Proposed Introduction of VAT for the Insurance Sector in China

Transcription

1 TAX Proposed Introduction of VAT for the Insurance Sector in China August 2013 kpmg.com/cn

2 2 Proposed Introduction of VAT for the Insurance Sector in China This special VAT publication is focused on analysing the likely impacts of the proposed Value Added Tax (VAT) reforms on the insurance sector in China. By international standards, the insurance sector in China is undergoing significant change and development. As the Chinese economy grows, an increasingly affluent middle class is expected to purchase insurance products as a means of providing protection against economic loss arising from motor vehicle accidents, property theft or damage, loss of employment or income, sickness, and other mishaps. Insurance products will also serve to insulate communities and governments more generally against losses from catastrophic events, such as earthquakes, floods and fire. The Chinese Government has a long history of using its VAT system as a tool of economic policy, and the extent to which the insurance sector s future development is encouraged through favourable VAT policies is keenly anticipated.

3 Proposed Introduction of VAT for the Insurance Sector in China 3 Drivers for change The rationale for the Chinese Government undertaking the VAT reforms may be succinctly stated as follows: 1. Modernise the system of indirect taxes in China, given that the Business Tax (BT) system is regarded as inefficient, leading to tax cascading in business-tobusiness (B2B) transactions 2. Promote the development and expansion of the services sector in China as part of the government s 12th Five-Year plan 3. Ensure that any reforms of indirect taxes in China are internationally competitive and adopt world s best practices 4. Simplify the system of indirect taxes in China, so that there is only one main system (VAT) for both goods and services instead of bifurcated systems, thereby reducing compliance costs. Insurance services were not included as part of the first phase of the VAT pilot program, which commenced in Shanghai in January At that time, Circular Caishui [2011] 110 merely stated that insurance services would be subject to a simplified VAT method. No further guidance has since been released to explain what is meant by the simplified VAT method, or the rate of VAT applicable under the simplified method. We understand from discussions with government officials that while Circular Caishui [2011] 110 does refer to insurance services being subject to a simplified VAT method, the government is now open to considering other options. The Chinese Government s current preferred approach While no formal decisions have been taken at this time, based on consultation with the Ministry of Finance (MoF) and the China Insurance Regulatory Commission (CIRC) in May 2013, their preferred approach at present to the implementation of VAT for the insurance sector is as follows: VAT is to apply to general insurance policies based on the value added models of VAT/GST currently applied in countries like New Zealand and South Africa Life insurance is to be exempt from VAT, which is consistent not only with the existing BT system, but also with international practice generally. If these approaches are adopted, the insurance sector is expected to have some of the most challenging issues to confront in transitioning to VAT. Those challenges arise in three main areas. The first is the move from a turnover based BT system, which effectively taxes gross premium revenues, to a modern VAT system, which taxes the value added by insurers. This results in a change to the tax base, which is likely to impact pricing, selling and marketing of insurance policies. Secondly, the introduction of an output/input VAT system will necessitate changes to the way agents and brokers interact with insurers, as well as claims management processes more generally. Insurers will need to adopt robust systems to effectively optimise their input VAT credit entitlements. Finally, insurers will need to implement changes to their IT systems and apply invoicing processes using the Golden Tax System. The good news is that during the consultation with the MoF and the CIRC where KPMG was involved, they have been made aware of these issues and have expressed their desire to work with the insurance industry to implement a modern VAT system, which reflects world s best practice.

4 4 Proposed Introduction of VAT for the Insurance Sector in China Purpose of this publication This special VAT publication is intended to highlight some of the key impacts and issues arising in applying VAT to insurance; this is not only based on international experience, but also on what may occur in China. It is also intended to serve an additional function the MoF and the CIRC have asked KPMG to provide a report setting out our recommendations in terms of guiding principles for applying VAT to the insurance sector. Our recommendations are set out in the concluding section of this report. While these recommendations may not necessarily be agreed to by all industry participants, they do reflect the overwhelming views of the majority of participants, the extensive international experiences in applying VAT to this sector, and an understanding of what may work best in China. In preparing this report, KPMG has consulted widely with a large number of both State Owned Enterprise (SOE) insurers and reinsurers in China, and also foreign insurers licensed to carry on business in China. While the views expressed in this publication are our own, we have noted throughout this report the general views expressed to us in those discussions. Glossary For ease of reading of this report, when referring to the position in other jurisdictions, we have used standard terminology, which is consistent with the terminology used in China: VAT is used consistently instead of GST, even for those countries such as Australia, Canada, New Zealand and Singapore with a goods and services tax

