China tax: Government announces more changes and clarifications to Business Tax rules

The Chinese Ministry of Finance (MOF) and the State Administration of Taxation (SAT) jointly published a tax notice on 27 September 2009 (Notice 111) that provides some preferential tax treatment for taxpayers, but more importantly provides a long-awaited clarification regarding the Business Tax (BT) treatment of certain cross-border services.

The BT regime was amended at the end of 2008, with the changes effective from 1 January 2009. The most significant change was the introduction of a new – and unanticipated – rule to determine the scope of liability to BT, i.e. income from services is now subject to BT if either the service provider or the recipient is located in China. Before 2009, BT liability arose only where the services were physically carried out in China. In August 2009, the government issued a circular (Circular 112), which clarified the transitional BT treatment for cross-year contracts.

Notice 111 is retroactively effective as from 1 January 2009 and can be considered an amendment to the new BT rules.


Policy implications

According to Notice 111, certain services that are provided wholly outside the Chinese territory will not be subject to BT, as follows:

1. Entities or individuals located in mainland China that render services outside China are "temporarily" exempt from BT with respect to construction, cultural and athletic activities (except for television and broadcasting activities).

This provision, which only looks at the place where services are performed, is an exception to the general BT rule that taxes services if either the provider or the recipient is in China.

2. Overseas entities or individuals that provide the following services to recipients in China, but the services are rendered outside of the Chinese territory, are not subject to BT:
     a. Cultural and athletic activities (except for television and broadcasting activities),
     b. Entertainment,
     c. Hotel and catering,
     d. Storage, and
     e. Other services such as the hairdressing, laundering and dyeing, mounting, transcription, engraving, photocopying and packing services.

It is interesting to note that Notice 111 provides that services under 1) are exempt from BT while those under 2) do not fall within the scope of BT, i.e. services under 2) are not subject to BT at all, whereas the services under 1) are subject to BT but temporarily exempt. The temporary exemption may be eliminated in the future at the discretion of the MOF and SAT.

Notice 111 also provides that individuals are temporarily exempt from BT in the following cases:
- Income derived from transactions involving foreign exchange, securities, financial futures and other financial products; and
- The transfer of immovable property and land use rights as a result of divorce, inheritance or as a gift to family members.

Unfortunately, Notice 111 does not clarify what is meant by the term "temporary," so this will require further clarification.

Notice 111 stipulates the supporting documentation that must be submitted with an application for the BT exemption, to include ID certificates of both the transferor and the transferee and an original copy of a judgment letter from a court or a notarial deed issued by a notarization organization that prove the relationship between the transferor and the transferee, etc.

It should be noted that any BT that was overpaid before Notice 111 was issued may be offset against the BT payable in a subsequent filing period or may be refunded to the taxpayer.


Comments

The issuance of Notice 111 clarifies one of the most controversial issues that arose after the BT reform was announced at the end of 2008. According to the Notice, certain services performed by overseas service entities/individuals totally outside China should not be subject to BT. Although the list of services that will be exempt or outside the scope of BT is limited, it is a welcome development and may be a first step in granting an exemption for other services as well.

Taxpayers should take appropriate action to ensure that any overpaid BT is refunded and to revise contracts as needed. Specifically,
- If BT has been overpaid for services that are now exempt from BT under Notice 111, proactively communicate with the in-charge tax officer and prepare sufficient documentation to apply for a refund or an offset against BT payable in a later filling period;
- Revise the coding of an ERP system if the charging of BT is driven by that type of system;
- Review service contracts or agreements to determine the nature of the services performed outside China and whether they fall within the scope of a BT exemption covered by the Notice;
- For individuals transferring immovable property or land use rights, determine whether the transfer qualifies for the BT exemption, and if so, retain the relevant supporting documents to obtain approval by the tax authorities for the exemption;
- Conduct a tax compliance review to bring to light any mistakes in daily indirect tax compliance and filing, and make improvements in internal controls; and
- Consult with a professional tax consultant for help with technical questions or to resolve difficulties in tax management or in the case of a tax dispute with the tax authorities.