Value-added Tax Pilot Reform in Shanghai: Clarification on the Treatment of Outbound Service Provision

Background

Subsequent to the issuance of circulars Caishui [2011]110 (“Circular 110”) and Caishui
[2011]111 (“Circular 111”) by the Ministry of Finance (“MOF”) and State Administration
of Taxation (“SAT”) for implementing the pilot Value-added Tax (“VAT”) reform in
Shanghai from January 1, 2012, MOF and SAT have recently published circular Caishui
[2011]131 (“Circular 131”).  Circular 131 clarified the VAT treatment on Chinese
enterprises’ provision of relevant services to overseas entities.

Key Points of the Circular:

•   According to Article 2.2.4 of Circular 110, outbound provision of relevant services
is subject to the zero VAT rate or is exempted from VAT.  However, according to
Articles 1 and 10 of Circular 111, Chinese enterprises and individuals providing the
relevant services “in China” are subject to VAT.  The service is regarded as being
provided “in China” if the service provider OR the service receiver is in China.
According to the latter, if a Chinese company provides the relevant services to an
overseas company, it seems that the services will be regarded as being provided “in
China” and thus should be subject to VAT.  It seems that Circular 110 and Circular
111 are not consistent on the VAT treatment of outbound VAT provision.  In this
regard, Circular 131 clarified that:-

•   Companies and individuals in the pilot areas that provide the following services to
overseas entities are applicable to the zero VAT rate:-

– International transportation services (the relevant companies should have
obtained the required operation licenses)
– R&D services provided to overseas entities
– Designing services provided to overseas entities (excluding the designing
services related to the real properties situated in China)

•    If your company’s provision of the relevant services to overseas entities is
exempted from VAT, then the relevant input VAT needs to be transferred out and
absorbed as cost. In this regard:-
– If the amount of input VAT related to the services like consulting service is not
significant, the impact of input VAT transfer-out will be immaterial.
– If your company has both VAT exemption items and zero rate items, or non
VAT-taxable items, then the relevant input VAT needs to properly separated
(on an actual basis or according to the formula stipulated in Article 26 of
Circular 111).  This can be a challenge to your company, but might also be
an opportunity.

•  If the services provided by your company are in the scope of zero VAT rate or VAT
exemption, then if commercially feasible, your company may improve the tax
efficiency if contracting with and receiving payment from an overseas entity of
your client, compared with contracting with and receiving payment from a Chinese
entity of your client.

•  Your company’ outbound provision of the relevant services generally was subject
to 5% Business Tax (“BT”).     Due to the VAT pilot reform in Shanghai, your
company’s tax cost will reduce (changed from a BT item to a VAT item, no output
VAT, and possible input VAT credit/refund).     Therefore, your company will be
able to offer a more competitive price to promote overseas clients.

•  If your company belongs to a multi-national corporation (“MNC”) group, when
your group selects its regional management or service provision center, it should
now consider the impact of Circular 131 and assess the comparative tax advantage
of your company (assuming it is a Shanghai company) of acting as such center.
For example, if your company is a China Holding Company or a Regional
Headquarter set up by a MNC group, then your company now has more tax
advantage to provide the above services to affiliates in other countries or regions
than before.     If so, your group may re-consider its regional or even global plan of
relevant subsidiaries’ function allocation.

This newsflash has been provided by Shanghai Nortex Public Certified Accountants Co., Ltd. For more information, please contact Tony Su at tony.su@nortex.cn or Tel: +86 (21) 6135 6286 x101

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