Value Added Tax ("VAT") reform in China has been the topic of discussion for several years. The existing indirect tax system makes a distinction between the supply of goods and the provision of certain services. VAT is applied at the standard rate of 17% to the sale of goods in China, the provision of repair, processing and replacement services, and the importation of goods into China. It taxes the ’value added’ by allowing business taxpayers a credit for the tax embedded throughout the supply chain. On the other hand, Business Tax ("BT") is levied on services and transfer of intangibles and real property. Rates range from 3% to 5 % (with a maximum 20% rate applying to the entertainment industry). BT incurred by suppliers in the supply chain is not recoverable for the taxpayers. In some cases both VAT and BT may be levied, which would create double tax situations.
The Chinese State Council announced that it will launch the much-anticipated pilot VAT reform program on January 1 2012. The grogram initially will apply to transportation and "modern service" industries in Shanghai. The government is expected to gradually expand the grogram across the nation when conditions permit. The aim of the pilot program is to resolve the double taxation issues under the prevailing system and to foster the development of specified modern service industries by gradually transitioning these industries from liability to Business Tax to liability to VAT. If implemented nationwide, the reform could lead to a drop in tax collection of about RMB400 billion a year. But the policy could help business to grow and lead to overall tax revenue increase in the long run.
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