Provisional rules on taxing international transportation services under the Chinese VAT pilot scheme released

On 29 June 2012, the Ministry of Finance and the State Administration of Taxation jointly issued the Supplementary Circular on Several Taxation Policies Concerning the Pilot Scheme of Replacing Business Tax with VAT in Transport Sector and Selected Modern Service Sectors (CaiShui 2012 No. 53) (“Supplementary Circular”).

Article 1 of the Supplementary Circular provides that for entities or individuals from countries or regions that have not concluded bilateral transport arrangement with China, if they provide international transportation services to entities or individuals in China and meet the conditions stipulated under Article 6 of the Implementation Rules on the Pilot Scheme of Replacing Business Tax with VAT In Transport Sector and Selected Modern Service Sectors (Caishui 2011 No. 111) (i.e. such foreign service providers have no establishment or place of business within China), such services will be provisionally taxed at the VAT-collecting rate of 3% during the pilot period, to be withheld and paid by the local agents of the service providers (or by the service recipients, where applicable). This new rule is retroactively effective as from 1 January 2012.

The 3% VAT-collecting rate in general is a reduced rate applicable to small-scale taxpayers without right of deduction, thus the 3% tax becomes the extra burden on the service recipients as they may not deduct from its output tax payable. The foregoing indicates that customers in China will bear a higher cost if they choose to purchase international transportation service from the service providers in those countries or regions without the bilateral transport arrangement with China, which then makes such service providers less competitive in the international transportation market.

As such VAT-collecting rate is only provisionally applicable, likely in the future such collecting rate will be replaced with the standard VAT rate of 11% applicable to transport sector under the pilot scheme, in which case the right of deduction will supposedly be granted and the 11% deductible tax will not be the extra burden to the service recipients.