# 2013/1 January 2013

China Tax - 2012 highlights in retrospect The main regulatory developments in 2012

Contacts Shanghai

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Pilot VAT - reform has taken shape in Shanghai from January 2012. Since then, the following cities and regions have followed: Beijing, Jiang Su province, An Hui province, Fu Jian province, Guang Dong province, Hu Bei province, Zhe Jiang province and Tian Jin

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Social Insurance for expatriates is still not implemented in Shanghai, whereas in most other regions in China it has been implemented and companies started paying for their expats

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A clear definition of illegal employment has been introduced and considering the general push towards higher compliance we expect tighter controls

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Conclusion and Outlook for 2013

Hongxiang Ma Partner [email protected] +86 21 5047 8665 Hong Kong Claus Schuermann Partner [email protected] +852 2528 1229 Germany Karsten Gnuschke Partner [email protected] +49 89 28646 139

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Introduction The most crucial changes were announced in the middle of 2012, when the Ministry of Finance (“MOF”) and the State Administration of Taxation (“SAT”) jointly issued a Circular regarding the second wave of the Value Added Tax (“VAT”) pilot program in Beijing and seven other provinces/cities. Additionally, two Circulars concerning the qualification of zero-rated or exempted VAT-able services and the application of the “tax exemption, credit and refund” method were released. We noted that the Chinese government continued to strengthen the administration on foreigners in China. In order to narrow the gap between the treatment for foreign individuals and Chinese nationals, various districts have issued local regulations in order to implement the New Social Insurance Law, which under certain conditions includes foreigners in the scope of Social Insurance in China. In addition, a new entry and exit administration law announces some attractive visa possibilities for talented foreigners, and at the same time introduces a stricter administration in general. The Shanghai Tax Bureau issued a pre-settlement mechanism for tax disputes, which opens a new door for settling disputes with the tax authorities in Shanghai, and could be a signal for the dispute settlement treatment on a nationwide level. Further important regulations were issued in 2012 with regard to cross border activities, i.e. Double Tax Agreements (“DTA”) and customs related issues. Specifically, the determination of the “beneficial owner” of income under China’s DTAs has been further clarified. In addition, further to the national customs regulation with regard to the pre-evaluation issue in terms of export/import, variable local Customs authorities have issued local implementation regulations. In conclusion, it appears that the Chinese government is continuing its approach to establish a more standardized and international taxation regulatory system. Therefore, it is vital for companies and investors to get prepared for the reforms and changes in the Chinese tax system in order to run their businesses in a healthy and efficient manner. In the following, please find further details regarding the top 6 developments in the tax and business area in China in the year 2012.

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Pilot Value Added Tax (“VAT”) Reform in China

1. 

Second wave of VAT-pilot scheme

After Shanghai being the first city experimenting with the Pilot VAT-reform in China, the second wave of the 1 VAT pilot scheme in China was expanded to eight other provinces/cities in China. The first result of this is, that dealing with VAT/BT has become a complex task, as you have to consider where a service is provided, who is the recipient, is the exact service covered under the new rules or not and when is it actually provided, i.e. before or after implementation of the pilot scheme. The detailed regions and dates of implementation of the VAT-pilot reform are:

Implementation 2012 September 1:

date

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Covered Areas 1. Beijing

October 1:

2. Jiang Su province / 3. An Hui province

November 1:

4. Fu Jian province (including Xia Men ) / 5. Guang Dong province (including Shen Zhen ) 6. Hu Bei province / 7. Zhe Jiang province (including Ning Bo) / 8.Tian Jin Municipal City

December 1:

In general, the scope and rules of the second wave VAT reform locations will follow those of the Shanghai VAT pilot program. As such, the scope will cover transportation and certain modern service industries which have 2 been set out in Circular 111 . The services which fall under the VAT pilot program shall therefore include land, water, air and pipeline transmission, as well as services of or in connection with research, development and technology, information technology, cultural innovation, logistics supports, lease of corporeal movables, attestation and consulting. Two factors have turned out to be crucial for companies who are located in a pilot-area and who want to benefit from the VAT-pilot reform: -

-



Large multi-national companies, who are engaged in several or even dozens of BT categories, shall review the nature of the BT transactions to clearly understand whether and to what extent they are covered by the VAT reform and if so, which VAT categories they fall into. It is indispensable to obtain in-charge tax bureaus (both the State Tax Bureau and Local Tax Bureau) opinion on the categorization of the previous BT transactions because it may happen that the State Tax Bureau may regard the relevant services as covered by the VAT reform and therefore subject to VAT, whereas the Local Tax Bureau does not agree.

