We need to talk about platforms: Ongoing tax challenges in China

Understanding domestic tax law and administration issues for China's digital economy (DE) requires an understanding of its rapidly evolving landscape, and in particular the importance of the platform economy in China. Last year's DE chapter, A Sisyphean task? – Tax playing catch up with the fastest moving digital economy in the world, provided a thorough overview. Here is the up-to-date version.

China's booming e-commerce has driven the expansion of China's overall retail economy to such an extent that in 2019 China is to overtake the US as the world's largest retail market for the first time, with $5.6 trillion in sales for China against $5.5 trillion for the US. According to analysis from eMarketer, e-commerce makes up 35.3% of Chinese retail sales against 10.9% in the US. Such is the scale of Chinese e-commerce that it is set to account for 56% of the global total in 2019 and as much as 63% in 2022.

Beyond e-commerce, the broader China digital economy, defined to encompass the sharing economy, the ICT sector, mobile payments and other facets, is also booming and projected to reach 35% of Chinese GDP by 2020. Of particular importance in driving this trend are the digital ecosystems being built through the 'superapps' developed by several leading Chinese DE companies. Alibaba and Tencent (through WeChat) have built the most prominent superapps, providing services relating to payments and finance, shopping, transport, social media and messaging, health, entertainment, dining, education, and much more. It is often remarked that this is the equivalent (in a Western context) of bundling WhatsApp, Apple Pay, Uber, Facebook, Expedia and a host of others.

These superapps are seen as tantamount to 'critical infrastructure' and a 'public utility'. Consumers can spend most of their time within a given ecosystem, which caters to all their needs, while the superapps provide a crucial gateway for third-party suppliers (for example through WeChat mini-programs and public accounts). Other players are now building substantial ecosystems, including Meituan Dianping, which evolved from group buying and restaurant review and ordering businesses, and Bytedance's Douyin (branded Tiktok in the West), which developed from a video streaming service.

The strength of this digital ecosystem model is such that the major Chinese players have been rapidly expanding overseas. This is particularly notable in South Asia and South East Asia, where Alibaba, Tencent and others have made significant investments in regional e-commerce platforms, as well as rolling out many of the services refined in the Chinese market. In particular, Chinese mobile payment services have embedded themselves in overseas markets by first catering to Chinese tourists, who made 150 million trips abroad in 2018, and then expanding to serve the wider population (as in Malaysia).

Going further, some Chinese DE players are having outstanding successes in Western markets, such as Tiktok's 200 million overseas monthly active users, of which 40 million are in the US.

Last year's DE article provided a thorough overview of the long-running tax issues existing for digital business models in China. These issues remain largely the same and we recap them here in brief. (This article should also be read in tandem with its sister chapter, BEPS 2.0: What will it mean for China? which picks up the evolving DE tax story at global level.)

China's regulatory and tax framework finds it difficult to keep up with the breakneck evolution of China's digital economy, with the growth of superapps and the sharing economy. For example, regulatory classification of ride-sharing platforms as information technology or transport services complicates their classification for tax purposes, and the application of the 6% or 9% VAT rates.

Platform intermediation is remaking huge swathes of the Chinese economy, from transport to retail to finance to health services. Questions arise over whether the platforms should be designated as brokers or as principals, with the obligations and liability of platforms for service quality in a state of evolution, and with challenges for platforms in obtaining use of so-called 'double clearing accounts'. If the platforms are to be treated as principals, then China's documentation-heavy tax system creates potentially severe headaches, as tax invoices (fapiao) are needed to be issued by vendors (taxi drivers, restaurants, etc.) in order for VAT input credits or corporate income tax (CIT) deductions to be claimed. With tax compliance levels low among many small vendors, this can prove very challenging. Many are hoping for new policies and reliefs on general tax invoice control and tax computation mechanism to bring the actual cost of being tax compliant to a more reasonable level.

As superapps ecosystems and platform models occupy a greater part of the economy, some local tax authorities have actively pursued platform operators to withhold tax from platform participants; for example, individual income tax (ITT) withholding on taxi driver fares. At a national policy level, it is still not clear what direction the government will go in for drawing platforms further into tax collection efforts.