5 Proposed Introduction of VAT for the Insurance Sector in China 5 Input VAT credits is used consistently instead of input tax credits, input tax, input credits Exempt is used consistently instead of input taxed (which is the term used in Australia) Zero rated is used consistently instead of GST-free (which is the term used in Australia) General VAT taxpayer is used consistently instead of GST registered, registered for GST purposes and other similar terms to refer to taxpayers who pay output VAT for the goods and services they supply, and who are generally eligible for input VAT credits for business expenditure. Background The insurance market in China It is beyond the scope of this publication to set out a detailed analysis of the state of the insurance sector in China. It suffices to note the following by way of brief overview 1 : Insurance penetration of the market in China is 3.8 percent (being premium income as a percentage of GDP), which remains low compared to the global average exceeding 7 percent 2 Total non-life insurance premiums in China was USD 84.8 billion in 2012, which was an increase of 27.9 percent on The market share of participants in the non-life insurance sector in China in 2012 was PICC (35 percent), Ping An (18 percent), CPIC (13 percent); China Insurance (4 percent); China Life Property & Casualty (4percent); China Continent P&C (3 percent); others (22 percent) and foreign insurers (1 percent) 4 The market share by product category for the non-life insurance sector in 2012 was motor (75 percent), property (7 percent), liability (3 percent), cargo (2 percent), credit (3 percent), others (5 percent), agriculture (5 percent) 5 For the non-life reinsurance sector, the market share in 2012 was China Re (37.7 percent), Swiss Re (29.0 percent); Munich Re (22.9 percent), Lloyd s (3.4 percent), LICCL (0.7 percent) and others (6.3 percent) 6 The overall participation of foreign insurers remains low with a market share of 1.2 percent 7 The market share of intermediaries such as brokers and agents selling non-life insurance products in China is 14 percent. 8 1 These statistics have been helpfully collected in a presentation by Lloyd s China, Market Presentation, January The World Bank, January CIRC Yearbook CIRC Non-Life Insurance Company Primary Insurance Premium Income 2012 (published January 2013) 5 CIRC Non-Life Insurance Company Primary Insurance Premium Income 2012 (published January 2013) 6 CIRC Yearbook of China s Insurance CIRC Foreign Insurance Company Conference, November CIRC Q Insurance Intermediary Operation Report (19 December 2012)

6 6 Proposed Introduction of VAT for the Insurance Sector in China The current BT system To properly assess the commercial impact on insurers and their customers in transitioning to VAT, it is necessary to briefly give an overview of the existing treatment under BT. In very simple terms, BT applies to the insurance sector in China as follows: Life insurance in accordance with Caishuizi [1994] No.2, ordinary life insurance, which refers to insurance plans that are longer than one year and insure against human survival, death and disability, with a one-off payment on maturity, a death benefit, or a disability benefit to the beneficiary, is exempt from BT. General insurance BT applies to general insurance premiums at the rate of 5 percent. BT is effectively a cascading turnover tax. This means that when general insurance premiums are sold to businesses, the 5 percent BT is a real cost. Furthermore, under the existing BT regime, there are very few exemptions, meaning that insurance provided inbound into China, or outbound from China, are effectively subject to a 5 percent BT liability. It should also be noted that in accordance with Caishuizi [1994] No.2, both superannuation insurance and health insurance are also exempt from BT. Superannuation insurance refers to any insurance plan where the insured (or the beneficiary) contributes a set amount of premiums over a set period of time, and the insurer pays a retirement pension in accordance with the insurance contract to the beneficiary upon reaching an agreed age. Health insurance refers to any insurance product that provides compensation for loss suffered as a result of sickness, childbirth, disability or death. As noted previously, the Chinese Government s overall objective is to replace BT with a VAT throughout the entire services sector. The replacement of BT, which is a cascading and inefficient form of taxation, with a modern VAT, is intended to promote the future growth and development of the services sector in mainland China. International comparisons of VAT and insurance In considering the appropriate VAT treatment of the insurance sector in China, the MoF and the CIRC have asked KPMG to analyse the systems used internationally, and most importantly, their suitability (or lack thereof) in China. In this section of this report, we have outlined a summary of the VAT treatment of the insurance sector applicable in many countries throughout the world. Brief overview of international treatment By way of a brief overview only, general insurance products in many jurisdictions throughout the world are exempt from VAT, such as the 28 European Union (EU) member states, Canada and Japan. However, that statement does not provide a complete picture because in many countries, insurance premium taxes, stamp duties or other levies apply in lieu of VAT.

