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Fapiao
Table of Contents

As is well known, digitalization in China is much more advanced than one could even imagine in Europe. With effect from January 1, 2019, the paper form of the Fapiao was abolished in a pilot phase and replaced by an electronic form. In several cities, including Shenzhen, the WeChat app, which is installed on practically every smartphone in China, has been functionally expanded. Additional provinces were added on September 1, 2020. The new system is expected to be introduced across the board by the end of 2020.

Table of Contents

Control through technology

China is now one of the world's leading nations when it comes to electronic facial, voice and posture recognition. The technology is used across more than 170 million video cameras for traffic, building and street monitoring. It is also used to network databases with the computers of the border authorities or to record citizens who are on the blacklist of loan defaulters. This system is increasingly being expanded to include companies. The new Chinese sales tax system, which will apply from January 1.1.2021, XNUMX, plays a central role through the built-in monitoring function.

Companies are not soulless entities, but rather places where people come together. When they buy a roll in China on the way to work, they don't pay with cash, but instead hold their smartphone with the WeChat app up to the scanner. This means that the state has control not only over their spending habits and whereabouts, but also over their diet.

Nobody in China thinks about something like the General Data Protection Regulation. The state uses smartphones and so-called algorithms to eavesdrop on every private conversation and ultimately also what is said in companies. This is not a conspiracy theory, but common practice. Here the state stays out of it. But Alexa, Siri and other “services” also listen in and provide us with individualized information or advertising.

China and compliance

Given the noticeably harsher tone between the governments in Europe and China, one should not be under any illusions that the authorities will not make use of the new legal options. I therefore advise every company to arm itself with information, training and clear instructions regarding a resilient internal control system (ICS) and strict adherence to compliance.

In China there is not yet a particularly strong sense of compliance. Even if compliance is regularly certified by the local CPA, their certificates largely prove to be unsuitable. It is still the case that local employees often come up with “solutions” to problems, with their own advantage or comfort being given more consideration than the compliance of the company and its management. But this now becomes a question of existence.

Points scoring

Citizens in China have largely come to terms with the fact that their every move is monitored and graded on a point system. Points are deducted for everyone who, for example, does not pay their debts or taxes, runs a red light or does not behave healthily.

There is also a deduction for those who do not regularly visit their parents or who are even critical of the regime. Anyone who has too few points must expect sanctions. Suddenly there are no more train tickets or flights, the place for the children to study or the new apartment has already been taken. There will then no longer be any loans for your own home. So you submit.

Total data acquisition

Point scoring and thus total data collection and monitoring have since been largely ignored and expanded to include foreign companies operating in China. Anyone who does not behave in accordance with the rules must expect sanctions. According to the EU Chamber of Commerce in China, this development is catching many companies completely unprepared. Unfortunately, this also means that many have not prepared to follow the rules and are sailing in the gray area against their better judgment. Often to do your local employees or business partners a favor.

It is the most comprehensive regulatory system ever introduced by any government. The new points system will decide whether individual companies are or are not, with WeChat and the upcoming sales tax reform playing a central role. The first stress test, which is also the opportunity for a systemic realignment, is the upcoming annual financial statements and the turn of the year.

However, there is no need to be afraid of China. But it is high time to rethink your own strategy and, above all, to send clear signals to companies in China and regularly check compliance with them. The focus is on taking stock of the business processes and the internal control system. The protection of a company's vital interests must extend to all areas in terms of real surveillance, from technology, the use of voice recognition, smartphones and emails to the behavior of employees.

Tough action with digital transformation

New since September 1.9.2020st, XNUMX 
As is well known, digitalization in China is much more advanced than one could even imagine in Europe. With effect from January 1, 2019, the paper form of the Fapiao was abolished in a pilot phase and replaced by an electronic form. In several cities, including Shenzhen, the WeChat app, which is installed on practically every smartphone in China, has been functionally expanded. Additional provinces were added on September 1, 2020.
The new system is expected to be introduced across the board by the end of 2020. 

Fapiao - WeChat

The first fapiao of modern times was issued by a restaurant. WeChat can also be used to book free parking spaces and pay for the hairdresser or the bread roll at the kiosk. For this purpose, information from consumers' smartphones is automatically linked to that of entrepreneurs and the tax office based on blockchain technology. The old officially issued forms may continue to be used for the time being. Therein lies the danger of continuing as before. Not all companies have noticed this and have therefore not instructed their employees on how to deal with the new situation.