Possibility of tax refund for certain “exported” services 3

In 2012, two important Circulars were released stipulating for which services one of the two VAT schemes (zero-rating or exemption) shall apply. For services that are zero-rated, it is possible for companies to credit the input VAT for such services against the output VAT whereas in case of a VAT exemption, such input VAT can not be offset against output VAT. Furthermore, the new regulations clarify that the refund rate for zero-rated taxable services will be identical to the VAT rate applied to the corresponding services provided within the territory of China.

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Caishui [2012] No. 71 Caishui [2011] No. 111 3 Caishui [2011] No. 131, Announcement [2012] No. 13 2

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The services, for which aforementioned zero-rating will apply include: -

International transportation services, i.e. carrying passengers or goods from China to overseas, from overseas to China or entirely overseas; ch and development and design services to overseas units.

The calculation applying the “exemption, credit and refund” method is the same as the general calculation method. The aforementioned regulations also give some guidance on how to ratify such VAT refund declarations prepared by variable taxpayers. Most importantly, it must be verified whether or not such service provision is genuine. In the light thereof, we recommend that enterprises keep sufficient documentation proving the truthfulness of such service provision in the event of a challenge by the relevant tax authorities.

2.

Update on Social Insurance for expatriates in China

The PRC Government continuously shows its determination to effectively implement and to collect Social 4 Insurance contributions from foreigners working in China. It is expected that the requirement for foreign employees to participate in the Chinese Social Insurance scheme will be widely implemented and enforced in the near future. Cities with important expatriate communities have already started requesting foreigners and their employers to take certain measures in the direction of the implementation of the new Law. th

The latest update (status as of January 30 , 2013) regarding these implementations and the current status of the implementation of the Social Insurance obligation for foreigners in practice in various cities currently is: 

Beijing: According to the city’s implementation rules, expatriates working in Beijing shall contribute to Social Insurance accordingly. Meanwhile, as confirmed with the Beijing Social Insurance administration, from a practical perspective, authorities are already collecting Social Insurance premiums for qualified foreigners working in Beijing.



Shanghai: No further local implementation rules related to this issue have been released since the issue of the regulation Hurensheyangfa [2009]. Therefore, at the moment it is not compulsory for long term working Shanghai expatriates to contribute to Social Insurance in China. Based on the negotiation between the employer and the expatriates, expatriates working in Shanghai can contribute to Social Insurance. However, only pension, medical and work-related injury insurance are acceptable to be contributed for expatriates currently.



Shenzhen: From 2005 onwards, a local practice has been implemented according to which expatriates shall contribute to Social Insurance. Refund of contributions is possible upon departure from the PRC.



Guangdong: Since the release of Yuelaoshe [2005] 133, nationals from Hong Kong, Taiwan and Macau with a local employment contract shall participate in pension, medical, unemployment and workrelated injury insurance. As for other expatriates working in Guangdong Province, no further implantation rules have been released so far regarding the requirement for the Social Insurance contribution. According to our latest correspondence with the local administrations in the cities of Guangzhou and Zhuhai, all foreigners employed by companies located in the respective city shall also contribute to Chinese Social Insurance in accordance with the national Social Insurance regulation.

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Suzhou: The Social Insurance administration issued Surenbaogui [2012] No.1, according to which qualified expatriates shall register and start contributing to Chinese Social Insurance accordingly from the effective date of the Implementation Rules.



Hangzhou: Based on our latest communication with the Hangzhou Social Insurance administration, a local regulation named Hangshexianzong [2012] 29 has been issued which basically follows the

4

Please also refer to Ren She Ting Fa [2011] No.113

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national regulation. However, this regulation is currently not available in public. In practice, authorities have already started to collect Social Insurance premiums for foreigners who are working in Hangzhou. In order to avoid the late payment surcharge of 0.05% per day, we recommend that employers should already withhold their employee’s contributions, so that such premiums can be paid immediately as soon as authorities start collecting the contributions accordingly. Companies shall also stay closely informed about the development in this regard in order to avoid any possible penalties. In addition, since German expatriates can be exempt from pension and unemployment insurance in China according to the Social Insurance treaty, we recommend that companies with German expatriates review the respective contracts with their expatriates to determine if the expatriate shall contribute to German Social Insurance and apply for exemption in China or if he shall cease his Social Insurance obligation in Germany and start to contribute to Chinese Social Insurance only.

3.