7 Proposed Introduction of VAT for the Insurance Sector in China 7 The primary jurisdictions where VAT applies to general insurance products (but not life insurance products) are: Australia New Zealand Singapore South Africa Malaysia (proposed). The differences between these systems may be shown diagrammatically as follows: International treatment of insurance - high level overview Scope of exemptions for insurance: Narrow: Life insurance exempt: Australia, New Zealand, Singapore, South Africa Broad: Life & general insurance exempt: Canada, EU, Japan Source: KPMG As noted earlier in this report, the MoF and the CIRC both acknowledge that VAT should apply to general insurance. In other words, the model for VAT exemption applicable in many other countries is not likely to be implemented in China. The rationale behind this view would seem to be based on the fact that because general insurance products are currently subject to BT at the rate of 5 percent, the introduction of a VAT exemption would result in a loss of government revenue. It would also lead to inequities in the tax treatment of insurance compared with other sectors. Furthermore, a VAT exemption would result in insurers bearing irrecoverable VAT on their inputs, resulting in VAT being embedded in B2B transactions. For these reasons, the merits (or otherwise) of a broad-based VAT exemption for general insurance products is not explored further in this report. The VAT systems of the countries we have considered represent many of the major developed countries in the world with a VAT. In some cases, such as New Zealand and South Africa, their VAT systems are generally regarded by academics and policy-makers as amongst the leading systems in the world, and their design has influenced the drafting of VAT laws in many other countries.

8 8 Proposed Introduction of VAT for the Insurance Sector in China The following table summarises the VAT treatment of general insurance products, reinsurance and related services in these major developed countries: General insurance: Australia Canada EU Japan New Zealand Singapore South Africa General insurance products Taxable Exempt Exempt Exempt Taxable Taxable Taxable Reinsurance of general insurance Taxable Exempt Exempt Exempt Taxable Exempt Taxable Agency/ brokerage of general insurance Taxable Exempt Exempt Taxable Taxable Taxable Taxable Exports of insurance Zero rated Zero rated Zero rated Zero rated Zero rated Zero rated Zero rated Source: KPMG The following table summarises the VAT treatment of life insurance products, reinsurance and related services in these major developed countries: Australia Canada EU Japan New Zealand Singapore South Africa Life insurance: Life insurance products Exempt Exempt Exempt Exempt Exempt Exempt Exempt Reinsurance of life insurance Exempt Exempt Exempt Exempt Exempt Exempt Exempt Agency/ brokerage of life insurance Taxable Exempt Exempt Taxable Exempt Taxable Taxable Source: KPMG Further details on the VAT treatment applicable in each of these jurisdictions are set out below. This analysis is relevant because it highlights many of the options available to the MoF and the CIRC in preparing the VAT rules for the insurance sector in China. Already, the MoF has shown a willingness to adapt VAT rules used in other jurisdictions to China.