Anyone who allows themselves to continue to travel in the old ways by doing nothing is risking a lot. Because input tax fraud is increasingly being punished harshly. Anyone who, as a person or as a company, violates the applicable law can be forced to leave the country. One can imagine that successful companies will not be shut down in this context, but will be transferred to other hands. Companies are threatened with the total loss of their investment and years of development work. 

Gross or net?

If a purchase price is agreed in B2B business in Europe, it is generally considered the net price without sales tax. In China, however, unless expressly agreed otherwise, the agreed price is generally considered the gross price including VAT. If you don't know this and don't take it into account in your offer, you may be making an expensive mistake. Because in the end he does not receive the calculated price, but rather this minus the Chinese sales tax / VAT. 

Tax rate – VAT

The regular tax rate is 13% and is levied on the import and sale of goods, including, for example, the treatment and processing of goods.
Repairs are also taxed at the regular tax rate of 13%.
This tax rate also applies to the import of goods. In sales, however, the tax rates only apply if the entrepreneur making the service is a so-called general taxpayer and not a small entrepreneur who only pays 3% VAT, but has no input tax deduction and whose 3% VAT is neither considered input tax at the recipient, nor are the expenses tax deductible at all.

Reduced tax rates apply to certain industries and goods. Approximately 9% is charged for grain, cooking oil, books, newspapers, magazines, agricultural goods, water, natural gas and other everyday goods, depending on the type of goods. Most services are taxed at the reduced rate of 6%. Depending on the product group, additional taxes of different levels may be levied on the imports and sales of luxury goods. 

While the VAT can lead to input tax deduction for the recipient, the importer or the buyer bears the additional tax (surcharges) levied on the VAT to be paid, for example in the form of the city and river construction tax, which, depending on the local surcharges, can be up to approx. 7 %of the VAT can make up. This should also be taken into account when calculating. 

If you don't have an import license, you have to hire a licensed agent, who of course doesn't work for free. A foreign supplier can only deliver to the border, not further. Who exactly bears which costs and risks is determined by the Incoterms. Caution is also advised here with long-term contracts, as the internationally recognized Incoterms change regularly.
The current version of the Incoterms came into force on January 1, 2020. Since the Incoterms also regulate the distribution of costs for transport, insurance and storage, the Incoterms also influence the amount of the customs value and the import VAT. 

Customs duties and import sales tax

The importer pays customs duties and import sales taxes. The delivery contracts should therefore generally contain a clause according to which the price stated is the net price and the importer bears the customs duties and also the import sales tax. 

Industrial machinery and equipment

Mechanical and plant engineering is a mainstay of the German export economy. China is an important sales market, but it faces competition from local suppliers. What is usually required is the delivery and assembly of a system with a defined performance. The core components are usually manufactured in Germany and then shipped to China. There, additional components and services are either purchased locally or provided by the customer and the system is finally assembled using our own or third-party staff

Factory delivery - delivery

According to German law, this is a delivery of works. The process is not subject to sales tax in Germany. The formal requirements for export deliveries therefore do not need to be observed. Regardless of this, the company is entitled to full input tax in Germany.

According to Chinese law, this is a delivery. For sales tax purposes, the place of delivery of the work as a whole (planning, delivery, assembly) is the place where the system is set up. The delivery location can be in a free trade zone, but most of the time the assembly will take place in a normal industrial area.

Because of the lack of an import license, the work supply contract is often “divided” by the contracting parties into three or more contracts relating to the planning, delivery and installation of the system. However, according to the “substance over form” principle, these contracts are treated as a single contract in Germany and China and treated accordingly for tax purposes. The place of delivery of the work is the installation site.

Reverse charge

With regard to the import of the components, the tax liability is transferred from the supplier to the recipient of the goods by way of a reverse charge. The customer can also deduct the import VAT as input tax. However, the components are still the property of the supplier. Contrary to contracts that often state otherwise, there is no delivery of the components and therefore no transfer of ownership. If the contracts were agreed otherwise, they were interpreted accordingly for the past. However, more attention should be paid to this in the future because it has far-reaching civil law consequences for the entire contract.

 

The VAT is incurred by the supplier upon receipt of advance payments and the remainder upon completion (not just upon invoicing) in full for the entire work delivery in China. With regard to the output sales, the customer is not liable for tax on the output VAT, unlike with import. But the customer has to register and pay for the supplier (reverse charge). Therefore, customers often request that the supplier provide the funds for the initial VAT and refuse any payment until then.

No enforcement agreement

Since Germany and China do not have an enforcement agreement, the situation is difficult for the supplier. Because he can only hope to get the gross amount paid out afterwards. In order to prevent this, the contracts must be designed in advance to be China-specific and the special features of the Chinese sales tax system must be taken into account. It should be stipulated in the contract that the customer must provide proof of registration and payment. Otherwise he could refuse to pay the total outstanding amount, citing the lack of approval from the foreign exchange regulator SAFE.

