VAT EXTENDED TO VALUE-ADDED TELECOMS
Feb. to June 2014 China Bulletin

Replacement of the Business Tax on service industries with the Value-Added Tax (VAT) continues apace (see SERVICE VAT EXPANDED, Aug.-Sept. China Bulletin), and the Ministry of Finance and State Administration of Taxation issued the Notice on Including the Telecommunications Industry in the VAT Pilot Program, Cai Shui [2014] No. 43 (Notice 43).  This notice extends an 11% VAT to basic telecoms (mainly voice communication and infrastructure services) and a 6% VAT to value-added telecoms (messaging services used in mobile phones, transmitting and apply electronic data and information), replacing a 3% Business Tax Rate.  Certain exemptions under the Business Tax regime are no longer available, and a key challenge for non-Chinese basic and value-added telecoms service providers to Chinese consumers is that the fees they receive from China are likely to be reduced by 11% withholding.

VAT at 11% was earlier extended to the railway transportation and postal service industries in December, 2013, in Notice Cai Shui [2013] No. 106 (Notice 106), which also provided relief for financial leasing by allowing deduction of the tangible movable assets before calculating VAT.  In addition, Notice 106 identified translation services as a type of consulting service (and therefore subject to VAT of 6%), and removed prejudicial treatment of foreign shipping companies imposed by an earlier notice.  Notice 43, effective June 1, 2014, extends VAT to telecom services.

Outbound and inbound telecom services are treated differently under Notice 43.  Outbound services, i.e., services provided by a Chinese supplier to foreign customers outside China, are exempt from VAT, whereas inbound services, i.e., provided by a foreign supplier to Chinese customers in China, are subject to VAT.  It should first be noted that, although exempt from VAT, Chinese suppliers must separately track their VATable input costs and cannot offset them against the fees they received for services to foreign customers.  More critically, however, foreign providers will now be subject to an 11% withholding against payments to them from Chinese customers, unless they require their customers (or Chinese resellers) to agree to VAT withholding gross up provisions in their sales/purchase contracts.

Notice 43, and the Provisional Measures for the Administration of VAT Collection from Telecom Enterprises, effective at the same time, do not provide key details for several important issues.  For example, what is included in the scope of “value-added telecom services”?  Is the definition the same for tax as for regulatory purposes?  Such services seem likely to include, for example, supply chain management applications and security services provided from abroad, but other services, such registration by Chinese citizens of domain names hosted outside China, are less clear.  More details may be forthcoming in future notices, but the practical result may be that if payment is remitted out of China for the service, VAT must be withheld.

Additional challenges including bundled services with voice and value-added services subject to different rates, and the high cost of complying with the VAT fapiao (official receipt) system.

Questions? Please contact Allan Marson at china.desk@ishimarulaw.com or +1 408-738-0592 #719 for a complimentary consultation.