9 Proposed Introduction of VAT for the Insurance Sector in China 9

10 10 Proposed Introduction of VAT for the Insurance Sector in China Australia The position under Australia s VAT regime, which has been in operation since the year 2000, is broadly as follows: Life insurance (including reinsurance) is exempt from VAT Health insurance is zero rated General insurance (including reinsurance) is subject to VAT at the rate of 10 percent. The primary area of complexity which arises in relation to the Australian system exists in respect of the payment of claims under policies of general insurance. What happens in Australia is that rather than requiring the insured (who is a general VAT taxpayer) to account for VAT on the settlement of claims (as occurs in South Africa and New Zealand), the VAT liability in Australia is effectively accounted for by the insurer on behalf of the insured. The mechanism by which this occurs may be briefly described as follows: The insured is typically required to advise the insurer (when taking out the policy) if they are entitled to claim an input VAT credit for the premium If the insurer later makes a cash settlement of the claim under a policy which is subject to VAT, and the insured was eligible for an input VAT credit in relation to the premium, the insurer will reduce the cash settlement amount by the VAT amount, because it does not represent a loss to the insured If the insurer makes a cash settlement of a claim under a policy which is subject to VAT, and the insured was not eligible for an input VAT credit in relation to the premium (for example, because the insured was an endconsumer), then the insurer is effectively entitled to an input VAT credit in relation to the claim paid. This is called a decreasing adjustment, but is of the same effect as an input VAT credit. The economic effect of the Australian approach is the same as for New Zealand, South Africa and Singapore. That is, insurers pay VAT on the value added the difference between the premium received and the claim paid.

11 Proposed Introduction of VAT for the Insurance Sector in China 11 From a legislative perspective, the Australian system is complex. However, much of that complexity arises because of a desire to achieve a relatively perfect taxing outcome. Achieving that perfect outcome can be complex when dealing with an insured who is registered as a general VAT taxpayer, but who is only eligible for a partial input VAT credit in relation to the insurance premium. It is submitted that the circumstances where this occurs is relatively rare, and perhaps would be even rarer still in China. It should also be noted that under the Australian system, agency/brokerage services in relation to all forms of insurance are subject to VAT. However, to overcome the problem of cascading of tax, which would otherwise arise in relation to agency/brokerage services provided in relation to exempt life insurance, the purchase of agency/brokerage services qualifies for an input VAT credit equal to 75 percent of the VAT incurred. This system, known as the Reduced Input Tax Credit system, is designed to overcome the disadvantages of outsourcing services in relation to exempt transactions. Interestingly, in designing the VAT system for insurance in Australia, Treasury officials initially decided to implement the New Zealand system, which requires an insured who is registered as a general VAT taxpayer, to account for VAT on settlement of a claim. However, after consultation with insurers, an alternative system was adopted, which achieves the same value added outcome, but does not require the insured to account for output VAT on settlement of a claim. The alternative system effectively allows the insurer to claim a deemed input VAT credit in settling a claim with an insured who is not a general VAT taxpayer.

12 12 Proposed Introduction of VAT for the Insurance Sector in China Canada As noted from the table set out earlier, both life and general insurance products are also exempt from VAT in Canada. Importantly, in Canada the exemption also covers the payment or receipt of an amount in full or partial settlement of a claim. In other words, the exemption captures both the payment of money, and the provision of goods or services in settlement of a claim. The breadth of the exemption in Canada means the VAT treatment of insurance products is relatively simple. Where any complexity arises, it tends to be in relation to issues such as whether a repair service, for example, is purchased by the insurer (where no input VAT credit would arise), or by the insured (where an input VAT credit may arise). Another area of complexity is that the amount of any loss suffered by an insured who is registered as a general VAT taxpayer must be calculated net of any VAT, whereas for an insured who is not a general VAT taxpayer, the loss would be inclusive of VAT. This is merely a mechanism designed to ensure that the insured is only compensated for the actual loss they have suffered. This issue is common amongst many of the jurisdictions we considered.

