Taxing times for China's tax reformers(2)

Booster of confidence

Business tax applies to a production process, with the tax rates varying from 3 to 15 percent according to different sectors, while VAT is deduced from the difference between a commodity's price before taxes and its cost of production.

VAT and business tax together accounted for more than 50 percent of China's tax revenue in 2011.

Following Beijing on Sept 1, VAT will be further applied to the transport sector and some modern service industries, replacing business tax, in the provinces of Jiangsu and Anhui on Oct 1, Fujian and Guangdong on Nov 1 and Tianjin, Zhejiang, and Hubei on Dec 1.

The ambitious expansion was based on the positive results seen in the trial program that started in Shanghai on Jan 1.

A total of 135,000 enterprises had been included in the program and a tax reduction of about 4.4 billion yuan was recorded during the first half, according to the city's taxation authorities.

Jiang Zhuoqing, director of the Finance Bureau of Shanghai, said 90,000 small enterprises in the city, which is 66.5 percent of the pilot taxpayers, enjoyed tax cuts of around 40 percent.

"At a time of an intensifying economic downturn, the tax reform has forcefully promoted the healthy development of small and micro businesses," Jiang said.

"The structural tax cut is a major part of the proactive fiscal policies promised to relieve the increasing downturn pressure facing the Chinese economy," said Zhang Bin, a director of the tax research department with the National Academy of Economic Strategy at the Chinese Academy of Social Sciences.

A series of measures adopted by Chinese authorities seems to have had little positive effect on the world's second largest economy, which was expanding at its slowest pace in three years in the second quarter at 7.6 percent.

Amid a declining marginal effect of easing monetary policies, as well as concerns of a possible rebound in inflation and especially housing prices, experts are calling for more in-depth solutions to revitalize the economy, and many appeals have been made for tax cuts to play a major role.

Gao Peiyong, head of the Finance and Trade Economics Institute under the Chinese Academy of Social Sciences, predicted China has the room for a maximum of 600 billion yuan in tax cuts this year.

According to a calculation by the Research and Development Center affiliated to the Shanghai municipal government, the municipality's total tax revenue would decline 10 billion yuan in 2012 because of the pilot program, which is equivalent to 3 percent of the local government's total tax revenue.

In the Shanghai pilot program, the reform brought down the tax burden for 75 percent of IT and financial service companies and 80 percent of taxpayers in creative industries, said Xiao Jie, minister of the State Administration of Taxation, at a forum in Guangzhou.

Moreover, "the reform could lead to a reduction in tax revenue of more than 100 billion yuan once expanded nationwide," he added.

To that end, the tax cut could help fuel the country's GDP growth by 0.5 percent, increase service sector output by 0.3 percent, raise domestic consumption by 1 percent and create 700,000 new jobs, said the minister.

Meanwhile, the VAT pilot program will provide a timely boost to China's exporters, who are struggling amid sluggish demand from overseas and rising costs domestically, said Lachlan Wolfers, a tax partner at KPMG China.

The VAT pilot program benefits exporters in two main ways. First, services provided to overseas entities will typically qualify for exemption from VAT, which compares favorably with the previous position where 5 percent business tax was payable, Wolfers said.

"This is consistent with the central government's strategy to promote the development of the service industry in China and to make it more internationally competitive.

"Businesses in the consulting, IT and logistics sectors are major beneficiaries of this change, which also serves to encourage the development of outsourced service centers in China," he said.

Second, manufacturers based in China who export goods to overseas will now be eligible to claim VAT credits for the services they purchase as inputs to their business.

"Previously, 5 percent of business tax was usually payable on those services. This reduces costs for the export industry, which is particularly welcome given current levels of global economic uncertainty," Wolfers said.