This content is from: Local Insights

More reform of turnover tax system

David LiuJulie Cheng

Since the implementation of its VAT regime and the supplemental turnover tax system which includes business tax in 1994, China has undergone continuous reform of these systems, which could be collectively labelled the turnover tax system.

Business tax and VAT are mutually exclusive: if VAT is imposed on a certain transaction, for example sales of goods, then no business tax will be charged with respect to the same transaction, and vice versa. An important distinction between VAT and business tax is that the latter is levied at each turnover, without taking into account that a portion of the same value added at current stage was subject to business tax at prior stage(s), thereby causing double and potential multiple business tax on a portion of the same value added.

The Chinese government realises the regressive nature of business tax and has planned to eventually replace it with VAT. As a first step, the State Council adopted a pilot programme for turnover tax system reform at its standing meeting on October 26 2011, aiming at substituting VAT for business tax which had been imposed on certain Shanghai-based service providers.

Highlights of the programme

The pilot programme of replacing business tax with VAT will first be implemented in Shanghai; starting from January 1 2012, all the service providers rendering services in the transportation industry or services selected for the pilot programme in Shanghai will be subject to and pay VAT, and will no longer pay business tax. It was reported that the Beijing Municipal Government also got permission to start a similar pilot programme in Beijing beginning from July 1 2012.

Effective as of January 1 2012, VAT applies to the transportation industry and some of the modern services in Shanghai. The transportation industry includes land transport service, water transport service, air transport service and pipeline transport service; and modern services under the pilot programme include R&D and technical services, IT services, cultural and creative services, logistics and its ancillary services, professional verification and consultancy services, and tangible movable property lease services. The applicable rates of VAT are shown in the table.

VAT rates for services under the pilot programme
TypePilot industry/services(Before) business tax rate(After) VAT rate
General taxpayer(s)Transportation industry3%11%
Selected modern services (tangible?property lease excluded)5%6%
Tangible property lease only5%17%
Small-scale taxpayer(s)Same as general taxpayersSame as general taxpayers3% (VAT levied on sales value without allowing deduction of VAT)

In general, the existing preferential business tax policies have been grandfathered. If a pilot enterprise (which originally enjoyed business tax exemption status for its business or part of its business) satisfies the specified conditions, such enterprise will be exempted from VAT during the remaining period of business tax exemption granted previously.


The implications of this tax reform for different types of enterprises will vary. On one hand, domestic VAT taxpayers will be able to claim as an offset against the output VAT the input VAT paid in respect of the services covered by the pilot programme, thereby reducing the tax burden it had to bear. On the other hand, business tax-payers outside the pilot area would, as end users, suffer from VAT charged by the pilot enterprises for their purchase of these services. In addition, due to the big difference between VAT and business tax rates, the tax burden for one transaction calculated based on the VAT rate will in most cases be higher than that calculated based on the business tax rate. Pilot enterprises in Shanghai, and other enterprises which trade with such pilot enterprises, should proactively study the potential impact of the tax reform on their respective financials and tax position and then develop corresponding strategies.

More policy guidance for implementing such tax reform is needed. There will be complicated issues relating to the interface of the VAT/business tax regimes for and between different regions (Shanghai and non-pilot regions), different types of taxpayers (pilot enterprises and non-pilot enterprises) and different service sectors (mixed sales involving both goods and services). We anticipate that the State Administration of Taxation and/or its local counterpart in Shanghai would issue operational rules to provide clarifying guidance for implementing the pilot programme.

David Liu and Julie Cheng

© 2021 Euromoney Institutional Investor PLC. For help please see our FAQs.

Instant access to all of our content. Membership Options | 30 Day Trial