13 Proposed Introduction of VAT for the Insurance Sector in China 13 European Union The exemption for financial services across the EU member states, relative to a number of other places, is cast in broad terms. It includes not only the provision of insurance, but also those who provide insurance related services as an intermediary for example, an insurance broker or agent. This approach in the EU of exempting agency or brokerage services effectively overcomes the problem of tax cascading in relation to agency or brokerage services, which would otherwise arise. That is, if insurance brokerage or agency services were subject to VAT, while the supply of insurance itself would be exempt from VAT, then the provision of brokerage or agency services would effectively give rise to an embedding of VAT. Where insurance is supplied to a general VAT taxpayer, this approach of embedding VAT into B2B transactions is generally considered to be undesirable from a policy perspective. While the exemption for financial services in the EU is relatively broad, there are, nonetheless, difficult issues, which still arise in determining whether certain outsourced services should, or should not, also benefit from exemption. In other words, exemption from VAT should not be seen as resolving all issues rather, it merely shifts the debate as to whether peripheral services qualify. More generally, it should be noted that in the EU, there are two noteworthy trends: 1. The rates of VAT applicable among the EU member countries are increasing considerably. For example, the VAT rate in Hungary is now 27 percent, and in a number of other EU countries, their VAT rates now exceed 20 percent. While insurance is exempt from VAT throughout the EU, the key point is that insurers absorb significant amounts of VAT on their inputs due to the high rate. 2. The EU member countries are currently considering a range of reforms to the VAT treatment of insurance. While it may be an oversimplification, a number of the issues they are considering relate to the appropriate demarcation line between exempt insurance (and other financial services), and other taxable transactions. For example, whether portfolio transfers of insurance contracts should be eligible for exemption from VAT, and further, whether certain outsourced services should also qualify for exemption.

14 14 Proposed Introduction of VAT for the Insurance Sector in China Japan The indirect tax system in Japan is called the Japanese Consumption Tax (JCT). The applicable rate of JCT is currently 5 percent, although the Japanese Government has proposed to increase the rate to 8 percent from 2014 and to 10 percent from Importantly, insurance premiums are not subject to JCT. This includes both life and general insurance as well as reinsurance arrangements. Due to the breadth of the exclusion of insurance premiums under the JCT, the issues which arise are relatively uncomplicated. However, we note the following two matters: The exclusion of insurance from JCT is not as broad as in the EU countries. Consequently, while insurance premiums are not subject to JCT, agency/ brokerage of insurance policies is subject to JCT. This means that insurers who bear the cost of agency or brokerage fees, incur JCT on their inputs, which is irrecoverable. The proposed increase in the rate of JCT will have the effect of increasing the costs for insurers in providing insurance because they will absorb more JCT on their inputs.

15 Proposed Introduction of VAT for the Insurance Sector in China 15 New Zealand The position in New Zealand may be summarised as follows: Life insurance (including reinsurance) is exempt from VAT General insurance (including reinsurance) is subject to VAT, now at the rate of 15 percent. Under the New Zealand legislation, where an insured who is a general VAT taxpayer receives payment in settlement of a claim under a policy, which is subject to VAT, the insured is required to account for output VAT on the payment. This is similar to the position in South Africa. From a compliance perspective, we understand that many businesses fail to recognise that they have a liability to remit VAT in relation to the receipt of indemnity payments made under insurance policies this often leads to the imposition of interest and penalty charges. It should also be noted that in New Zealand, liability to account for VAT in relation to claims payments can also extend to persons who were not parties to the insurance contract, but who still receive an amount under an insurance contract. Often VAT is not factored in to the settlement and issues of non-compliance readily arise. Insurers making payment of claims (under taxable policies) are also eligible for input VAT credits for the VAT element in the claims paid, irrespective of whether the claims are paid to general VAT taxpayers or to end-consumers. The combined effect of these measures is to ensure that insurers pay VAT on the value added to insurance policies that is, on the difference between premiums received, and claims paid. It should also be noted that the VAT rate in New Zealand recently increased from 12.5 percent to 15 percent. This is consistent with a global trend, most clearly demonstrated among EU countries, of increasing VAT rates. One interesting issue that the MoF and the CIRC will need to consider is how best to manage the transition from BT to VAT in relation to insurance contracts. The recent example of New Zealand increasing its VAT rate raises issues relevant for China. In New Zealand, there was grandfathering relief provided so that contracts which straddled the date of the change remained subject to the old rate until the contract was renewed.

