VAT net to be widened to realty, finance and consumer services

The government is likely to come out with a fresh value-added tax reform plan for the real estate, finance and consumer-oriented services industries next month, ending the three-year reform on all service industries, according to unconfirmed reports.

The Ministry of Finance is believed to have already drafted the plan and the same would be announced after approval from the State Council, the cabinet, Xinhua-affiliated Economic Information Daily said on Thursday, quoting unidentified people close to the ministry.

Even if the plan is sent to the State Council this month and approved in July, it would take another few months to finalize the implementation mechanism. So in all probability, the reforms are likely to be implemented by the end of this year, the sources said.

VAT rate for the real estate sector may be set at 11 percent, and for finance and consumer-oriented services industry at 6 percent, the report said. The ministry declined requests to confirm the report.

China started a pilot program to replace business tax with VAT in January 2012 in an effort to avoid double taxation, ease companies' tax burden and encourage the service sector. Reforms have already been implemented in sectors such as transportation, telecommunication and modern services, with real estate, finance and consumer-oriented services the only three sectors untouched.

Policymakers intend to wrap up the reforms this year. It is the debate over some specific issues that has hampered the progress. Among all technical challenges, "credit mechanism" is a focal point, experts said.

The VAT only taxes the "value added" at each stage of the supply chain, which generally allows businesses to credit tax incurred on business-related purchases. The VAT rate is generally higher than the current business tax. Any failure to "credit business expenses might actually increase the tax burden", which is contrary to what the policy intends to achieve.

"VAT invoices may not be readily available for some purchases, therefore the claiming of input VAT credit for the purchases may be limited. Besides land, major cost for developers will likely be raw materials (brick, lime, sand, stone, etc.) and labor. Suppliers of these may be individuals, or small business owners, who may not be able, or may have difficulty in issuing VAT invoices," said Alan Wu, national indirect tax leader at PricewaterhouseCoopers China.

The reforms also pose challenges to the projects that are under construction, or those where construction is completed but the sale is still going on, as it would be impossible to get input VAT invoices for the cost already incurred for credit claims. Since the applicable tax rate might be 11 percent and the current business tax rate is 5 percent, the costs would certainly go up, Wu said.

"A transitional measure might be more helpful to address these difficulties," Wu said.

For the finance industry, controversies are greater. Most countries exempt VAT on financial products. Kenneth Leung, indirect tax leader at Ernst & Young Greater China, said financial services subjected to VAT could be divided into three categories: Interest, earnings from financial trading, and service fees. According to the current policy discussions, the VAT charged on interest expenses and financial products might not be creditable as input VAT temporarily.

However, Wu said the reform will be less effective if any part of the chain is broken (input VAT not creditable), or if VAT on interest is not allowed as input credit. Regarding application of VAT to financial trading, one possible way out would be to continue the current net basis arrangement under business tax, while allowing a net negative position to be carried forward, without limitation, to offset against future positive position.