By Summer Qu

[Case Background] 

Company A commissioned an overseas company B to provide an international freight forwarding service that was carried out entirely abroad. Company A paid B for the service but did not withhold VAT and associated surtaxes. The competent tax authority believes that Company A’s failure to withhold VAT and its associated surtaxes violates relevant tax laws.

[Case Analysis] 

The focal issue in this case is whether the sale of the international freight forwarding service should be considered “domestic sales of service.” If the transaction is deemed to constitute a "domestic sale of service," then company A, as the withholding agent, is obligated to withhold VAT and its associated surtaxes in accordance with the law. Otherwise, company A would have no such obligation.

I.VAT Liability Arising from Domestic Sales of Services 

The tax obligation for VAT in China arises from the premise of "domestic sales of services." According to Article 1 of the Pilot Implementation Measures for the Transformation of Business Tax to VAT (Cai Shui [2016] No. 36) stipulates, "any entity or individual selling services, intangible assets, or real estate within the territory of the People's Republic of China shall be considered a VAT taxpayer..." This means that entities and individuals conducting taxable behaviors such as selling services within China are required to pay VAT on the consideration received for those services.

II. If the Buyer of the Service is Located within China, Even If the Service is Performed Abroad, It May Still be Considered Domestic Sales of Service

Article 12 of the Pilot Implementation Measures for the Transformation of Business Tax to VAT (Cai Shui [2016] No. 36) defines "domestic sales of services, intangible assets, or real estate" as follows: "(1) The seller or buyer of services (excluding rental of real estate) or intangible assets (excluding natural resource usage rights) is located within the territory of China..." Therefore, under current VAT laws, "domestic sales of services" is not limited to services physically performed within China. If the buyer of the service is located within China, even if the service is carried out abroad, it may still be recognized as a domestic sale of service, and VAT would thus be levied.

III. Services Purchased by a Buyer Located in China, but Performed Entirely Abroad, May Not Constitute Domestic Sales of Services – Restrictive Provisions in Regulatory Documents

Article 13 of Cai Shui [2016] No. 36 stipulates, "The following circumstances do not constitute domestic sales of services or intangible assets: (1) Services provided by overseas entities or individuals to domestic entities or individuals, where the services are entirely performed outside of China..." This provision implies that even if the service purchaser is located within China, as long as the service is entirely performed abroad, such a sale would not be considered a "domestic sale of services" under the current VAT laws and, therefore, would not be subject to VAT.

Furthermore, Article 1 of the "Announcement on Several Tax Administration Issues Concerning the Pilot Program for the Transformation of Business Tax to VAT" (State Taxation Administration Announcement No. 53, 2016) lists specific scenarios that are not considered “domestic sales of services.” These include postal services, collection and delivery services, construction services, project supervision services, engineering survey and exploration services, and conference and exhibition services provided by overseas entities or individuals abroad. Even if the buyer is located within China, such sales do not constitute "domestic sales of services" and are therefore not subject to VAT.

However, there is significant debate regarding whether the provisions of Article 1 in Announcement No. 53 of 2016 represent a restrictive interpretive explanation of Article 13(1) of Cai Shui [2016] No. 36, or simply a listing of specific scenarios under that provision. 

If the former interpretation is correct, then scenarios not listed in Announcement No. 53 of 2016 would be considered “domestic sales of services” and subject to VAT, unless otherwise explicitly specified by the Ministry of Finance, the State Taxation Administration, or other relevant departments. If the latter interpretation is correct, then when determining whether scenarios not listed in Announcement No. 53 fall under "domestic sales of services," a comprehensive assessment should be made, taking into account the spirit and objectives of Article 13(1) of Cai Shui [2016] No. 36.

IV. Interpretation of Article 13 of Cai Shui [2016] No. 36 and the State Taxation Administration Announcement No. 53, 2016

1.The Spirit and Purpose of Cai Shui [2009] No. 111 Still Applies

Although the provisions of Cai Shui [2009] No. 111 are directed at business tax regulations, after the business tax-to-VAT reform, services that were previously subject to business tax are now subject to VAT, and the nature of these services has not changed. Therefore, the spirit and purpose of Cai Shui [2009] No. 111 still applies when determining whether specific services are taxable.

Article 4 of the former "Implementation Rules for the Interim Regulations of the Business Tax of the People's Republic of China" stipulates: "For the purposes of Article 1 of these Regulations, the provision of services, transfer of intangible assets, or sale of real estate within the territory of the People's Republic of China (hereinafter referred to as 'within the territory') refers to the provision or receipt of such services by an entity or individual within the territory." 