16 16 Proposed Introduction of VAT for the Insurance Sector in China Singapore The position in Singapore may be summarised as follows: Life insurance is exempt from VAT General insurance is subject to VAT at the rate of 7 percent, with the exception of marine hull insurance All reinsurance is exempt from VAT. Similar to the position in Australia, New Zealand and South Africa, the rules in Singapore are designed to ensure that insurers pay VAT on their value added in relation to general insurance contracts. The value added is effectively the difference between premiums received, and payments of claims made. In Singapore, this is achieved by allowing insurers to claim a deemed input VAT credit where they make a payment of cash in relation to a claim under a general insurance contract to an insured who is not a general VAT taxpayer (or otherwise not eligible to claim input VAT credits). One issue in Singapore is that the ability for the insurer to claim a deemed input VAT credit depends on them knowing about the insured s VAT registration status. In Singapore, this can be ascertained relatively easily through a public database maintained by the Inland Revenue Authority of Singapore (IRAS). If an insurer subsequently recovers part of the claim settlement amount, either from the insured (e.g. because of a fraudulent claim) or from a third party (under the principle of subrogation), then the insurer must reduce the amount of their input VAT credit claim accordingly. What is different about the Singaporean system as compared to the South African and New Zealand systems, is that it is the insurer who is eligible to claim an input VAT credit for the payment of a claim the insured is not required to remit VAT. From a risk management perspective, the system places the majority of the compliance obligations on a relatively small number of insurers, rather than a large and diverse number of insured s.

17 Proposed Introduction of VAT for the Insurance Sector in China 17 South Africa The position in South Africa is similar to that of New Zealand, and we understand this same treatment is applied in several other southern African countries. Under the South African VAT system, insurance is treated as follows: General insurance premiums (including reinsurance) for policies of a short-term duration, such as household property and motor vehicle insurance, are subject to VAT at the rate of 14 percent General insurance premiums (including reinsurance) for policies of a long-term duration (being 12 months or more), such as life assurance, are exempt from VAT Brokerage fees, including in relation to life assurance products, are subject to VAT. This is based on the general position in South Africa that any explicit fees for services, including financial services, are subject to VAT. The primary effects of this approach are as follows: General VAT taxpayers will be eligible to claim input credits for premiums paid in respect of policies of a short-term duration The making of a claim under a policy of a short-term duration is treated as a deemed supply for VAT purposes, so an insured who is a general VAT taxpayer is required to remit VAT in relation to the receipt of an indemnity payment (but not where the insurer replaces goods, or makes a payment in kind) An insurer who makes payment of a claim under an insurance policy, which is subject to VAT, is entitled to claim an input VAT credit for the payment of the claim From a compliance perspective, it is understood that many businesses fail to recognise that they have a liability to remit VAT in relation to the receipt of indemnity payments made under insurance policies this often leads to the imposition of interest and penalty charges.

18 18 Proposed Introduction of VAT for the Insurance Sector in China Potential methods of applying VAT to general insurance in China Having analysed the VAT treatment applicable to the insurance sector in many other countries globally, we now turn to consider the options that may be applied in China. As noted earlier, the MoF and the CIRC have already expressed the view that the introduction of a broad-based exemption from VAT for the insurance sector, similar to what currently occurs in the EU, Canada and Japan, is unlikely to apply in China. We have set out the potential VAT position for general insurance only, on the understanding that life insurance will be exempt from VAT. Option 1 - Simplified VAT method Circular Caishui [2011] 110 states that financial and insurance services will be subject to the simplified VAT method. As previously noted, the proposed rate, detailed scope and way in which the simplified VAT method operates in relation to insurance products are not outlined. KPMG s understanding is that the simplified VAT method effectively involves the following: The supplier, being an insurer, will be required to pay output VAT in relation to the premium payable for general insurance products The recipient, if they are a general VAT taxpayer, will not be eligible to claim input VAT credits in relation to the purchase of those general insurance products The supplier will also be ineligible to claim input VAT credits in relation to their costs of sales, administration and claims management of those general insurance products No VAT should be payable in relation to the settlement of claims. In essence, the simplified VAT method merely implements the same features of a BT, but under the name of a VAT. It is important to recognise that while it is called a simplified VAT method, it bears very few of the features usually associated with a VAT, for example: It leads to taxes cascading through the supply chain, when one insurer supplies insurance to a business registered as a general VAT taxpayer. This characteristic is cited as one of the key reasons why BT is being repealed. As such, the implementation of this approach under a VAT would seem to undermine the purpose behind the introduction of a VAT for the services sector in China It leads to insurers bearing VAT on their inputs as a real cost. Given that VAT rates on inputs are expected to be higher under a VAT than they were under BT, this is likely to lead to a higher overall tax burden for general insurers It leads to the tax base essentially being gross revenue or premium income of the insurers, whereas the tax base under a VAT is the value added. In short, the adoption of a simplified VAT method is ill-suited to the insurance sector in China it is contrary to the core reasons why the government has sought to replace BT with a VAT. While it may be argued that a simplified VAT method is an appropriate substitute for the BT system for certain banking services (given that

