China VAT Roadshow – Managing VAT Effectively in Times of Rapid Change
China’s VAT regime is experiencing a reawakening of interest recently with the launching of the Shanghai VAT Pilot in January 2012 and other important regulatory changes.
These activities have raised the level of awareness and making companies rethink how they view VAT in China. There are also indications that the VAT Pilot may soon expand and eventually move towards complete reform by transitioning a majority of services from business tax to VAT. Ernst & Young has been closely involved with these VAT regulatory developments by providing comments and insight to the Authorities while also educating interested companies.
To that end, Ernst & Young China’s indirect tax group is hosting another China VAT seminar last/ this week in 12 cities across China with over 1,500 attendees. The overwhelming attendance to this event illustrates the growing level of interest from companies doing business in China as we discuss the following:
Update on the Shanghai VAT Pilot roll-out and possible future expansion plans
Overall VAT reform and other important regulatory developments
VAT processes and VAT accounting in China
VAT reconciliations and using technology
These topics were selected based upon results from a survey Ernst & Young China’s Indirect Tax Group conducted in November 2011 immediately prior to the starting of the Shanghai Pilot. At that time, over 550 professionals with interest in VAT were surveyed from all across China to understand their thoughts and opinions on China’s VAT system. The results were collated and analyzed to determine topics of interest and resulted in some very interesting findings on VAT in China.
China’s government has been considering undertaking a comprehensive VAT reform for the last few years. VAT and Business Tax (BT) currently account for over 50 percent of the China government’s tax revenue collection and adjusting such an important system needs to be carefully studied and monitored. As a result, the Shanghai VAT Pilot was introduced from 1 January 2012 to test the outcomes of a revised VAT regime.
It has also been reported that more VAT pilot programs will be launched in the near future to other cities and possibly including additional “in-scope” services.
Mr. Kenneth Leung, an Indirect Tax partner based in Beijing, explains: “We have seen that both the tax authorities and businesses in general welcome the VAT changes to be introduced on a pilot basis, as it provides the opportunities for both to gauge the financial and operational implications and changes, and help companies prepare in stages.
“We have also seen a good level of interaction between businesses and the tax authorities on VAT pilot matters. However, there are growing concerns about how the VAT pilot would expand in the future, specifically in terms of scope, location and timing.”
Under the new VAT pilot arrangements, there are certain companies and industries that are benefiting with lower tax levels.
General VAT taxpayers who used to incur BT costs imbedded in or charged on the purchase of “in-scope” services seem to enjoy the most benefit. Small-scale VAT taxpayers also have benefited from a lower rate. Some companies possibly incurring higher tax costs, such as leasing companies, have been supported with rules seeking to limit the amount of increased costs.
Those companies undergoing the most significant operational changes transitioning from a pure BT payer to a VAT payer– such as transportation, consulting and advertising companies – are experiencing the most growing pains as they struggle with the overall financial impact.
Mr. Robert Smith, Indirect Tax leader for the Asia Pacific region based in Shanghai, observes: “Affected companies in Shanghai are struggling to grasp the impact of the changes and are now starting to encounter practical and daily challenges related to VAT invoicing, return preparation and other pilot-related matters.
“These companies should have filed three months of VAT returns already – for January, February and March – under this new tax regime. Their experiences have ranged from generally smooth to a complete mess. These experiences can also be taken as a leading indicator for what companies will encounter when the Pilot is expanded to additional locations and companies should try to avoid repeating the same mistakes and learn from that.”
The rapid regulatory changes to China’s VAT regime, coupled with the lack of proactive or strategic management of VAT operations by companies, could lead to significant VAT costs and missed opportunities. New regulations are also creating chances for companies to streamline VAT operations and take advantage of special rules to recover lost VAT.
However, this is not easy and due to the numerous accounting, invoicing and reporting requirements, China’s VAT system could be considered one of the most complex in the world.
Mr. Kenneth Leung adds: “While we expect the pace to pick up towards VAT pilot expansion and overall VAT reform, the biggest risk and unexplored opportunity may possibly be a company’s daily regular VAT operations. Companies should focus on their VAT accounting and VAT processes to ensure compliance, to manage risks and to explore opportunities for VAT cost savings. VAT reconciliation is a best practice companies should consider. Companies should also consider adopting technological measures to assess VAT risk and opportunities so as, to better manage China VAT.”
Based on our experience, many companies, including the “old” VAT taxpayers and the “new” VAT Pilot taxpayers, are surprised at the total value of VAT their organizations are managing and the extent of VAT costs and inefficiencies being incurred. The material size of the VAT pool, essentially cash, running through the organization and quantum of direct and indirect VAT costs being incurred warrant dedicated efforts to manage VAT cost efficiently.
Mr. Robert Smith concludes: “The upcoming months and years will be exciting and challenging for VAT in China. This tax directly impacts the costs and cash flow of an organization to a level that surprises many executives when they delve deeper. Companies need to stay ahead of regulatory changes and adapt accordingly, especially in terms of allocating more resources to manage VAT more effectively – or risk of being left behind, incurring too much in indirect tax costs or accumulating compliance risks.”