No delivery to China without an import license

You need express permission to import goods in China. This is generally not granted to foreign companies. Chinese companies are also only allowed to import if they have been expressly permitted to do so as part of their business license. Therefore, a foreign entrepreneur can only deliver to the border and not into China, which should be reflected in the agreed Incoterms. 

If you don't have an import license, you have to hire a licensed agent, who of course doesn't work for free. A foreign supplier can only deliver to the border, not further. Who exactly bears which costs and risks is determined by the Incoterms. Caution is also advised here with long-term contracts, as the internationally recognized Incoterms change regularly. The current version came into force on January 1, 2020. Since the Incoterms also regulate the distribution of costs for transport, insurance and storage, they also influence the amount of the customs value and the import VAT.

The importer pays customs duties and import sales taxes. The delivery contracts should therefore generally contain a clause according to which the price stated is the net price and the importer bears the customs duties and also the import sales tax.

Fapiao only for deliveries and services

Fapiao may only be issued for deliveries and services. Requiring advance payments does not meet this condition. Nevertheless, customers very often require a fapiao before paying a requested deposit. Anyone who gives in to this pressure and issues a Fapiao is acting unlawfully. Against the background of the threatened sanctions and even the total loss of the company, the premises for action in the company should be clearly and unambiguously communicated.

Problem with wrong fapiao

Only genuine Fapiao from registered general taxpayers are entitled to input tax deduction. Small business owners do not calculate their own purchases of goods and services net, but gross, because they cannot deduct the VAT added to their invoices as an input tax deduction. If you do not receive Fapiao from the entrepreneur for your own purchases, then you cannot claim a deduction as business expenses. Anyone who purchases goods or services from a small business as a general taxpayer has the same problem.

There are millions of small entrepreneurs in China who would therefore have considerable problems getting orders at all. However, since practically every Chinese also has private, regular Fapiao from general taxpayers (e.g. from the purchase of furniture, household appliances, private trips or wedding celebrations), these Fapiao or even fake Fapiao were smuggled into company accounting when there were regular Fapiao for company expenses was missing. Those who didn't have Fapiao at home got some at the train stations and public places, where there was clearly a brisk black market in Fapiao. The state watched and did nothing about it. At least at first. Thanks to facial recognition and total surveillance, the Chinese state knows exactly who buys fapiao and which companies they end up in. This later serves as a means of exerting pressure against the company during tax audits or for other reasons. 

Free Trade Zones (FTZ) in China

Customs duties and import sales taxes must be paid immediately upon import. This can place a significant strain on liquidity. By delivering to a free port or a free trade zone, you can achieve a deferral or even exemption from import duties. 

A number of local “free trade zones” are also offered in China. However, these are not comparable and should not be confused with the free trade zones (FTZ) in international trade. The Chinese version only has some of the functions of the FTZ. Like all special zones, the Chinese FTZ is notionally treated as a foreign country for sales tax purposes. An import into the special zone is not subject to customs or import VAT. Import duties are only due when the goods are removed from the FTZ, although they may be at a higher value. Because the storage and transport costs within the special zone increase the customs value when legally entering the country. Assembly and even production can also take place in an FTZ. If all raw materials used in an FTZ come from abroad and are processed into a product, the duty is calculated on the value of the product and not on the raw materials. 

If raw materials from China are also used, the customs value is determined from the value of the imported raw materials! This opens up design possibilities. If the goods are also to be sold in China, precise proof of the origin of the raw materials helps to reduce the import duty value. Depending on the size of local sales, a move from the FTZ to the tax territory may make sense. 

In addition to the FTZ, there are other special sales tax zones in China:

  • Bounded Warehouse
    A permit is required for this, which enables duty-free storage in your own company. A customs record must be kept of entries and exits. Any shortages will be taxed like an import. 

 

  • Export Processing Zones (EPZ)
    analogous to FTZ, but immediate input tax reduction on goods “exported” to the EPZ

 

  • Bounded Logistic Parks: suitable for storage of goods and simple activities, exhibition, testing and maintenance

 

  • Bounded ports

 

  • Comprehensive Bounded Zones 

Choice of VAT status

Anyone who is not registered as a general taxpayer is considered a small business owner and pays 3% VAT. Small businesses are not entitled to a refund of input tax deductions or import sales tax. In exceptional cases you are allowed to issue Fapiao yourself with 3% VAT, otherwise you can also get the Fapiao through the tax office. However, this is quite complex. On the other hand, as a small business owner you have an advantage when selling to end customers who are not themselves general taxpayers if you only have to charge 13% instead of the regular rate of 3%.

