On 24 March 2016, the Ministry of Finance (MoF) and the State Administration of Taxation (SAT) jointly released Caishui  No. 36 on the Comprehensive Roll-out of the B2V Transformation Pilot Program (“Circular 36”), under which the real estate and the construction industry will be transformed from business tax (BT) to value-added tax (VAT) (“B2V Reform”) starting on May 1st 2016 (“expansion date”).
The key points of the notice include: qualified old construction projects can elect the simplified VAT method; selling or renting immovable property and the construction industry are subject to the general VAT method with a tax rate of 11%; a real estate development general VAT taxpayer selling an old self-developed real estate project can elect the simplified VAT method; qualified land acquisition price can be deducted from the sales amount; taxpayers can claim input VAT credit on VAT incurred on the purchase of immovable property with valid invoices; pilot taxpayers providing overseas construction service are eligible for VAT exemption.
Pilot taxpayers should be familiar with Circular 36, deal with the treatment of the VAT properly during the transition period, understand the regulations of VAT timely, pay attention to subsequent follow-up measures of theB2V Reform, and analyse the impact and react accordingly.
We analyzed the overall objectives, layout and directions of the B2V Reform in our News Flash entitled “B2V Expansion Measures Released — VAT is now completed for All Industries” published on 24 March 2016. We will not be repeating this again, but are providing our view and observation on the practical issues faced by the real estate and construction industry during the initial stage of this final round of B2V Reform.
Objectives of the B2V Reform and pilot taxpayer’s responding strategies
As a key structural tax reduction measure of the country, the objectives of the B2V Reform are to expand the VAT credit chain, solve the multiple taxation issue, optimize the taxation system and accelerate industrial upgrading.
However, for taxpayers in the real estate and construction industry, they should pay attention to the impact of the B2V Reform and focus on the following three areas:
- Preventing tax risk. Pilot taxpayers should make sure that they will be in compliant with the tax rules after the B2V Reform. As compared with the relatively simple BT administration, the administration of VAT is much stricter. In some aspects, such as day-to-day matters, tax return filing, special VAT invoices, the administration requirement of the tax authorities are more complicated. Pilot taxpayers in the real estate and construction industry should pay more attention to risks relating to revenue recognition, input VAT credit and invoice management and establish a sound tax internal control system to make sure the tax rules are fully complied.
- Monitoring the reduction of tax burden. For real estate and construction industry taxpayers, the treatment of pre- and post- B2V Reform projects, the timing of the purchase of assets and the business cycle of the enterprise can easily influence the VAT burden. Although the VAT will not be on an enterprise’s income statement, it will still have an impact on the income statement through items, such as revenue, cost, expenses, taxes, etc. The accounting method of tax-price separation will also affect the corporate income tax, land appreciation tax, etc. of taxpayers in the real estate and construction industry. Taxpayers should make full use of the policy reasonably, to monitor the reduction in tax burden. Taxpayers should also fully considered the impact to all taxes in estimating the changes in the total tax burden in order to understand the overall impact of the B2V Reform on the operational outcomes.
- To enhance business development. VAT has the characteristics of recovering input VAT at every stage of the business cycle. After the B2V Reform is completed, goods, labor and other services are all included in the VAT credit chain and every industry would be more closely connected with its upstream and downstream industry. Some new changes, such as price-tax separation and input VAT credit claim, will influence commercial negotiation and pricing strategy of pilot taxpayers. Pilot taxpayers should make use of the characteristics of the VAT tax system to enhance the development of business and increase its profitability.
The following are key points of the transition policy and observation on some important issues which are not clear in the policy for your reference.
- Summary of the transition policy
For real estate and construction industry taxpayers, the first issue is the application of the transition policy on 1 May. Circular 36 has provided a complete transition policy to make sure that the B2V Reform is smooth. The principle is to allow pilot taxpayers to elect to use the simplified VAT method for old projects without changing to the general VAT method immediately. Details are shown in the appendix.
