By Xi Si (席斯)
News, page 4?
Issue No. 530, Aug 1, 2011
Translated by Zhu Na
Original article: [Chinese]  ?

Shanghai will launch a pilot tax reform project from Jan 1 next year that will start the city and the whole country down the path of replacing corporate income tax (營(yíng)業(yè)稅) or turnover tax with value added tax (VAT).

The move was first reported by the EO in July this year before being officially announced by the State Council at the end of October.

The pilot tax project will cause China’s largest city to lose about 10 billion yuan in fiscal revenue this year. The city had revenue of approximately 290 billion yuan in 2010, 140 billion of which was collected locally.

Despite the cost, Shanghai officials have said that they are willing to bear the costs and will not seek assistance from the central government.

The Shanghai trial represents a breakthrough in terms of an ongoing push from some sections of the central government to reduce the overall tax burden on businesses by increasing VAT revenue. In addition, the reform eliminates double taxation on business, encouraging the development of tertiary industry in the city.

Pilot to Focus on Transportation Sector

The EO learned that the Shanghai government and the Ministry of Finance have reached an agreement to limit the pilot project to the transportation industry for the time being.

Currently the main costs facing the transportation industry are fuel and road tolls, according to an employee at a logistics company in Shanghai.

The EO has learned that under the pilot project, companies will be able to deduct spending on fuel and maintenance fees as a cost.

Despite expectations, the construction industry was not included in the pilot project, this is due to the fact that if the construction industry adopts VAT, then the real estate industry would need to do so as well, according to Guo Wei (郭偉), Chief Taxation Adviser at the Beijing Deweijing Accounting Consulting Co., Ltd (北京得威京會(huì)計(jì)咨詢有限公司).

Currently a large share of local government’s revenue comes from real estate sector and related industries, so if the government starts collecting VAT from the industry, then one of the main sources of local government income will be directed instead to the central government.

A Willing Guinea Pig

The most difficult problem with the initiative is sharing the VAT revenue between different levels of government. Some provincial officials said that if VAT replaces business tax without making any adjustment in how the local and central government share the revenue, then there will be little motivation for local governments to collect the tax.

According to one local tax official, “the Ministry of Finance has been actively preparing for the details of the pilot for a while now, but most local governments don't want to be a part of it because of the way the VAT revenue will be split.”

Dong Qinfa (董勤發(fā)), Deputy Director of the Shanghai Pudong New Area Finance Bureau (上海市浦東新區(qū)金融局) explained that the reform would lead to local governments losing a major source of revenue stream from business tax receipts, as the central government profited instead from higher VAT revenue.

VAT revenue is shared between central government and local governments at a ratio of 75:25, while business tax revenue go directly to local governments. in fact, business tax receipts are one of the main sources of ax revenue for local governments, accounting for more than a quarter of their tax take since 1995. Once VAT is in place, local government revenue will be severely impacted.

The EO has learned that most local governments think that VAT revenue should be a split 50:50, otherwise it will not be able to make up for the lost revenue.

Shanghai’s transportation industry is willing to test the waters of this tax reform because they are happy with the current sharing ratio and are prepared to bear the 10 billion yuan hit to their book  without asking for additional support from the central government.

“The first trials can be held in Shanghai because of recent incentive policies in the transportation industry. In addition, Shanghai is a special financial zone, so its national tax, local tax, and financial departments are all part of the same institution and are therefore easier to coordinate,” according to one taxation official.

Aside from Beijing, Shanghai and the others municipalities that are directly under the control of the central government, the financial, national tax and local tax departments operate separately in most other provinces and cities in China.

The EO has learned that the tax rate for VAT will stay at 17% after the tax pilot project is implemented in the transportation industry, but may be lowered at some stage in the future.

Background of Business Tax in China

Turnover tax is a local tax collected from all enterprises, units, household businesses and other individuals engaged in providing taxable services, transfer of intangible assets or sales of immovable properties within the territory of the People’s Republic of China.

It is levied at rates ranging from between 3 and 20 percent, and covers nine sectors: post and telecommunication, culture and sports, transportation and construction industry are taxed at a rate of 3 percent, financial and insurance businesses, transfer of intangible assets, sales of immovable properties, and the service industry are taxed at 5 percent, and companies operating in the entertainment industry are taxed  at anything from between 5 and 20 percent.

In 2010, the domestic VAT revenue was 2.1 trillion yuan, accounting for 28.8 percent of total nationwide tax revenue. Turnover tax revenue was more than 1.1 trillion yuan, accounting for 15.2 percent of total tax revenue.

Links and Sources
Gov.cn: China works to replace turnover tax with a value-added tax