Financial world watches China to assess effect of the tax reform

Financial services leaders in China are expecting more detailed rules on the value-added tax reform to come out so that they could be better prepared for the reform, which is aimed at lightening their tax burden.

Matthew Wong, PwC China financial services tax leader, said: "We talked to a number of bankers and they cannot see how this reform can help banks reduce tax because the rate is higher and the amount of input VAT they can effectively credit is difficult to be estimated.

"Until the government can further clarify some of the uncertainty about the interpretation of the VAT rules, it's premature for us to say the VAT reform can save tax for the banking industry at this stage."

The financial services sector in China has been paying 5 percent business tax for many years, but starting from May 1 they will switch to a 6 percent VAT.

Many items still require further clarification from tax authorities, Wong said. For instance, the new VAT rules have exemptions on the interest in connection with interbank funding activities, but the scope of exemptions is narrower than that of the old business tax rules. As interbank funding is a normal activity for the banks to get the money to re-lend to customers, the change in the scope of non-taxable items will lead to higher costs of re-lending business.

"The VAT reform changes the overall operating environment of the banks. It changes the accounting and reporting format of the banks and other financial institutions. It also changes the pricing model and therefore, it will change the banks' relations with their clients," he said.

Generally speaking, large banks are less likely to be affected by the tax reform because they can shift additional tax burden to the clients. But smaller banks that do not have the discretion to raise their price may not be able to do so.

"Banks have to talk to their clients and see how their clients will think about the situation. They may revise their agreement in the new contract and need to test in the market whether or not the client will accept the new terms of the agreement," he said.

Kenneth Leung, EY greater China indirect tax leader, said: "Financial institutions need to communicate actively with the clients, tax authorities and IT vendors for VAT related matters. Reviewing terms and conditions is a 'must do' to ensure the implication of VAT will be fair and transparent to all relevant parties."

He emphasized that under the VAT rules, banks "will have to change their management system and mindset in various aspects of operation".