- Division standard for old projects and new projects
Circular 36 uses the “Building construction permits” as the dividing line between old and new projects. Old projects refers to projects which has a construction commencement date that is on or before 30 April 2016, and is written in the “Building construction permit”. In the situation where the “Building construction permit” has not been received, old projects refer to those projects which has a construction commencement date that is on or before 30 April 30 2016 and is written in the construction contract.In practice, these two types of pilot taxpayers would generally face the situation of different “Building construction permits” for different buildings in a project. If these “Building construction permits” are issued and spread out before and after the expansion date, pilot taxpayers might have to deal with the complicated issue of using the simplified VAT method and the general VAT method respectively for the same project.
- Transition policy for selling immovable properties (Details are shown in appendix.)
Circular 36 stipulates that real estate development enterprises which pre-sell development projects should pay provisional tax of 3% on receiving the pre-sale payments. However, it has not clarified whether the 3% provisional tax rate or the 5% levy rate under the simplified VAT method would apply to the pre-sale of old projects by taxpayers which have elected to use the simplified VAT method. We suggest taxpayers to pay attention to the interpretation of this provision and the follow-up policies.In addition, for general VAT taxpayers which sell non-self-developed immovable property acquired before the expansion date, Circular 36 has kept the original BT regulation on the deduction of the acquisition cost and the acquisition cost can be deducted from the sales amount in arriving at the VAT taxable turnover in paying VAT.Circular 36 divides the sellers of immovable properties into “Real Estate Development Enterprises” and “General VAT taxpayers” mainly from the point of view of tax collection. Real estate development enterprise which sells its own developed real estate belongs to “new house” selling, and can directly issue official invoices to its customers and pay VAT to the state tax bureau. General VAT taxpayers which sell self-developed and non-self-developed immovable properties belongs to “second-hand house” selling (since property ownership certificate would be received on the transfer of self-developed immovable property to self-use property, the re-sale belongs to “second-hand house” selling), the official invoices would be issued by the tax authority for the taxpayer and the VAT would be collected by the local tax bureau for the state tax bureau.
- Transition policy for leasing of immovable properties (Details are shown in appendix.)
In practice, it is quite common for real estate development enterprises to lease its self-developed real estate to earn rental income. Whether the leasing of self-developed old project real estate that was completed before the expansion by real estate development enterprise would qualify for the above transition policy depends on the interpretation of the scope of “Acquisition” in the provision. Unlike the selling of immovable properties, the word “Acquisition” in this provision is not annotated by the term “Not including self-developed”. Therefore if it is interpreted as including “Original Acquisition and Inherited Acquisition”, then real estate development enterprises which lease self-developed old project real estate to earn rental income can elect to use the transition policy and pay VAT at the levy rate of 5%. We suggest taxpayers to pay attention to the interpretation of this provision and the follow-up policies.Circular 36 stipulates that general VAT taxpayers, who lease immovable property acquired before the expansion date can elect to use the simplified VAT method and pay VAT at the levy rate of 5%.
- Issuing invoices and claiming input VAT credit by the Downstream
The current policy is unclear as to whether taxpayers which provide construction services, have real estate development old projects or lease old project real estate that are eligible for the transition policy and have elected the simplified VAT method to pay VAT, can issue VAT invoices with the 3% provisional tax rate or the 5% levy rate to the downstream customers, or can only issue general invoices. Under the existing policy, if VAT invoices cannot be issued for items using the simplified VAT method, they will be clearly listed in the rules. Taxpayers should pay attention to the follow-up policy on this issue. Taking into consideration that obtaining VAT invoices would determine whether or not the downstream customers can claim the input VAT credit and would also affect business decisions, pilot taxpayers should fully considered the policy when facing this issue.
- Transition period
Circular 36 does not provide a specific ending time for the transition policy, therefore the valid period of the relevant transitional policy is uncertain. It may be clarified in the future specific industry rules or combined with the enactment of the VAT legislation.
