The switch to VAT: Ensuring compliance for new VAT payers

Tax-reform_276354359China’s value-added tax (VAT) pilot reform was implemented nationwide on 1st May, 2016. With the expanded scope now covering four new sectors—construction, real estate, finance and life-style services—business tax has now become history in the story of China’s tax system. Stephane Rinkin, VAT Partner, and Daphne Cheok, VAT Manager, Ernst & Young (China) Advisory Limited (EY China), look at the compliance challenges for new VAT payers.

The China VAT scope is now much broader than previously with many varying rates of VAT, depending on the industry. The finance industry and life-style services industry have been added to the ‘supply of services’ category with a VAT rate of six per cent, while for the construction and real estate industries a VAT rate of eleven per cent applies. It is worth noting that special VAT rates of three per cent for the construction industry and five per cent for the real estate industry will also apply for transitional contracts and/or transitional projects, i.e. agreements signed on/before 30th April, 2016, and which will continue after 1st May, 2016.

Circular 36, Implementing Measures for Pilot Collection of Value Added Tax in Lieu of Business Tax, jointly released by the Ministry of Finance (MOF) and the State Administration of Taxation (SAT), lays down relatively specific rules for the four industries, each of which has unique features in terms of business models, income and cost structures. This will likely bring new challenges for new VAT payers when implementing the new rules.

China’s tax authorities have been playing an important role in ensuring a smooth transition from business tax to VAT (B2V) and implementing rules for new VAT payers. So far the public has been appreciative of their efforts to provide further clarity on the VAT issue, by continuously releasing documents and announcements.

Preparing for VAT compliance

Despite the best efforts of the Chinese tax authorities, though, the complexity of the new VAT rules means that further clarification is still required. The B2V reforms demand that entities not only adjust their business operations to comply with the new VAT rules, but that they also focus on preparation and submission of more complex VAT returns. In addition to newly added VAT forms, Chinese tax authorities have also announced revisions to existing VAT returns and appendices forms, which could present additional challenges.

Developing an innovative VAT compliance methodology

Entities need to concentrate on developing a comprehensive workflow in order to turn data into VAT reports. This in itself is by no means a simple exercise, let alone the subsequent consolidation process, which involves collating a large volume of the transactions/source data if the ‘get start’ [1] method has not been implemented properly. This typically includes integrating data flowing and data mapping with the Golden Tax System,[2] the company’s enterprise system and enterprise resource planning (ERP) system.

The question then, is whether the company has already begun establishing a comprehensive workflow from the capturing of source data to processing the information in the system and generating reports. Of the four industries, the finance industry has the most complicated process. For instance, a bank’s operational model relies on different systems communicating financial information through multiple sources and database interchange processes.

Preparing a tax reporting team for VAT compliance

There are two key steps that entities must follow in order to prepare for their VAT reporting and ensure timely submission. The first step is to train the relevant personnel (e.g. tax and accounting staff members) on the new VAT compliance and reporting processes. The second step is to establish robust procedures to monitor the submission status of VAT returns, especially for entities with multiple branches. It would appear that not all entities know how to complete these steps internally, and, moreover, there are not many tax compliance professionals available to handle the new and revised VAT compliance requirements that will take effect from June 2016.

Finding an efficient way for VAT compliance and reporting

Entities employ many solutions for their VAT compliance and reporting. One approach is to outsource the VAT compliance and reporting to a third-party service provider. Outsourcing may help the entity manage its VAT reporting obligations and guarantee accuracy and proper reporting from the beginning. However, if there are multiple service providers across different jurisdictions (local tax agents), the standards of the VAT reporting may vary significantly in each location.

The alternative approach is using in-house resources. Of course, this would require the entity to invest a lot of effort and resources immediately to assess, design and implement a centralised system to complete the VAT returns in multiple jurisdictions, some of which may have different reporting requirements. However, in the long term this approach may allow a better integration of the enterprise’s finance and operation functions.

Getting it right for the first taxable period

Getting it right from day one is important from a VAT compliance perspective. The affected entities should consider a solution which offers more than the preparation of VAT returns. It should also provide the ability to trace the data, together with the capacity for a comprehensive analytical review. For example, the ability to perform the transactional analytical test by identifying anomalies, errors and exceptions on a transactional line basis.

In conclusion, entities need to establish an effective VAT compliance methodology for both VAT returns preparation and analytical processes. China tax authorities would expect all entities to have quality VAT compliance and reporting procedures. In order to achieve this, entities must have more clarity and visibility on their VAT position, tracking of source data and providing the broad range of management analysis that is required. It is recommend that you employ the best and most appropriate resources to evaluate the VAT implications and set up action plans.             

The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organisation or its member firms.

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[1] Company’s standard operating procedures.

2 China’s national tax system.