After years of boom, the China economy is experiencing a slow down. Premier Wen Jiabao announced in March 2012 China's official growth target would be 7.5% in 2012, compared to 9.2% in 2011. "We aim to promote steady and robust economic development, ...
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After years of boom, the China economy is experiencing a slow down. Premier Wen Jiabao announced in March 2012 China's official growth target would be 7.5% in 2012, compared to 9.2% in 2011. "We aim to promote steady and robust economic development, keep prices stable, and guard against financial risks by keeping the total money and credit supply at an appropriate level, and taking a cautious and flexible approach," said Wen in his annual work report to the National People's Congress (NPC).
Tax authorities have become much more aggressive and strategic to maximise revenue collection. Practitioners have noticed the State Administration of Taxation (SAT) becoming increasingly sophisticated as China becomes more exposed to and wants to learn from other countries long-standing tax methods.
Transfer pricing and the General Anti-Avoidance Rules (GAAR) are two key areas that the SAT will continue to attack as they are identified as significant revenue generators. The SAT's tactic has been to focus on the later stages of proceedings and corporate taxpayers have been subject to more tax audits in relation to those two key areas. "This requires the taxpayer to put more focus or make more efforts to ensure that they have a good team to ensure compliance and minimise audit risk," said Vivian Jiang from Deloitte.
Practitioners across the board agree that the SAT's approach will lead to a rise in tax litigation, in so far as it exists in China, and disputes. "The prevailing view was that there was no point to formally challenge tax assessments in China," says Eugene Lim from Baker & McKenzie. However, recent successful challenges against the tax bureau in China show that the odds are not stacked in favour of the tax authorities in every tax dispute. "This proves that there are effective avenues to challenge tax decisions in China. To the credit of the Chinese authorities, they are adopting a very enlightened approach to ensuring that China continues to develop a sophisticated and robust tax regime that will cater to the needs of global businesses," said Lim.
"In recent months, except for the VAT rules which are already on trial, I don't think that there will be significant rules coming up because of the other issue that the government will be changed in October 2012," said Dennis Xu from Hendersen Taxand. "Having said this, the next government has to face a big challenge with the current taxation structure which is the unbalanced state and local tax revenues. The local government's main revenue source has been selling land in the past, while the real-estate sector is slowing-down nowadays, most of them are facing a difficult fiscal situation," said Xu.
One important tax change that is teething is the VAT pilot programme that was implemented in Shanghai on January 1 2012. The pilot was introduced as a response to the inherent inefficiencies with the Business Tax regime. "The Chinese regime today is frankly very difficult to use and this causes unnecessary complexity for the tax administration of companies operating in China," explained Lim. "In China there is a legacy of history where you have two bifurcated systems that separate supply of goods and services where different rules would apply, but the pilot programme is a good development and heralds positive changes."
After the success of the pilot in Shanghai, the State Council has announced the extension of the trial to Beijing, Tianjin, Shenzhen, Xiamen, Guangdong, Jiangsu, Anhui, Fujian and Hubei from August 1 2012 until the end of the year.
"The problem with Business Tax is the cascading effect–there is generally no credit on tax paid on purchases, so the more transactions, the more tax a business will bear. Unlike VAT, where there is credit throughout the chain, so companies involved in a middle of a transaction cycle will not suffer as they will ultimately pass the VAT on to the consumers. The pilot programme is to address this tax leakage issue," says Khoon Ming Ho from KPMG.
"I anticipate that in the next 5 years, VAT will replace Business Tax. VAT would apply across all service sectors, as Business Tax is regressive in nature and creates double and potentially multiple taxation of the same portion of value added by the service providers," predicted DingFa "David" Liu from Jun He Law Offices. Once completely phased out, the scope of VAT may be expanded to cover areas such as financial and insurance services, real estate and construction, entertainment and telecommunications.
Another reform, Announcement 30, issued on June 29 2012, is a supplementary notice to Circular 601 regarding beneficial ownership in relation to PRC double taxation agreements (DTAs).
"It is relatively more liberal than before. The tax authority is now to look at the whole picture of an offshore payment to assess the entitlement to tax treaty benefits, getting more rational and reasonable than what was literally interpreted from Circular 601," explained Tony Dong from King & Wood Mallesons. "Previously, [tax authorities] mainly looked at the offshore recipient to see whether they had sufficient business presence but now tax authority is looking at the real economic substance of the transaction to identify the beneficial owner" explains Dong.
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