Tax News 15

Tax News 15 : 2010-09-07

EU Business Slams China's Business Tax

In a series of critiques of the Chinese taxation regime published by the European Union Chamber of Commerce in China (EUCCC), the Chinese business tax on services was described as a "critical obstacle to the growth of the service sector and other high-value knowledge industries in China".

The EUCCC also said that its detrimental effects on service providers had been "accentuated by the recent shift from a production-based to a consumption-based VAT regime".

Business tax is applied at a standard rate of 5% on the gross turnover derived from: the provision of services rendered in China; assignment and licensing of intangible assets; and sale or rental of real estate, provided that such activities are carried out within China.

The EUCCC said the structure of business tax could lead to double or even higher multiple levels of taxation. Business tax is mainly levied on gross turnover with no corresponding input credit for business tax paid along the supply chain as there is with VAT. As a flat tax on gross income, if a taxpayer has a very small profit margin, the imposition of the business tax can actually contribute to an economic loss.

The EUCCC also disapproved of business tax being imposed on services performed for foreign customers, whereas outside China, export of services is typically zero-rated under VAT systems.

Sales of goods, repair, replacement and processing services, as well as the importation of goods, are not subject to business tax in China, but instead to VAT levied at a standard rate of 17%. As a result of a recent change, the EUCCC said these taxpayers may now offset input VAT related to fixed asset purchases. The fact that VAT is not recoverable for payers of business tax clearly penalizes service industries, as compared to the manufacturing and trading sectors, according to the EUCCC. The Chamber also criticizes the repeal of the preferential tax treatments which aimed to compensate the non-deductibility of VAT on fixed asset purchases since January 1, 2009.

These preferential tax treatments consisted of VAT exemption on imported equipment or a refund of input VAT paid on domestically purchased equipment. They were enjoyed by foreign-invested as well as domestic enterprises pursuing an activity regarded as “encouraged” under various investment categories.

However, according to the EUCCC, enterprises engaging in activities for which business tax applies now face an increase in their fixed asset investment cost of 17% (corresponding to the non-exempted/refundable upstream VAT).

The EUCCC considers the situation to be especially harsh for equipment leasing and finance leasing enterprises. Such enterprises suffer from both an irrecoverable 17% VAT paid on equipment purchases and a 5% business tax levied on equipment rental fees, a tax burden which does not arise when the equipment is purchased.

The EUCCC recommended:

• Restoration of the previous VAT exemption and refunds of VAT on equipment purchases for certain service industries as well as R&D companies;
• Extension of these exemptions and refunds to equipment leasing and finance leasing businesses;
• Elimination of double business tax on subcontracting of labour, service and sublicensing of IPR activities by allowing deduction on subcontracting/sublicensing costs for business tax purposes; or
• Replacement of business tax with a VAT on service income and other items of income currently subject to business tax.