China Tax/Business News Flash 

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Please click on the links below to view more:   Significant changes to export value added tax ("VAT") refund rates    On 18 June 2007, the Ministry of Finance ("MOF") and State Administration of Taxation ("SAT") jointly issued Cai Shui [2007] No.90 ("Circular 90") which introduces significant changes in China's export VAT refund rates to echo the increasing pressure and critics from major trading partners with respect to the excessive trade surplus, together with the concerns of resources preservation and environmental protection in China.   Read more...... Expand / Collapse The coverage as well as the magnitude of this round of export VAT refund rates reduction are the most remarkable comparing to those of the previous rounds.    The attached lists to Circular 90 show 2,831 types of commodities covering an extensive range of commodities which generally include: Construction materials Base metals, minerals and their products Chemical products Animal and vegetable products Garment and textile articles Electrical and mechanic appliances These commodities are those of high-energy consuming and polluting nature and/or involve low-tech and low value-adding manufacturing processes.    The magnitude of the rates reduction is not nominal.  The changes can be categorised as follows:    Category Export VAT refund rates change to A Withdrawal of export VAT refund entitlement B As low as 5% C Exemption According to the current export VAT refund policies, the VAT implication for Category B commodities is that part of the input VAT paid in the previous stage before export will become costs to the exporters who may or may not recoup the same back from the foreign buyers through price increases.  The VAT implication for Category C commodities is that the entire input VAT paid in the previous stage before export will become costs.  The exporters of Category A commodities could be facing the heaviest burden because their exports would even be subject to "deemed domestic sales" VAT treatment.  We understand that there are different assessing practices in different localities so far.    The current round of export VAT refund rates reduction will come into effect on 1 July 2007, with transition treatments for only very few industries.    Export VAT refund system    The current Chinese VAT regime entitles exporters of goods to obtain refunds of their input VAT incurred in the importation, purchase and production stages.  The amounts of refund vary partly depending on the export VAT refund rates applicable to specified types of goods.  The input VAT could be refunded fully, partially or even with no refund at all. PwC observation    This change may bring along macro implications as follows: Increase the costs of exports and in turn increase the costs of purchase of the foreign buyers (impact on sourcing); Reduce the incentives of exports by manufacturers and change more of their products to local market (impact on market focus); Affect the evaluation of setting up manufacturing bases in China by multinational businesses (impact on "World Factory" profile). China's trade surplus for the first five months of 2007 is growing tremendously without any sign of slowing down (83.1% as compared to same time last year).  It has decided to take the reduction of export VAT refund rates as a tool to rectify this situation at this stage because this would to certain extent discourage exports.  However, its effectiveness still remains to be seen.    While China moves to achieve her overall State development goals, businesses should expect and prepare that, together with other policy changes, the export VAT refund policy will continue to be used as one of the tools to steer the State's development.   Close Foreign exchange procedures for employee share plans involving overseas listed shares    The Measures for the Administration of Foreign Exchange for Individuals (Order of the People's Bank of China [2006] No.3) and its Detailed Implementation Rules (Hui Fa [2007] No.1) issued respectively in December 2006 and January 2007 have clarified, for the first time, that Chinese individuals would be allowed to participate in employee stock option plans ("ESOP") and employee stock purchase plans ("ESPP") involving overseas listed shares.  On one hand, this provides a legal basis for foreign exchange administration for ESOP and ESPP.  On the other hand, it signifies that such plans are subject to foreign exchange restriction and the approval from the State Administration of Foreign Exchange ("SAFE") and its local branches becomes mandatory.   Read more...... Expand / Collapse It is understood that with an aim to trace the inbound/outbound capital flows as a result of ESOP and ESPP involving overseas listed shares, the SAFE has established a set of "Internal Guidelines" in April 2007 which provides for the detailed procedural requirements for employers to implement such arrangements.  The most important aspects of this "Internal Guidelines" cover: ESOP and ESPP have to be approved by the SAFE at local or state levels before they can be implemented; Outbound payment for share purchase is subject to a quota subject to local SAFE's approval on an annual basis; Where applicable, onshore and offshore financial institutions have to be engaged for the custody or management of the assets under the plans (collectively called "agencies"); and ESOP and ESPP already implemented before the existence of the "Internal Guidelines" has to go through the same procedures as required within three months of the publication date of the "Internal Guidelines" (which is still unknown upon the date of this News Flash). PwC observation    It is interesting to note that although the "Internal Guidelines" has already been implemented by local SAFEs in some cities, such as Beijing and Shanghai, it is still in existence in the form "Internal Guidelines" within the SAFE and has not yet been released to public.    As such, companies interested to launch ESOP or ESPP need to approach the local SAFEs in their localities to clarify the detailed procedural requirements and apply for approval.  Meanwhile, it is uncertain whether companies that have already implemented ESOP and ESPP without SAFE approval would be penalised if they do not voluntarily report their case to the local SAFEs or go through the necessary procedures as required.  In addition, it is hard for employers, employees and those agencies to observe full compliance when requirements are still meant to be confidential and non-public information.  Such unclear situation may be due to the fact that the "Internal Guidelines" is lacking a clear set of information and clear direction, such as approval criteria of ESOP or ESPP, penalty provisions for compliance failure, etc.  It would likely take some time for the SAFE to assess the efficiency and effectiveness of this policy by going through more real-life experience. Close New development on individual income tax ("IIT") treatment on housing fund contribution for local employees in China    The MOF and SAT jointly issued a circular Cai Shui [2006] No.10 ("Circular 10") on 27 June 2006.  Among its various provisions, Circular 10 provides that if the contribution made to the housing fund by either the employer or the employee does not exceed 12% of the employee's average monthly salary in the preceding year, the contribution made by the employer may be exempt from IIT and the employee's contribution is tax deductible for IIT purpose.  Circular 10 also sets a cap such that the employee's average monthly salary in the preceding year shall not exceed 3 times the city average monthly salary in the same year.  The city average monthly salary shall be determined by the local government and may vary from year to year.  Any contribution in excess of such cap should be taxable for IIT purpose.   Read more...... Expand / Collapse Although Circular 10 was issued during middle 2006, the enforcement date varies among different localities.  For example, Guangzhou and Dalian have implemented the circular since July 2006 and Shenzhen in September 2006.  Shanghai has already implemented the circular and some district tax bureaus require retroactive IIT adjustment from June 2006 and onwards.  Beijing implemented Circular 10 by issuing a local Circular Jing Cai Shui [2006] No. 2891 ("Circular 2891") on 9 January 2007 which had not been received by most district tax bureaus until recently.   PwC observation   It is, however, unclear whether in-charge district tax bureaus in Beijing would apply Circular 10 retroactively from June 2006 or from January 2007, the issuance date of Circular 2891, and whether there would be any late payment surcharge imposed on tax underpayment (if any) in case Circular 10 would be applied retroactively.   If Circular 10 is applied retroactively, we foresee that some companies may have difficulties in recouping the under-paid tax (if any) from the resigned employees.  In light of the above, it is highly advisable that companies review the housing fund contribution arrangements for their local employees and clarify the uncertainties with their in charge tax bureaus as soon as possible. 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