As Partner at Big Four accounting firm PwC, LS Goh has been providing clients with her expertise in China tax consulting and business advisory since 1994. She has seen the withdrawal of special tax treatment for foreign-invested enterprises, the lowering of the corporate income tax rate to 25% after 17 years, and the gradual shift from business tax to value-added tax.
Expect more changes, Goh tells CFO Innovation’s Pearl Liu in an interview. Excerpts:
Companies from Asia and elsewhere are eager to sell to China’s huge domestic market. What are the important tax considerations that their CFOs must bear in mind when investing there?
Basically when you invest into China, there are three taxes you need to be concerned with. One is the corporate income tax. A lot of attention also needs to be paid to turnover taxes, which include value added tax (VAT)/business tax (BT). Consumption tax is also a form of turnover tax, but this is not as important because it is [levied only] on luxury items.
There is another element that a lot of companies actually overlook, and this is the individual income tax (IIT). In China, the individual income tax [the top rate is 45%] is much higher compared to a lot of places like Hong Kong. So a lot of companies have to bear the incremental tax [the difference between the rate in China and what they pay at home] in order to encourage staff to move over to China.
In China, as a payer of salaries, in fact of anything, to your employee, the company is the withholding agent. If it fails to withhold [the appropriate tax], you get a penalty. If the authorities cannot catch the employee, they will catch the employer. The penalty is high; the surcharge is 0.05 % [of the tax due] per day. That’s about 18.7% [a year].
Business policies and regulations continue to evolve in China. Have there been changes recently with regard to these taxes?
The first is, of course, the transformation from BT to VAT. It took [the Chinese tax authorities] a long time to decide to do it, but now they feel that the economy is not getting on very well and they want to encourage exports, especially export of services.
A lot of services and high-tech stuff could be subjected to business tax, rather than VAT. For example, if I want to do medical research, I need a lot of equipment. But if I’m subject to business tax, when I buy the equipment for my research, it increases my cost. It becomes so expensive, because I’m not only paying the business tax but also for the input VAT.
The government has expanded the VAT pilot programme to more cities from just Shanghai, initially, to Beijing, Jiangsu, Anhui, Fujian and Guangdong as of 1 November this year. Do you think there will be more follow-up moves?
Definitely a lot, although it’s still in a state of flux. There are two main laws. The three-page Circular 110 is the big law that captures the government’s B-to-V intention. Can you imagine such a big change in three pages? It captures the framework, the intention to cover transportation, modern services, construction, finance.
Circular 111 contains the detailed regulation for only two sectors, transportation and modern services; the rest is not covered yet, but these are all in the main law. Obviously, VAT will spread to all these areas, which we expect to happen in 2015, probably.
Do you expect more cities will want to join the VAT programme?
Of course. After the pilot programme in Shanghai, we saw cities like Beijing and Tianjin all raise their hands subsequently. Why? Because they were afraid that a lot of services companies would probably move to Shanghai.
Let me give you an example. Imagine a manufacturing company that is getting a service from ABC Transport Company in Harbin, which is subject to the normal BT because the B-to-V has not rolled to Harbin. The manufacturer pays $100 to ABC, and ABC has to pay $5 to the government on it as business tax.
But imagine if ABC were to move to Shanghai. It will probably reduce the price for the service to maybe $98, then impose the VAT [at the standard rate of 17%]. It will get $98 in Shanghai and pay no business tax. In Harbin, only $95 will go to its pocket, because $5 in business tax will go to the government.
The manufacturer has to pay 17% VAT, but it can credit that because it’s in manufacturing; it’s a VAT payer. ABC is also charging it a lower price, $98, [because it no longer needs to pay the business tax]. So it’s a win-win situation. That’s why some companies already started planning to move their operation to Shanghai.
What should companies do to prepare for the transition?
If I know the city I’m operating in is going to transform into VAT in December, and now it’s November, I will not buy a fixed asset now. I’ll buy in December. It’s simple, but it can cause a lot of differences in taxes.
In terms of B-to-V, the most important thing you have to look at is where your customer is located and whether it is a VAT or business tax payer. If your major client is a business tax payer, you can choose to continue paying business tax, which is a better deal because it’s a lower tax.
But if your customer is a VAT payer, you would want to change to VAT because it’s a pass-on tax. So automatically, the one to bear the tax is the consumer, not you and not even your client. Everyone is happy.
You should also look at your stated business scope if you want to be subject to VAT. It’s actually very grey, [the determination of what companies are under] modern services industries. You want to park as close as possible to the wording, so maybe you [can tweak the wording of] your business scope, change your business scope or expand your business scope. These are some of the little things you need to do.
Let’s move on from turnover to income. Are there incentives that companies should look at to reduce their corporate income tax rate?
The income tax regime got a major reform in 2008, after not experiencing change for 17 years. The standard rate is now 25%.
China changed to encourage more high-tech companies. In the past, it just wanted to bring in more investment, so it offered a lot of incentives. Under the new corporate income tax regime, China is much more selective. Generally no tax holidays are given anymore, except in special situations such as in the high-tech area.
You can see the transformation, from manufacturing to high-tech plus regional. Also, you can see that regional locations are focusing to on special services, on niche services. For high-tech or special regions, the corporate income tax is lowered to 15%. You can see that they keep it very simple.
What if you are still in manufacturing?
You do not have incentives. But a lot of regions actually give financial subsidies [to manufacturers]. It’s all about bargaining power and whether they want you there. For example, if you are a top-tier MNC, they will want you.
The financial subsidies are used to pay your future taxes, so they’re not cash in your pocket. You must put [the money] in a special account to pay off your future taxes.
What kind of companies can benefit from the high-tech tax incentives?
There’s a lot – those in research and development, for example. Every big organization has R&D. A lot of them do not want to park their R&D in China because they are afraid that they will lose their intellectual property. But if you give incentives and if they feel that some of the research is not that high high-tech, something they are not afraid of losing, they will park them.
For example, Minute Maid, one of my clients, always comes up with different flavours. That’s research and development. R&D is not just those super high-techs, not necessarily. It could be a new product or a new way of production.
Is it better to carve out a separate R&D company? Or should you just set up a special R&D department?
It depends. To enjoy the incentives, there are conditions. Every year, you have to plow back 3-6% of your turnover into R&D expenses. So imagine, if you have a company doing manufacturing, if you put the R&D in there, that’s 3-6% of your turnover, your sales. It’s going to be huge.
If you can meet that condition, good for you. Your full income will be subject to the reduction, which means 15% CIT rate, which is very favourable. It’s best if you can park into one organization, including your core business.
But if you cannot [spend 3-6% of your sales to R&D], you’re better off carving it out. The thing is that you will then be tied down by the commitment on spending on R&D. But you will be able to charge royalty from the R&D company to your related sister company in China, or across borders. Part of the revenue will be shifted from the main business into royalty income, into this company, and subject to 15% income tax.
Click here to read the concluding part of this two-part interview.