- Change in tax burden
For pilot taxpayers eligible for the above transition policy, although the levy rate is basically similar to the original BT rate, as VAT is a price exclusive tax [that is: sales price=price inclusive of VAT/ (1 + levy rate)], the actual tax burden of general VAT taxpayers which select the transition policy will reduce slightly from the original 3% and 5% BT rate. However, input VAT of general VAT taxpayers and land acquisition cost of real estate developing enterprises will be irrelevant for the VAT calculation. In choosing the applicable policies, taxpayers should perform a meticulous assessment by considering the status of input VAT, the ratio of land cost to total costs, the input VAT requirement of downstream customers, the internal accounting capability, the impact on tax burden and then carefully select the appropriate transition policy.
Tax analysis of different phases in the real estate and construction industry
- Development phase
Apart from loan financing, pre-sale is also a common financing method by real estate development enterprises. Circular 36 follows the original BT rules that real estate development enterprises which pre-sell their self-developed real estate projects are required to pay provisional VAT at the rate of 3% on receiving the pre-sale payments. Although it does not need to pay provisional VAT at the applicable VAT of 11%, this provisional tax payment will still have a certain impact on the cost of capital.Circular 36 stipulates that input VAT on lending services such as interest payment as well as advisory fees, commission charges, consulting fees, etc. that are directly related to the lending services are not creditable. This means that interest expense incurred during the real estate development phase cannot be creditable and hence the taxpayer’s cost of capital will not be reduced.Land acquisition costs
Pilot taxpayers which purchase land from the government are not able to obtain valid invoices to support the input VAT credit and therefore are not allowed to claim input VAT credit for the land cost. In that respect, Circular 36 stipulates that the land cost can be deducted from the sales revenue (see details below: sales revenue-land cost net basis deduction)
- Construction phase
According to the original BT regulations, for pilot taxpayers which subcontract the construction project to other units, the BT taxable turnover is the balance of total sales consideration (sum of sales revenue and fees in addition to the price) less the subcontracting fee paid to the other units. Circular 36 only keeps the deduction rules for the simplified VAT method. As for the pilot taxpayers using the general VAT method, input VAT credit can be claimed for the sub-contracting fee actually paid with valid supporting invoices.Contract without supplying materials
In construction services contract without materials, the major cost of the contractor does not include (or only includes a little) material cost, and at the same time, the non-creditable labor cost represent a very large proportion. Pilot taxpayers, which are subject to the 11% tax rate, are likely at risk of an increasing tax burden due to insufficient input VAT credit. Therefore, Circular 36 provides the simplified VAT method option to taxpayers. Considering that VAT taxable turnover = sales revenue inclusive of VAT/ (1+levy rate), the contractor’s tax burden will be slightly reduced, but at the same time, the service recipient will not be able to fully claim the input VAT credit.Circular 36 stipulates that general taxpayers in the construction industry which provide construction services via contract without supplying materials can elect to use the simplified VAT method. Construction services via contract without supplying materials refers to project that the contractor does not purchase any project material or only purchase auxiliary material and only charge for labour cost, management overheads or other construction service costs.
Contract with the principal providing equipment and material
The policy consideration for these two types of construction services is basically the same. It is necessary to note that even if the principal only provides part of the equipment, materials and power, the construction service provider can still elect the simplified VAT method. Circular 36 does not have any minimum threshold for the percentage of the equipment, materials and power provided by the principal, therefore even in extreme cases where the principal only provides very few materials, the service provider may likely be able to elect the simplified VAT method as well. Taxpayers should pay attention to follow-up policies to see whether they will be any specific requirement on the percentage of equipment, materials and power provided by the principal supplements.
Circular 36 stipulates that general VAT taxpayers providing construction services under contracts where the principal is responsible for providing all or part of equipment, materials and power can elect to use the simplified VAT method.
