BT-able turnover.  We are eager to see how the two groups of tax bureaus would communicate and compromise with each other on their turnover determinations, so that no duplication and thus double taxation would arise.

The change in the definition of "provision of labour services within China" is totally beyond expectation.  The impact of the change can be depicted in the table below.

Starting from 1 January 2009, as long as the service-provider OR the service recipient is located in China, the service income shall be taxable for BT purpose, regardless the services being rendered onshore or offshore China.  On the other hand, the literal reading of the relevant article appears suggesting that the situation where both the service-provider and service-recipient are located outside China may be excluded from BT-able services.  We are following up with the Chinese authorities to clarify this position.

We anticipate that this would cause significant impact to many foreign-service providers rendering services inside and outside China, to Chinese service-recipients or non-Chinese service-recipients.  It is advisable for them to review their BT exposure arising from their services related to China as soon as possible to determine the appropriate course of actions.

Effective 1 January 2009

The three Amended DIRs provide further clarification and details for the implementation of the three Provisional Turnover Tax Regulations.  Apparently, there are still some uncertainties left to be resolved.

This is not the end of this round of Turnover Tax reform.  We understand that the MoF and SAT are in the process of clearing and updating all the previous Turnover Tax circulars in an effort to enhance policy consistency and transparency.  The volume of the previous circulars is tremendous.  We are not sure how soon the authorities can complete this work.  Taxpayers, tax practitioners, and even the local-level tax bureaus are very eager to see the progress as the implementation of the three Provisional Turnover Tax Regulations and their respective Amended DIRs will take place on 1 January 2009.