Clarifying corporate income tax under the VAT regime

The value added tax (VAT) pilot programme was launched at the beginning of 2012 in Shanghai. Although the programme establishes a basic framework of VAT administration, problems still exist and need to be addressed. For example, how to deal with conflicts between VAT applications and the original business tax (BT) regime.

The Announcement

When it comes to cross-border royalty arrangements, the situation gets complicated. Before the VAT pilot programme, a royalty income derived by a non-tax resident was generally subject to a 5% BT and a 10% withholding tax (WHT). Specifically, in determining the tax basis for WHT, BT was also allowed to be deducted before the new corporate income tax (CIT) regime became effective on January 1 2008. The Circular on Issues Relevant to the Levy and Collection of Enterprise Income Tax on Non-tax-resident Enterprises (关于非居民企业征收企业所得税有关问题的通知) (Circular 130), then provided that no taxes or other charges may be deducted in determining the tax basis of WHT. In other words, BT must be included when calculating WHT. However, under the current calculation of WHT, a new issue arises as to whether VAT, in place of BT, must be included under the programme. (Figure 1 shows the effect of the VAT pilot programme on royalty fees in which the turnover tax surcharges are not considered).

Figure 1: VAT pilot programme and royalty fees

In response to this issue, on February 19 2013 the State Administration of Taxation promulgated the Announcement on an Issue Relevant to the Payment of Enterprise Income Tax by Non-tax-resident Enterprises Involved in the Pilot Projects for the Levy of Value-added Tax in Place of Business Tax (关于营业税改征增值税试点中非居民企业缴纳企业所得税有关问题的公告) (Announcement 9). The Announcement expressly states that VAT shall not be included in the tax basis of WHT when calculating the WHT applicable to passive income as stipulated by the current PRC Enterprise Income Tax Law (中华人民共和国企业所得税法).