Calculating Value-Added Tax in China

In 2012, China launched the value-added tax (VAT) pilot reform to improve the efficiency of its national tax system. The VAT pilot reform replaces business tax (BT) with VAT in the transportation industry and certain modern service sectors at the start of 2012.
 
First implemented in Shanghai, the reform expanded to Beijing in September 2012 and Jiangsu, Anhui, Fujian, Guangdong, Tianjin, Zhejiang, and Hubei later in the same year. On August 1, 2013, the VAT pilot reform was implemented nationwide, as formalized by the promulgation of the Notice Concerning the Nationwide Adoption of VAT in lieu of BT Pilot Tax Collection Policy in the Transportation Industry and Certain Modern Service Industries (Caishui [2013] No. 37, “Circular 37”) by China’s Ministry of Finance (MOF) and State Administration of Taxation (SAT) on May 24, 2013.
 
Calculating VAT
There are two methods for calculating VAT payable – the general calculation method and the simplified calculation method. Generally, the former applies to general taxpayers and the latter applies to small-scale taxpayers.
 
General Calculation Method
VAT payable under the general calculation method is the current output VAT deducted by the current input VAT, i.e.:
 

• VAT payable = Current output VAT – Current input VAT

Output VAT refers to the VAT amount calculated according to the sales volume of the taxable services provided and the applicable VAT rate, i.e.:
 

• Output VAT = Sales volume x VAT rate

Sales volume refers to the entire price and other charges obtained by the taxpayer from providing taxable services. Where the taxpayer’s pricing combines sales volume with output VAT, the below formula should be used to calculate the sales volume:
 

• Sales volume = Tax-inclusive sales volume / (1 + VAT rate)

Input VAT refers to the VAT paid or borne by the taxpayer when purchasing goods or receiving processing, repair and replacement services and taxable services. Input VAT that can be deducted from output VAT includes the VAT amount specified on:
 

• A special VAT invoice (including goods transportation industry VAT special invoices) obtained from the seller;
• A Customs Import VAT Special Payment Document obtained from Customs; or
• A tax payment certificate obtained from the tax authority or Chinese agent for taxable services provided by foreign entities or individuals (in this case, the written contract, proof of payment and bill or invoice issued by the foreign entity are also required).

Example:
A design company purchases RMB600 worth of design services from a supplier, and then provides RMB1,000 worth of design services to a customer. The VAT rate for design services is 6 percent. The VAT payable is RMB1,000 x 6% – RMB600 x 6% = RMB24
 
If the current output VAT amount is less than the current input VAT amount, the outstanding portion can be forwarded to the next filing period. Certain input VAT items cannot be deducted from output VAT. These include non-VAT taxable items (i.e., BT taxable services, transfers of intangibles and real property, as well as construction and renovation of real property), VAT-exempt items, and items that adopt the simplified calculation method.
 
If a taxpayer provides taxable services that are subject to different rates, the sales volume for each tax rate should be accounted for separately, or else the highest tax rate applies. Similarly, VAT taxpayers who concurrently provide services subject to BT should conduct separate accounting, or the in-charge tax authority will determine the sales volume for the taxable services.
 
Where an overseas entity or individual provides taxable services in China and does not have an operating entity in China, the tax withholding party should calculate the amount of tax to be withheld using the below formula:
 

• Amount of tax to be withheld = Price paid by the service recipient / (1 + VAT rate) x VAT rate

Simplified Calculation Method
Under the simplified calculation method, no input VAT is deductible and a uniform 3 percent levying rate applies:
 

• VAT payable = Sales volume x VAT levying rate (i.e., 3%)

Zero-rated VAT and VAT Exempt Services
As mentioned above, the export of taxable services are zero-rated or VAT exempt. Both zero-rated and VAT exempt services are exempt from output VAT. The difference between zero-rated and exempted VAT is that, under zero-rated VAT, the input VAT attributable to the export of services can be credited from VAT payable and/or refunded. Under the exemption system, the input VAT attributable to export of services cannot be credited or refunded.
 
Circular 37 clarifies that if a pilot service is eligible for both VAT zero-rating and VAT exemption, VAT zero-rating takes precedence over VAT exemption. Providers of zero-rated VAT services may opt to pay VAT or apply for VAT exemption instead by filing a relevant declaration. However, taxpayers will be prevented from electing VAT zero-rating in the subsequent 36 months. Since the procedures for obtaining a tax refund for zero-rated VAT services is quite complex, some taxpayers who have little input VAT deductible may opt for VAT exemption.
 
Zero-rated VAT
For zero-rated VAT services, the “exemption, credit and refund” method applies to the provision of zero-rated services by taxpayers who adopt the general calculation method; while the “exemption and refund” method applies to foreign trade enterprises that provide both zero-rated and other services. These methods are defined as follows:
 

• Exemption, credit and refund method – VAT is exempted, and the corresponding amount of input VAT is used to offset the amount of VAT payable. Any surplus is refunded.
• Exemption and refund method – VAT is exempted, and the corresponding input VAT on purchased taxable services is refunded.

No special VAT invoice can be issued for zero-rated services. Providers of zero-rated taxable services should submit the following materials in order to qualify for the treatment:
 

• Application form for recognition of export tax refund (exemption) eligibility and electronic data generated by the export tax refund (exemption) reporting system;
• For international transportation services, the relevant business licenses and permits;
• For lessees leasing transportation tools via voyage charter, time charter and wet lease to provide international transportation services, the relevant contract or agreement;
• For R&D and design services, the Technology Export Contract Registration Certificate;
• For zero-rated VAT services providers who also engage in export of goods but have not undergone export tax refund (exemption) – certification qualification, the Foreign Trade Operator Filing Registration Form and the PRC Customs Goods Import and Export Consignor Consignee Customs Registration Certificate.

Following the recognition of the sales revenue from the provision of zero-rated VAT services, the service providers should file VAT returns and apply for refunds with the competent tax authority within the VAT filing period in the subsequent month (or quarter). They should collect all relevant certificates and apply for a refund between the subsequent month (or quarter) following revenue recognition and April 30 of the following year, or they will no longer be entitled to obtain the refund (exemption).
 
Among other materials, international transportation service providers should provide original copies of the cargo or passenger manifest or other vouchers reflecting the service revenue; while R&D and design service providers should provide the relevant Technology Export Contract Registration Certificate and R&D or design agreement signed with the overseas entity.
 
VAT exemption
To obtain exemption for exported services, a written cross-border service contract must be signed with the service recipient. In addition, the entire income from providing the service must be obtained from overseas. This could pose problems for intercompany arrangements – if a local branch or company pays, then no exemption can be applied. Taxpayers providing VAT exempt exported services should conduct separate accounting for the sales volume of the exported services and accurately calculate non-deductible input VAT. No special VAT invoice should be issued for VAT-exempt income.
 
To apply for exemption, taxpayers should conduct filing with the competent tax authority and submit materials including the service agreement (translated into Chinese if in a foreign language), proof that the service took place overseas, that the service recipient is located overseas, or that the transport involves foreign destinations.
 
This article was first published on China Briefing.
 
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