Article 4 of the "Notice of the Ministry of Finance and the State Taxation Administration on Several Exemption Policies for Business Tax on the Sale of Personal Financial Products" (Cai Shui [2009] No. 111) provides: "Services provided by overseas entities or individuals to domestic entities or individuals, where the services are prescribed by the Interim Regulations on Business Tax (State Council Order No. 540, hereinafter referred to as the 'Regulations') and are entirely performed outside of China, do not constitute services provided within the territory as defined in Article 1, and are therefore not subject to business tax... According to the above-mentioned principles, services provided by overseas entities or individuals to domestic entities or individuals, such as those in the cultural and sports industries (excluding broadcasting), the entertainment industry, the hospitality, catering, and warehousing sectors within the service industry, as well as other services like bathing, hairdressing, laundry, framing, transcription, engraving, photocopying, and packaging, are not subject to business tax."

Regarding the specific types of services listed above, a common feature is that the domestic entity or individual receiving the services must be physically present abroad when the overseas entity or individual provides the service, either through a representative of the unit or the individual themselves.

2.Authoritative Interpretation

On March 31, 2016, the State Taxation Administration (STA) published an article on its official WeChat account titled "Authoritative Interpretation: Pilot Implementation Measures for the Transformation of Business Tax to VAT (Part 1)" (originally by Shanghai Taxation), which provided an interpretation of Article 13 of Cai Shui [2016] No. 36. The interpretation outlined three key requirements to be met for determining a service not sold within China: 

●The seller of the service is an overseas entity or individual;

●The domestic entity or individual purchases the service abroad;

●The service must be fully used or consumed outside of China.

The Fujian Provincial Taxation Bureau addressed the issue of "services fully performed abroad" in its publication, "Key Issues and Difficult Problems Collection of 12366 Consultation in February 2020,” with the following explanation: "The term 'fully performed abroad' refers to a business transaction where all elements of the sales act must occur outside China. Specifically, the following conditions must be met:

●The seller (either an entity or an individual) of the service (excluding real estate leasing services) or intangible assets (excluding natural resource usage rights) must be located abroad;

●The buyer (either an entity or an individual) of the service (excluding real estate leasing services) or intangible asset (excluding natural resource usage rights) must receive the service abroad;

●The address, phone number, bank location, place of payment, and other elements related to the payment made by the buyer for the service must be located abroad."

Therefore, the author believes that Article 13(1) of Cai Shui [2016] No. 36 should be interpreted with reference to the explicit provisions, spirit, and purpose of the [2009]111 Document. Specifically, determining a service purchased by a domestic entity or individual from an overseas entity or individual as not sold within China requires not only the service carried out entirely abroad but also that the representative of the domestic entity or the individual receiving the service must directly enjoy the service abroad. Otherwise, even if the service provided by the overseas entity or individual is carried out entirely abroad, if the domestic entity or individual receives the service within China, the transaction will still be considered a "domestic sale of services" and subject to VAT.

Additionally, the author believes that the State Taxation Administration (STA) 2016 No. 53 Announcement is a specific elaboration and refinement of the circumstances under which services do not constitute "domestic sales of services" under the principles of Article 13(1) of the [2016]36 Document, rather than a restrictive application. It should not be concluded that, except for the situations specified in STA 2016 No. 53, any situation where the service purchaser is located within China constitutes a "domestic sale of services." Instead, the determination should still be based on the provisions of Article 13(1) of Cai Shui [2016] No. 36, the provisions of Cai Shui [2009] No. 111, and their legislative spirit. For the circumstances listed in the [2009]111 Document, they should naturally be recognized as not constituting a "domestic sale of services." For specific situations outside the scope of the State Taxation Administration's 2016 Announcement No. 53 and the [2009]111 Document, it is necessary to assess whether they align with the criteria in Article 13(1) of the [2016]36 Document and the legislative intent of the aforementioned [2009]111 Document. If they do, these situations should also be deemed not as "domestic sales of services." Otherwise, they should be recognized as services provided within China and subject to VAT tax.

V. Conclusion

In conclusion, in this case, the author believes that although Company B provided the freight forwarding service entirely abroad to Company A, Company A accepted the service within China, which does not meet the criteria that the domestic entity must directly enjoy the service abroad. Therefore, the transaction should be regarded as "domestic sales of services" and subject to VAT and its associated surtax. Company A, as the withholding agent, is obligated to withhold the tax.