In January 2023, China introduced proposed rules that indicate that foreign providers of digital services will potentially face Chinese value-added tax (VAT) withholdings. The rules are expected to be enacted in 2023.
The proposed VAT law targets services and intangible assets, such as intellectual property, sold or provided by entities or individuals located outside of China, and provided to Chinese entities or individual consumers within China.
Under Chinese VAT principles, the responsibility to “collect” VAT on these types of transactions is shifted to the Chinese resident customer. This is the case where the services are provided to Chinese business entities, registered for VAT in China, in so-called “B2B” (business-to-business) transactions, or to consumers in what is typically referred to as “B2C” (business-to-consumer) transactions.
Consequently, under these potential new rules, Chinese consumers or businesses are required to withhold the applicable VAT amount from the invoiced amount. The standard VAT rate currently amounts to 13%; although, there are widely used reduced rates amounting to 9%, 6% or 3%, depending on the services provided.
For example, in the case of a U.S. seller or provider issuing an invoice for $100, the Chinese party would pay only $87 of it, and submit $13 to the Chinese tax authorities (assuming an applicable VAT rate of 13%). Considering such a scenario, sellers or providers may want to add the VAT withholding amount to the sales price to arrive at the intended net amount for the services they are providing if the rules are enacted.
In particular, in situations where the services are provided to businesses located in China, it is recommended that the Chinese VAT amount due is reflected on the invoice. Under local Chinese VAT provisions, the Chinese entity would be able to offset this VAT amount, charged by the foreign provider against their domestic VAT liability, if this is contractually agreed upon between the two parties. In this scenario, the VAT amount does not become an additional expense for the foreign entity.
The above-described approach would also be applied by Chinese marketplaces, which means a risk to the foreign provider in terms of a partial loss of intended revenue due to the VAT withholding. The possibility of reclaiming the VAT amount is unlikely as non-resident entities cannot obtain a Chinese VAT registration to reclaim any Chinese VAT amount withheld.