Obtaining VAT obtained
The supply channels of raw materials such as brick, lime, sand and earthwork etc. are relatively messy in construction projects. Suppliers are normally small-scale taxpayers or individuals. Hence, for construction industry enterprises, how to strengthen the verification of suppliers in order to timely obtain valid invoices for the full amount in claiming input VAT credit would have a big impact on the tax burden.
- Sales phase
- Sales revenue minus land acquisition cost net basis deduction
Real estate development enterprises which purchase land from the government are not able to obtain valid invoices to support the input VAT credits. Since land acquisition cost generally makes up a large proportion of real estate development cost, there has been a lot of attention on how this significant costs can participate in the VAT calculation.
Circular 36 stipulates that, for real estate developers who are general VAT taxpayers, the sales amount for VAT purpose of selling self-developed real estate projects (except for old projects elected to be taxed under the simplified method) is the balance of the total sales amount and additional fees received less the land cost paid to the government. Though the land cost cannot be directly included in the scope of allowable input VAT credit, the net basis method under Circular 36 of allowing the land cost to be deducted from the total sales amount has in substance achieved the same effect in the VAT calculation. It is important to note that although the land acquisition cost can be deducted from sales revenue, other expenses with no valid invoices are still not creditable, for example, land use fee, land idle fee, house removal compensation expense, crops lost compensation expense and labour cost.Circular 36 stipulates that taxpayers need to obtain valid receipts for the land acquisition cost deduction. These receipts should be monitored (printed) and issued by the provincial level or above (including provincial level) Finance Bureau.
- Selling real estate with decoration, furniture and appliances
Circular 36 has not provided clear guidelines to determine whether related business activities is “concurrent operation” or “a single activity”. If a buyer can choose to buy only the property and not the full decoration, furniture and appliances, would the sales activity be considered as “concurrent operation”; if the buyer has no choice and can only buy the fully decorated house, would the sales activity be considered as “mixed sales”. Taxpayers should pay attention to the follow-up documents.In practice, real estate development enterprises may also provide decoration, furniture and home appliances when they are selling residential property. This creates the issue of concurrent operation and mixed sales.
Circular 36 stipulates that where a taxpayer provides VAT-able activities that are subject to different VAT rates or levy rates, it should separately account for the turnover of each activity. If the VAT-able activities are not separately accounted for, the highest VAT rate would apply to all VAT-able activities. Mixed sales refers to a sales transaction comprising of both services and goods, taxpayers engaging in the production, and the trading of goods would be subject to VAT on such mixed sales under the category of sales of goods, while other taxpayers would be subject to VAT under the category of sales of services.
- Timing of tax obligation and places for tax filing
Under Circular 36, if taxpayers adopt the prepayment method for the provision of the construction services and leasing services, the timing of the VAT obligation shall be the date on which the prepayment is received, for example, real estate development enterprises which pre-sell their self-developed real estate projects are required to pay provisional VAT at the rate of 3% on receiving the pre-sale payments. If taxpayers provide cross-counties (cities) construction services, they shall prepay VAT to the tax authorities at the location of where the construction services are performed, and file the VAT returns to the tax authorities at the location of their establishments. If taxpayers sell or lease immovable properties, they shall prepay VAT to the tax authorities at where the immovable properties are located, and file the VAT returns to the tax authorities at the location of their establishments.In fact, in coming up with the regulations of timing of tax obligation and place of tax filing for the construction industry and real estate industry, it has not only focused on the principles in Circular 36 but also considered a number of practical factors, such as prepayments, issuing invoices in advance, territorial taxation of construction services and real estate, local tax authority collecting VAT and issuing invoices on behalf of the “second-hand house” seller, the tax burden of industry can only decrease and not increase, etc. As to how it will works in real practice, pilot taxpayers should continue to pay attention to the follow-up implementation measures.
