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The impact of China’s new VAT reforms on transportation and logistics
Between 1 January 2012 and 31 July 2013, the area of pilot regions was expanded to 8 regions (starting with Shanghai - the first pilot city). Now, under Circular 37, the pilot program is being carried out across the country. Besides the expansion of the pilot area, Circular 37 has also made some significant changes to VAT implications in transportation and logistics industries, which may even require the companies to revisit their pricing method. Taxand China investigates these changes and details the likely impact for businesses with activity in the region.
Change 1: Cancellation of net margin basis for VAT for transportation and logistics auxiliary services
Circular 37 has removed the provision of computation of VAT-able turnover on a net margin basis, with the exception of financial leasing. Previously, Cai Shui  No.111 allowed certain pilot taxpayers, who used to file BT on a net margin basis under the BT regulations, to consistently compute their VAT-able turnover on the net margin basis. Payments made to non-pilot taxpayers and certain types of pilot taxpayers could be deducted from their output VAT calculation base.
Now, taxpayers are not allowed to deduct relevant payments from their VAT-able turnover. For logistics and auxiliary services, and especially for the freight forwarding industry, such policy change has dramatically increased their China VAT cost due to the lack of input VAT.
Change 2: Cancellation of provisional VAT rate of 3% for international transportation services
Circular Caishui  No. 53 provided a provisional VAT rate of 3% as a transitional measure for international transportation services, where the service providers are from countries without treaty protection with China. The main reason for this is to balance the withholding indirect tax burden between pilot regions versus non-pilot regions. In Circular 37, this favourable transitional treatment has been cancelled. Now, foreign transportation service providers (with no treaty protection rendering international transportation services) are facing a significant increase in their indirect tax burden (ie 11% VAT as compared with 3%) starting from 1 August 2013.
Below are two scenarios designed to demonstrate the impact of the above policy:
- Scenario one
The case in hand deals with an overseas company (“B1”, an international transportation/freight-forwarding company) that provides transportation/logistics related services to a Chinese company (“A1”, a transportation/freight-forwarding company).
If there’s a VAT exemption treaty between the target two countries, B1 is exempted from VAT and A1 has no withholding VAT to claim as corresponding input VAT. Earlier the payment to B1 could have been deducted by A1 to compute its turnover liable to VAT, even though B1 was exempted from VAT. The result of this new provision is that A1 has an increased VAT burden by not being able to calculate VAT on a net margin basis. There is no direct impact to B1 due to its VAT exemption.
- Scenario two
The next case study deals with an overseas company (“B2”, an international transportation company) that provides transportation services to a Chinese company (“A2”).If there’s no treaty or the treaty does not contain a VAT exemption between the target two countries, A2 pays B2 a service fee and there is a withholding obligation on A2.
Before the pilot program, the withholding BT in the scenario is 3%. After the pilot program and before Circular 37, B2 still has a 3% indirect tax burden (BT/VAT). After Circular 37, B2’s VAT burden abruptly increased from 3% to 11% and accordingly A2 had a much higher input VAT credit of 11% (on the basis that A2 is a general VAT payer).
Circular 37 also provided additional clarity around tax guidelines. For example, taxpayers have the right to determine whether a zero VAT rate or VAT exemption (different input VAT credibility) is appropriate, based on the companies’ actual business situation – a potential benefit to companies operating within the region.
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Under Circular 37, it’s essential for businesses to stay abreast of the changes taking place. Using the above case studies, the following should be considered:
- For a Chinese company, when deciding on an international transportation service provider, the above-mentioned B2 will likely provide more tax benefit (there’s no VAT exemption treaty between the target two countries), and it is less likely to engage B1
- For a China transportation/freight-forwarding company that was previously able to calculate VAT on a net margin basis (with B1), now the cancellation of the net margin policy will dramatically increase its own VAT cost, so it should re-consider any agreed service fees with B1
- For B1, generally after Circular 37, its VAT burden remains unchanged, while it should pay attention to the possibility that the Chinese companies may intend to request lower fees
- For B2, due to its abruptly increased VAT burden in China (3% to 11%), it should review the profitability under the new status to evaluate the pricing adjustment to the Chinese companies
Currently, and unsurprisingly, many transportation/logistics companies have complained and called into question the rationality of the discussed changes arising from Circular 37. Communication with SAT and even diplomatic means to resolution have been seen. Longer term, however, the change of the VAT burden for transportation/logistics related enterprises is likely to get shifted to other parties.