Starting on Wednesday, China will expand a pilot reform of replacing business tax with value-added tax (VAT) to 10 more provinces and cities, in an effort to lower the overall tax burden and boost certain sectors.

The municipality of Shanghai started the trial program on Jan. 1. By the end of May, a total of 135,000 enterprises had been included in the program and a tax reduction of about 3.7 billion yuan (580.8 million U.S. dollars) was recorded during the first five months, according to the city's taxation authorities.

The VAT will be further applied to the transport sector and some segments of the service industries in the municipalities of Beijing and Tianjin, the provinces of Jiangsu, Zhejiang, Anhui, Fujian, Hubei and Guangdong, as well as the cities of Xiamen and Shenzhen, according to a decision made last week at an executive meeting of the State Council, China's Cabinet.

Turnover tax and VAT are two major tax categories in China. Turnover tax applies to a production process of a business 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.

Results

In Shanghai, business tax has been substituted by VAT with an 11-percent VAT rate on the transport sector and a 6-percent rate on modern service industries including research and development, culture, logistics and consultation, and technological services.

Jiang Zhuoqing, director of the Finance Bureau of Shanghai, said 90,000 small-scale enterprises in the city, which is 66.5 percent of the pilot tax payers, 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 the small and micro businesses," Jiang said.

Gu Ju, head of Shanghai Tax Bureau, said the reform means companies can avoid being taxed twice.

Tang Li, vice president of finance in CBI Group, a company providing information, exhibitions and deal making for bulk commodities, said that the company's revenue for the first five months was 23.25 million yuan, and the VAT was 998,000 yuan.

Tang said that if the company was levied by turnover tax, it would have to submit 1.162 million yuan.

The tax reform has also facilitated the companies to restructure and move up the value chain.

Chang Qing, director of finance of Huayi Group, said the group has outsourced its service sectors after the tax reform, for the outsourcing cost can be used as input tax to be deducted from the output tax under the VAT system, while before the tax reform, the company's services were seen as a part of the production cost, and to out source the services meant that the company would have to pay more business tax.

Further, industrial insiders said that the tax reform has attracted more multi-national companies to set up their headquarters in Shanghai, for the VAT receipts issued in the headquarters are deductible to subsidiaries.

Prospect

Experts say that the biggest difficulty for the tax reform is that it touches on the country's fiscal system.

Under China's current tax regime, VAT is collected by the state taxation authorities, with 75 percent turned in to the central government and the rest to local governments. Revenues from business tax belong to local governments and account for more than one-third of local government incomes.

In Shanghai, the national and local taxation authorities are one and the same, which means that the pilot program would not face many institutional problems.

However, the expansion of the reform will inevitably force the repositioning of the local taxation departments in the participating cities and provinces.

Yang Zhiyong, a researcher with the Chinese Academy of Social Sciences, said to replace the turnover tax with VAT can be seen as an opportunity for China to reform its fiscal system to be more reasonable.

China's VAT pilot is part of a structural tax reduction that began in 2009. From 2009 to 2011, China's VAT reform reduced taxes by over 500 billion yuan against the backdrop of the global financial crisis.

The State Council has also promised to expand the pilot reform to more cities and sectors next year during an executive meeting last week.

The replacement of the turnover tax with VAT could boost China's GDP growth by 0.5 percentage points, if the reform was extended nationwide, Xiao Jie, director of the State Administration of Tax (SAT), said in an article in March.

Bai Jingming, an official with the Ministry of Finance, said that with the expansion of the tax reform, the country will see a reduction of its tax revenue for the time being, but in the long run, it will promote the development of related industries, which will lay a solid foundation for the country's taxation.