- Holding phase—leasing of immovable properties
- Leasing of immovable properties together with other taxable services
Taxpayers that lease commercial immovable property would usually provide other accompanying VAT taxable activities, such as property services, construction services, utility consignment, repair and maintenance services and so on. To be eligible for the concurrent operation policy, taxpayers need to account for each activity separately in the contract, accounting and invoices to avoid the use of the highest tax rate for all activities. If mixed sales policies apply, according to the type of taxpayers, all revenue should be taxed at 11% as leasing real estate. Pilot taxpayers should measure the impact carefully and arrange their business accordingly.
Circular 36 contains provisions for both concurrent operation activity and mixed sales activity. Where a taxpayer provides VAT-able activities that are subject to different VAT rates or levy rates, it should separately account for the turnover of each activity. If the VAT-able activities are not separately accounted for, the highest VAT rate would apply to all VAT-able activities.
- Rent-free period or decoration period
Circular 36 stipulates the provision of services and the transfer of intangibles or immovable properties for no compensation should be deemed as sales and subject to VAT based on the relevant calculation method unless they are used for charitable purpose or targeted towards the public. In practice, with the gradual increase in market competition and innovative sales models, a “rent-free period” or “decoration period” is generally provided in the leasing of immovable properties. In determining whether the above activity is considered as provision of services with no compensation, one not only has to consider the slogan or name of the promotional activity but also has to analyze whether it is closely associated with the compensated services and whether or not it is essentially a discount.
- Land acquisition cost
Notice 36 uses the positive list method for allowable net basis items, and only permits “sales of real estate development projects” to deduct the land acquisition cost. Therefore, if general VAT taxpayers lease self-developed real estate rather than selling them, the rental income would be taxed at 11%, and they cannot deduct the land acquisition cost So there is a risk of increase in tax burden for the pilot taxpayers.
Circular 36 will be formally implemented on 1 May, leaving the pilot taxpayers a very short period for responding. In the remaining one month period, the pilot taxpayers must do the following to respond:
- Actively cooperate with the tax authorities, and prepare for a series of work before B2V, including providing supplementary tax registration information, performing general VAT taxpayer registration, applying for VAT invoices, obtaining appliance for issuing VAT invoices, attending training, record filing for various tax incentives, record filing for export tax rebate eligibility, obtaining access right to online filing system, etc. In addition, the VAT filing deadline in June will be extended to June 25, and pilot taxpayers should ensure they file and pay tax in time.
- Conduct a comprehensive assessment on the impacts to profit, revenue and cost/expenses brought by the B2V Reform, and analyze the effect of input VAT to cash flow and financing cost; reasonably allocate benefits and the impact among developers, general contractors, subcontractors and customers on the upstream and downstream of the VAT credit chain; adjust the pricing mechanism for products or services, study supplier’s profile and improve supplier management.
- Study the transitional measures and assess the impact on its tax burden. Adjust commercial contract terms template, reschedule the time and manner of selling real estate projects, and consider transforming and upgrading business operations models after a comprehensive analysis of all the B2V Reform policies.
- Adjust the implementation and processes of business operations and refine the system’s transformation; revamp the system to separate price and VAT to fulfil the VAT accounting requirement; pay attention to VAT risk control management, adjust the system for matters such as, interconnection between the accounting system and the tax filing and upgraded invoice system, reasonable allocating non-creditable input VAT, etc.
- Modify the turnover tax management procedure; compile a VAT operating manual to ensure compliance. Be familiar with the requirements of upgrade VAT invoice system and properly issue VAT invoices; understand the requirement in obtaining and storing VAT invoices and the time period for claiming input VAT credit so as to ensure that the full amount of VAT can be claimed.
- Pay close attention to follow-up measures of the B2V Reform, study the various policy interpretation and detailed implementation rules, and timely analyze the relevant impact and act accordingly.
- We are in the process of analyzing the impact to the remaining industries in this round of the B2V Reform and will share that with you soon. Please stay tuned.
For any further questions or more detailed analasys of your current situation;
please contact PwC’s China Indirect Tax Team:
+86 (10) 6533 2889
Image source: Rolf Handke / pixelio.de