New entry and exit administration law

The new added type of visa provides a more convenient entrance for foreign talents. Meanwhile, the new EEAL offers a chance of permanent residence for qualified foreigners; on the other side, a stricter administration and increased penalties for illegal employment of foreigners in China are stipulated. Therefore, we recommend employers of foreign employees to review the foreigners’ visa status in order to avoid any punishment according to the new law. th

On June 30 , 2012, the National People’s Congress promulgated the new Entry and Exit Administration Law st (hereafter as “EEAL”), which shall come into force from July 1 , 2013. The salient points of the EEAL are elaborated as follows: 

Introduction of new “talent-visa” The new EEAL introduces a new type of visa, the so called “talent introduction”. This new type of visa constitutes a sub-category of the “ordinary visa” type and is intended to attract foreign talented professionals to work in China. It is anticipated that the relevant implementation regulations stipulating the detailed requirements will be released in the near future.



Permanent residence status The new EEAL formulates that a foreigner who has made outstanding contributions to China’s economic and social development or who fulfills further eligibility requirements could apply for the permanent residence status in China. We expect that the relevant detailed implementation rules shall be prescribed by the Ministry of Public Security and Ministry of Foreign Affairs in conjunction with the relevant departments of the State Council.

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Stricter requirement in regard to work permits and residence permits The new EEAL formulates that foreigners working in China shall obtain work permits and work-related residence permits. All Chinese entities and individuals are not allowed to employ foreigners who have not obtained work permits and work-related residence permits.



Clear definition of illegal employment An enumerated definition for illegal employment is stipulated in the new EEAL. According to Article 43 of the new EEAL, a foreigner shall be deemed to be working in China illegally if any of the following circumstances is met:  

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A foreigner works in China without obtaining a work permit or a work-related residence permit as required; A foreigner has carried out jobs beyond the permitted work scope in China; or

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 

A foreign student works in China beyond the types of work or duration in violation of the administrative provisions on work-study.

Stricter punishment measures Foreigners working illegally in China shall be fined with an amount between RMB 5,000 and RMB 20,000; in serious cases, foreigners may be detained between 5 to 15 days. Corporations employing illegal foreigners shall be fined RMB 10,000 for each employed foreigner, with a maximum fine of RMB 100,000. In addition, the relevant authorities will confiscate all financial gains derived from the illegal employment. Foreigners who are proved to enter, stay or work in China illegally may be repatriated to her/his home country by the in charge authority. The repatriated foreigner may not be allowed to enter China within 1 to 5 years from the day when he is repatriated.

4.

Further clarification of recognizing “beneficial ownership” in tax treaties th

Substance over form is further on the rise. With further clarifications stipulated in Circular 30 issued on June 29 , 5 2012 , the SAT provides enhanced guidance on how to determine "Beneficial Owners" in Tax Treaties: 

Overall objectives and principles Circular 30 regulates clearly that, when determining whether a company shall be the beneficial owner of 6 income, ALL the relevant factors as mentioned in Circular 601 have to be taken into consideration equally. The determination shall not be made based on simply one of the factors as listed or just because the purpose of evading or reducing tax or transferring or accumulating profits does not exist.



Listed company safe harbor For dividend income, if the immediate recipient is a resident company of a DTA contracting state and is a listed company, it will automatically be treated as the beneficial owner of the dividends distributed from a Chinese company. The same treatment shall be applied, if the subsidiary, which receives the dividends, is 100% directly or indirectly owned by the listed parent company and is located in the same jurisdiction as the listed company (provided the subsidiary is not indirectly held through a third jurisdiction).



Further clarification on administrative procedures Circular 30 grants the right to the in charge tax authority to temporarily refuse the application of DTA benefits, in case it is difficult to determine whether the recipient of income is the beneficial owner and such decision can not be made within the specified period. In case the recipient is ultimately recognized as the beneficial owner indeed, a corresponding tax refund on the overpaid tax shall be granted to the tax-payer. In addition, Circular 30 stipulates that in case a tax authority decides to reject an application for DTA benefits on the grounds that the applicant is not the beneficial owner of the income, the tax authority in charge must obtain the approval of the provincial level tax authorities. In addition, the decision has to be reported to the SAT’s International Tax Department for record.

Circular 30 further clarifies certain issues which have not been covered sufficiently in Circular 601. Particularly, it guides tax offices to apply the beneficial ownership test more in a way that is in line with international standards. 5 6

Announcement of the State Administration of Taxation [2012] No. 30 Guo Shui Han [2009] No. 601

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5.