It is a question of calculation as to whether the loss of the input tax deduction outweighs this. In China, it is therefore important to clarify when selecting suppliers whether they are entitled as general taxpayers to issue proper invoices, so-called Fapiao.

Input tax deduction - possibly lost after three months

General taxpayers receive input tax deduction in China. Another requirement is that the Fapiao is available. If you don't prepare for this now, you will miss out on input tax deduction from January 2021 at the latest if no electronic Fapiao is available. It should also be noted that Fapiao can only be submitted for a very limited time within three months. Otherwise, the input tax deduction and the business expense deduction will be lost forever.

The VAT shown and paid by other Chinese entrepreneurs on a Fapiao is generally deductible as long as the expenses are “reasonable”. VAT from small businesses can only be deducted as input tax if you receive a VAT fapiao, which is often difficult.

Input tax surplus

Input taxes that exceed the sales tax to be paid will not initially be refunded, but will be offset against the sales tax to be paid for the following month. This can develop into a liquidity problem if a company is stuck with the mountain of input tax that is building up. Since April 2019, at least 60% of the input tax excess can be refunded if the excess has been building up for more than 6 months and exceeds RMB 500.000. Exporting companies, on the other hand, receive a proportional input tax refund. 

VAT paid on goods or services from which VAT-exempt goods were produced is not eligible for deduction. A proportion of 10% of the fee paid to a forwarding company can be offset against the VAT to be paid.

Input tax reduction when exporting

Exports are not “tax-free” in China but are taxed via an input tax cut depending on the type of company and the goods exported. A product-related “tax refund rate” of 13%, defined according to the HS Code, means that the full input tax can be refunded. A tax refund rate of, for example, 11% leads to a reduction in input tax, which is calculated differently for a manufacturing company than for a trading company. 

For example: 

Exporting a product made in China. The input tax key should be applied based on the HS code with 9%. The input tax reduction is 

Regular tax rate 13% 

Reduction rate for exports 9% 

= Input tax reduction 4% Problem: calculated by the UK 

This leads to the following situation with an easy-to-understand calculation 

netto Input tax 
Material costs 100 13 
Wages 100 - 
Other costs 100 2 
calculated profit 100 - 
Total input tax 15
retail price 400 
Reduction of input tax
4% of the UK -16 
aremovable Input tax0

The non-deductible input tax of actually 16 (4% of the UK), here limited to the maximum amount of input tax of 15, leads to real costs that must be taken into account in the calculation. The higher the value added, the higher the input tax reduction. 

As the export share and margin in export prices increase, the production company's net cost costs increase. For trading companies, exports also lead to a reduction in input tax. However, the reduction is not calculated by the UK, but by the EK.

Strategy to reduce non-refundable input taxes

There are three models to choose from for contract manufacturing (extended workbench) in China:

 

  • The “contract manufacturing” company purchases machines and raw materials itself. The reimbursement of input taxes is possible according to the rules described.

 

  • The “Toll Manufacturing” company receives machines and/or raw materials from the principal. Tax consequence: no input tax refund possible.

 

  • Mixed sales
    The company trades in machines, installs them and then carries out maintenance and service. In these cases, taxation depends on the main business area of ​​the performing company.

 

The usual commercial purchase price for such paper is 50% of the associated input tax. Anyone who bought a Fapiao in passing on the way to work in the morning and smuggled it into the company earned cash for themselves and the company. It goes without saying that this was not legal and that the informative value of the accounting was compromised and that it also opened the door to fraud. However, it was common practice and could be found in almost all companies.

However, it wasn't always about employee fraud when fake Fapiao were introduced. Unfortunately, it is common practice for regular business expenses that were not available for a variety of reasons to be purchased from the family or on the black market in order to "legalize" the expense from the company's cash register. Since the amounts rarely matched the Fapiao 1:1, the differences were offset by withdrawals.

What was recorded was what was written on the honest or smuggled fapiao and not what the money was actually spent on. That's why hardly any Chinese would come up with the idea that accounting could be trusted and, unlike a European entrepreneur or controller, they would certainly not come up with the idea of ​​using the results of accounting as the basis for operational decisions.

Jürgen Bächle
Jurgen Bachle

has been working as an independent tax consultant and expert in international tax law since 1989 and has been a member of the board of the German Association of Tax Consultants Baden-Württemberg, DSTVBW, for over 20 years.

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