Doing Business in China? Make VAT Part of the Revenue Equation|
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Consider this increasingly common international business scenario: A service provider offers data analytics to clients in China through an online platform. The provider does not have a physical presence in China. In fact, there is no office or legal entity set up in China. And service payments coming from China-based customers are consistently less than the contracted price.
The service payment is being reduced by Value Added Taxes (VAT) in China.
How VAT Can Affect Revenue Models
Unfortunately, VAT is often left out of the business plan by U.S. companies doing business with China-based entities in a virtual environment.
According to SAT (The State Administration of Taxation, China) CaiShui  #36, any customer who is a Chinese resident (entity or individual) and receives services from a U.S. business is subject to VAT collected by the Chinese government.
China’s VAT applies to services such as:
- Legal services
- IP registration services
- Product and advertising design services
- Environment consulting services
- Architectural services
- Data analytics
- Professional Services such as human resources and financial capital consulting
- Other services rendered in the U.S., but received in China
If a Chinese company in Shanghai is making a service payment of $100,000 to a U.S.-based provider, then the VAT will be $100,000 times 6 percent, which is $6,000. Then there are local miscellaneous taxes, which is 12 percent of VAT, or in this case, $720.
So the U.S.-based provider would only receive $93,280 of the $100,000 contracted payment.
Revenue could be further reduced by the application of a 10 percent withholding income tax if the income is classified by the tax authority in China as passive income such as royalties or licensing fees, according to the U.S.-China Income Tax Treaty.
Avoid the VAT + Withholding Income Tax Trap
U.S.-based companies providing services to China-based entities or individuals should include VAT provisions in all written service contracts and invoices. If the written documents fail to address VAT, the responsibility for VAT and any additional income tax is automatically assumed to be the liability of the foreign service provider.
Chinese companies typically push their U.S. service providers to pay VAT tax. But it is entirely reasonable for service contracts to split the tax burden. U.S. companies are often successful in asking for a price net of VAT tax and fees, but not often for additional withholding taxes.
To reduce the likelihood of unexpected tax exposure, U.S. companies should submit the following documents to the tax authority in China before providing service:
- Execute a written service agreement with payment terms net of taxes and/or fees as agreed to by all parties.
- Make sure the Chinese counterpart submits the contract to the local tax authority.
- Make sure the Chinese counterpart assists with registration with the local tax authority for VAT tax purposes.
The Chinese tax authority will review the contract and verify the VAT filing status of the Chinese customer and its withholding tax status, as well as the tax calculation, so there will be no surprises when the payment is executed.
There are mainly two types of VAT filers based on revenue. One is a regular VAT taxpayer; the other one is small VAT taxpayer. Different types of filing statuses will have different VAT tax rates.
U.S. companies should provide a written, signed invoice for every payment due for services provided.
Alternatively, U.S. companies may consider providing the service to a U.S. branch or affiliate of the Chinese client, thus getting paid by the U.S. office or affiliates — and avoiding VAT entirely.
If you have any further questions, please consult with Wendy Lu.