Implementation of local Customs pre-valuation ruling

Pre-valuation is being introduced in order to provide upfront certainty on the valuation of the imported good. On th 7 December 27 , 2011, the Harbin Customs authority issued a Circular (“Circular 1”) announcing that the local 8 st implementation of Circular 124 would apply as from January 1 , 2012. Further, the cities Hangzhou, Urumchi, Shanghai, Nanning and Shijiazhuang have issued similar regulations in order to implement the pre-valuation mechanism in practice. The provisions applicable to all 6 cities are set out as follows: 

Scope of pre-valuation All local implementation regulations only mention the pre-valuation possibility for importation, but not for exportation of goods.



Deadline for application To be taken into account, an application for pre-valuation must be submitted to the respective Customs authority at least 15 working days prior to the effective importation of the goods.



Positive/negative decision of Customs authority Positive decision: the Customs authority decides that the pre-valuation application complies with the relevant rules on assessing the dutiable price. As a consequence, the Customs authority then issues a “Decision on the Customs pre-valuation on Imported Goods”, the validity period of which varies according to the respective district. Negative decision: The Customs authority disagrees with the pre-declared price or cannot determine the transaction price of the goods to be imported. The Customs authority then issues a “Notification for Customs pre-valuation on Imported Goods”, and the concerned enterprise will have to complete the regular import declaration formalities.

2012 seems to be setting a trend for nationwide implementations: the Circulars issued in Harbin, Hangzhou, Urumchi, Shanghai, Nanjing and Shijiazhuang may only be the first ones to come in this domain.

6.

Pre-settlement mechanism for tax-related disputes in Shanghai

Taxpayers in Shanghai now have the possibility of initiating a pre-settlement mechanism for disputes with tax authorities, which brings a higher degree of certainty on tax positions and a big advantage compared to other locations in China. th

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On April 17 , 2012, the Shanghai Tax Bureau issued a Circular (“Circular 7”), concerning the introduction of a th pilot pre-settlement mechanism for tax-related disputes. Circular 7 is with effect from April 17 , 2012 and only covers the area of Shanghai. Circular 7 sets out detailed implementation rules for the pre-settlement mechanism for tax disputes. The key points include: 

Basic principles: The pre-settlement mechanism for tax-related disputes will not replace other existing

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Bulletin of the Harbin Customs [2011] No.1 GAC [2005] No.124 9 Hu Guo Shui Na [2012] No. 7

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mechanisms for dispute settlement, but will serve as a beneficial supplement to the existing framework. In order to ensure a fair and equitable result of the mediation, the leading department for pre-settlement of tax-related disputes shall be a department relatively independent of the parties to the dispute. 

Scope for pre-settlement of tax disputes: Where taxpayers are dissatisfied with the facts ascertained by the competent tax authorities, tax laws and regulations based on which the specific administrative act was made, and the procedures followed thereby when handling of matters such as tax registration, tax declaration, tax collection, tax inspection, administrative penalty imposition, tax credit rating and other tax-related matters; or where taxpayers or third parties having a direct interest in the matters applied by the taxpayers consider the tax authorities fail to perform their duties in accordance with the law.



Applicants of pre-settlement of tax disputes can be: Taxpayers, third parties having direct interest in the issues conducted by the taxpayers and competent tax authorities for the tax disputes.



Circular 7 also sets out the detailed process for pre-settlement of tax disputes and the timeline for tax authorities to settle the tax disputes, which provides a clear working guideline for tax authorities and applicants.

In addition to the administrative review and administrative litigation, with the implementation of pre-settlement mechanism, there is an additional type of remedy for tax disputes in Shanghai. As such, the pre-settlement mechanism is a supplement to the existing frame-work, which means taxpayers are still entitled to exercise the right of relief through the administrative review and administrative litigation if they are dissatisfied with the presettlement result.