Some initiatives, such as Tencent's collaboration with the Shenzhen tax bureau on a pilot blockchain tax invoicing system, might point in the direction of more effectively taxing the vendors themselves. This system, already in operation for a year and deemed a success, involves the automatic generation of digital fapiao, simultaneous with vendor sale and customer mobile payment. The tax authority has real-time information on this data and the customer expense reimbursement claims with employers (who will make corresponding deductions). At the same time, the Tax Collection and Administration Law, due to be finalised in late 2019, contained provisions requiring platforms and financial intermediaries to report to the tax authorities all transactions above a threshold, involving them in the tax administration process. Future evolution in this space remains to be seen.

A large range of issues remain to be resolved. Considerable ambiguity exists around the classification of various digital service for CIT withholding tax purposes, such as imported cloud services. Furthermore, it is also unclear when imported digital services can be said to be fully consumed outside China and so outside the charge to VAT (for example, outbound payments for online adverts shown on Facebook to overseas users).

Chinese foreign exchange rules, and their limited categories of outbound payments, also compel companies to characterise/bundle digital product sales in a tax inefficient manner (for example, as licence fees, as shrink-wrapped software) to facilitate the making of the remittance.

Chinese PE guidance remains ambiguous on many matters. While tightened data transfer and protection rules under the Cybersecurity Law may compel foreign enterprises to store and process data onshore, the treatment of servers, mirror servers, UIs etc. as PEs is still unclear. China's adoption of the BEPS PE changes, and in particular the agency PE changes, in recently updated tax treaties (see the international tax chapter) raises questions about the PE exposure of warehousing, purchasing, and representation activities in China. This is particularly pertinent for the mushrooming number of special e-commerce zones (35 and rising) and free trade zones (FTZs) (18 and rising) which are being promoted as hubs for e-commerce platform activity.

Finally, China runs a digital services export surplus and the government is increasing the scope of VAT refunds for excess input credits for various encouraged sectors. However, the rules are still piecemeal and evolving.

It might be noted that, if there is a major global agreement of the revision of international tax rules, then resolution of many of the matters above, for withholding tax, foreign exchange, and PE, will become increasingly pressing. With the Chinese economy slowing, and with the government conscious that the DE holds the key to sustained growth into the future, it remains to be seen if further efforts will be made to address at least some of these issues in the coming year.

Sunny Leung

Partner, Tax KPMG China Shanghai Tel: +86 21 2212 3488 sunny.leung@kpmg.com Sunny Leung is KPMG China's national technology, media and telecommunications (TMT) sector tax leader. She has assisted various local tax authorities to perform studies on common China tax issues that have emerged in the new digital economy, possible solutions, and the potential impact of BEPS. Sunny has been extensively involved in advising clients on setting up operations in China, M&A transactions, and cross-border supply chain planning. She has been providing China tax advisory and compliance services to domestic and multi-national companies in the TMT, as well as traditional manufacturing and service industries. Sunny has also been providing tax due diligence and tax health check services in China.

Conrad Turley

Partner, Tax KPMG China Beijing Tel: +86 10 8508 7513 Fax: +86 10 8518 5111 conrad.turley@kpmg.com Conrad Turley is a tax partner with KPMG China and heads up the firm's national tax policy and technical centre. Now based in Beijing, Conrad previously worked for the European Commission Tax Directorate in Brussels, as well as for KPMG in Ireland, the Netherlands and Hong Kong SAR. Conrad has worked with a wide range of companies on the establishment of cross-border operating and investment structures, restructurings and M&A transactions, both into and out of China. He is a frequent contributor to international tax and finance journals including ITR, Tax Notes International, Bloomberg Tax and Thomson Reuters, and was principal author of the 2017 IBFD book, A new dawn for the international tax system: evolution from past to future and what role will China play?. He is also a frequent public speaker on topical China and international tax matters. Conrad received a bachelor's degree in economics and a master's degree in accounting from Trinity College Dublin and University College Dublin, respectively. He is a qualified chartered accountant and a registered tax consultant with the Irish Taxation Institute.