Following the promulgation of the Circular on National Implementation of the Pilot Program of Levying Value-added Tax in lieu of Business Tax (the [2016] No. 36 Circular) that included the financial industry into the pilot program, the Ministry of Finance and the State Administration of Taxation released the Circular on Clarifying Value-added Tax Policies for Financial, Property Development, Education and Auxiliary Services Sectors (the [2016] No. 140 Circular) on 21 December 2016, the Supplementary Circular on Issues Concerning Value-added Tax Policies for Asset Management Products (the [2017] No. 2 Circular) on 10 January 2017 and the Circular on Issues Concerning Value-added Tax on Asset Management Products (the [2017] No. 56 Circular) on 30 June 2017, marking formation of a value-added tax (VAT) framework for asset management products (AMPs). In order to apply VAT policies for AMPs properly and prevent VAT compliance risks, asset managers should keep the following issues top of mind:

VAT payers. Asset managers shall be the VAT payers for any VAT taxable activities arising out of AMP operations. This was first explicitly specified in the [2016] No. 140 Circular, and later in the [2017] No. 56 Circular, which went further to categorize managers (or in other words, VAT payers) by AMPs. Despite being defined as VAT payers, asset managers are not withholding agents. Taxpayers and withholding agents have different legal statuses, rights and obligations. As VAT payers, asset managers have a responsibility to pay VAT. But they can structure their agreement with clients so that the VAT imposed on AMPs are passed on to, and ultimately borne by, their clients.

Managers’ VAT taxable activities. VAT taxable activities of asset managers are classified mainly into two categories, the first being AMP operations, which include lending services and transfer of financial commodities. The second is known as “other” activities, including asset management services for clients (i.e. directly charged financial services), and any activities other than AMP operations and asset management for which VAT is payable.

Is the investment income of AMPs subject to VAT? It depends on whether they are principal-guaranteed income, which as defined by the [2016] No. 140 Circular means investment income of AMPs with contracts explicitly specifying that the products are fully principal guaranteed upon maturity. Scenarios where there are no such explicit assurance but the structure is designed in such a manner that principal is indeed fully refunded upon maturity remain controversial. These AMPs must be considered carefully by asset managers.

VAT basis. As VAT is a tax included in the calculated price, VAT basis should be sales price without taxes. When providing lending and directly charged financial services, asset managers shall make it clear with the service receivers whether the interests and fees are tax inclusive. In the absence of such consensus, which is deemed a material omission, dispute may arise.

The sales proceeds of lending and directly charged financial services means the total price and fees and expenses not included in the price that are receivable by managers in connection with the aforesaid VAT taxable activities, unless otherwise stipulated by the Ministry of Finance and the State Administration of Taxation. “Fees and expenses not included in the price” refers to fees, charges and levies of whatever nature that are not included in prices, excluding government funds or administrative fees imposed by administrative agencies or any monies invoiced in the name of and collected on behalf of clients, which meet the conditions specified in Article 10 of the Implementing Measures for the Pilot Program of Levying Value-added Tax in lieu of Business Tax (see the [2016] No. 36 Circular).

The sales proceeds from the transfer of financial commodities refers to the sales price of financial commodities net of the purchase price. The positive or negative differences resulting from the transfer of financial commodities after offsetting with gains/losses shall be deemed sales revenue. The negative difference despite offsetting will be carried forward to the next taxation period and offset with the sales revenue from transferring financial commodities in this period; but negative difference as of the year end is not allowed to be carried forward to the following fiscal year. The purchase price of financial commodities may be calculated according to weighted average method or weighted moving average method, as selected by managers at their discretion. Once selected, the method is not allowed to be changed within 36 months.

VAT collection approaches and rates. Different collection approaches apply to VAT taxable activities of AMPs. Tentatively, the simplified tax calculation method applies to AMP operations, which are subject to a VAT rate of 3%. For the other activities, the general tax calculation method will apply at a tax rate of 6% in the case where the managers are identified as general taxpayers; otherwise the simplified tax calculation method will apply at a tax rate of 3%.

Asset managers should make sure that separate accounts are maintained for sales revenue and VAT payable of AMP operations and the other activities. If they fail to do so, the simplified tax calculation method shall not be applied to AMP operations.

Filing VAT returns for AMPs. For AMP operations, asset managers may choose to conduct accounting of sales revenue and VAT payable on a transaction-by-transaction basis or on an aggregate basis. They should file and pay VAT for AMP operations and the other activities on an aggregate basis according to scheduled taxation periods.

These are the five key takeaways of VAT policies for AMPs. An accurate understanding and application of such policies will help managers prevent VAT risks and meet VAT compliance requirements.

Liu Yungang is a partner at AllBright Law Offices