Conclusion and Outlook From a tax and legal perspective, the year 2012 in China was clearly characterized by three major developments. Firstly, the turnover tax reform has been extensively widened. Up to now, in addition to Shanghai, 8 further provinces and municipalities including Beijing have been included in the second wave of the pilot VAT reform. We hope that this development continues and that the VAT reform will be implemented in all regions in China eventually, thereby reducing indirect tax cost. Companies providing services such as land, water, air and pipeline transmission, research, development and technology, information technology, cultural innovation, logistics supports, lease of corporeal movables and attestation and consulting are the big winners of the VAT pilot program, since it is generally possible for such enterprises located in pilot-areas to benefit from the inputVAT scheme. Specifically companies who are engaged in International transportation services or who provide research and development and design services to overseas units can benefit, since they are allowed to apply for a VAT-refund upon providing such services. However, there are still some issues when applying the new regulations in practice. As such, it has turned out to be rather time consuming to obtain the determination from the tax authority in regard to whether the relevant services fall under the VAT-pilot program or not. In addition, some companies reported that it is difficult to obtain the approval for tax-exempted/0-rated services, when companies located in pilot-areas “export” their services to overseas. As a result, some companies still face a situation of relatively big uncertainty with regard to invoicing their services to overseas companies and applying the correct tax rate. Secondly, the administration on foreigners in China has been strengthened and brought to a more international level. Aside from the Social Insurance obligation for expatriates, a new entry and exit administration law has been issued in 2012, which includes positive changes but strengthens the overall administration on foreigners at the same time. With the obvious desire of the Chinese government to treat Chinese nationals and foreigners more equally, the strengthened administration of foreigners in this regard is generally a positive development on China’s way to a more international regulatory system, but still increases costs of expatriates significantly. Thirdly, Chinese tax authorities tend to adjust administration with regard to tax related disputes. Before the introduction of the new pre-settlement mechanism in Shanghai, tax authorities have been in a more powerful position with regard to tax treatments, which have been determined by the tax authority itself. In practice, only a few companies would raise tax appeals for certain controversial cases due to the long time scale and relatively Page 8 of 10

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high uncertainty of the tax appeal process. By introducing such pre-settlement mechanism of tax disputes in Shanghai, a new door is opened for tax payers, who, during certain tax compliance procedures, have a different opinion on a tax issue than the tax authority. By allowing companies to report such issues and settle the disputes before the final decision is made by the tax authority, unnecessary time costs can be avoided and, to some extent, a correct taxation approach can be negotiated between taxpayers and tax authority before-hand. The new regulations with regard to the determination of beneficial ownership, Social Insurance for foreigners and the new entry and exit administration show the government’s desire to enhance control over previously rather unregulated areas. Clearly, companies doing business in China must continuously review their degree of compliance. Regular adjustment reviews are necessary in order to avoid pitfalls and penalties and stay tax efficient. For the year 2013, we expect the following major developments: Control and administration over foreign companies and foreign individuals will continue to increase. Companies located in Shanghai shall prepare to pay Social Insurance contributions for their expatriates. Though Shanghai currently has not yet issued local implementation rules, we expect that the Central government will soon push for Shanghai to implement such obligation the same way most other regions in China already do. In addition, we expect that according to the new entry and exit administration law, authorities will strictly enforce the new, generally stricter, rules. As such, we recommend not to take this development slightly and not to underestimate the practical consequences of incompliance in this area. The fact that the Chinese government decided to include, next to Shanghai, eight further cities and provinces in the VAT-reform at the end of 2012 can be considered a signal that the VAT-reform is generally regarded as a success. Therefore, we hope and expect that in 2013 the VAT-reform will be a) expanded to further regions in China and b) expanded in terms of services, which fall under the VAT-reform. As for the existing issues in regard to carrying out the VAT-reform in practice, it is likely that current obstacles in dealing with tax authorities will decrease over the next year as authorities are gaining experience on an ongoing basis in a so far still quite new area of tax law in China.

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Author

Contact

WTS Consulting (Shanghai) Ltd. Unit 031, 29F, Hang Seng Bank Tower 1000 Lujiazui Ring Road Pudong New Area, Shanghai 200120 PRC Tel: +86 21 5047 8665 Fax: +86 21 3882 1211 www.wtscn.cn [email protected]

Shanghai Hongxiang Ma Partner [email protected] +86 21 5047 8665 Hong Kong Claus Schuermann Partner [email protected] + 852 2528 1229 Germany Karsten Gnuschke Partner [email protected] + 49 89 28646 139 4 9 8 9 2 8 6 4 6 1 3 9

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Disclaimer

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The above information is intended for general information on the stated subjects and is not exhaustive treatment of any subject. Thus, the content of this Infoletter is not intended to replace professional tax advice on the covered subjects. WTS Consulting (Shanghai) Ltd. cannot take responsibility for the topicality, completeness or quality of the information provided. None of the information contained in this Infoletter is meant to replace a personal consultation. Liability claims regarding damage caused by the use or disuse of any information provided, including any kind of information which is incomplete or incorrect, will therefore be rejected. If you wish to receive the advice of WTS Consulting (Shanghai) Ltd., please make contact with one of our advisors. All copyright is strictly reserved by WTS Consulting (Shanghai) Ltd.

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