19 Proposed Introduction of VAT for the Insurance Sector in China 19 other jurisdictions generally do not tax most banking services under a VAT), it is not an appropriate or necessary substitute for the insurance sector. That is because there are many countries such as Australia, New Zealand, Singapore and South Africa that have now implemented VAT regimes for the insurance sector, which tax the value added. Finally, we note that KPMG sought feedback from its clients and other industry participants about their preferred model for a VAT. The overwhelming response from industry was that they preferred a VAT system for insurance which taxes the value added, modelled on the principles applicable in countries such as Australia, New Zealand, Singapore and South Africa. Option 2 taxing the value added The overview of the jurisdictions which tax general insurance under a VAT highlights that the approach they adopt for doing so is as follows: VAT liability = VAT rate x (gross premiums less claims paid) Essentially, the value added is not calculated on a policy-by-policy basis, but rather, is pooled amongst all of the premiums invoiced and claims paid during each tax period. Furthermore, the calculation of claims paid is effectively undertaken on a cash basis that is, the actual payment of a claim reduces the VAT liability of the insurer. The insurer does not take into account reserves or other accruals in that calculation. It is also important to recognise that in addition to the two components highlighted above, (gross premiums and claims paid), insurers in each of the jurisdictions which tax general insurance under a VAT are eligible to claim input VAT credits for their general business expenditure, such as claims administration costs and general overheads. Furthermore, in South Africa, a helpful distinction is sometimes drawn between trade payments ( payments made by insurers to suppliers of goods or services, either to replace or repair damaged property of the insured, claims handling fees, assessor fees and other administrative charges) and indemnity payments ( payments made by insurers to an insured in settlement of a claim pursuant to a right of indemnity). Insurers are generally entitled to input VAT credits for both categories of payment where the policy is a taxable policy. Importantly, while countries such as Australia, New Zealand, Singapore and South Africa all tax general insurance products under a VAT, the method by which they achieve this outcome differ. Broadly speaking, those countries taxing general insurance under a VAT apply one of two different methodologies, as explained in the table below:

20 20 Proposed Introduction of VAT for the Insurance Sector in China Premium income Cash settlement of a claim with an insured who is not a general VAT taxpayer Cash settlement of a claim with an insured who is a general VAT taxpayer Settlement of a claim by providing the insured with a replacement good (or service) e.g. a new motor vehicle Source: KPMG Method A Australia and Singapore The insurer remits VAT; the insured can generally claim an input VAT credit if they are a general VAT taxpayer Insurer claims a deemed input VAT credit No deemed input VAT credit may be claimed. That is because no VAT has been paid on the premium i.e. insurer s output VAT = insured s input VAT credit Insurer claims an input VAT credit for the purchase of the new motor vehicle. No output VAT is payable on the supply of the motor vehicle to the insured Method B New Zealand and South Africa Insurer remits VAT; the insured can generally claim an input VAT credit if they are a general VAT taxpayer No output VAT is payable by the insured The insured must remit output VAT. Insurer can claim a deemed input VAT credit no special VAT invoice is generally required. Insurer claims an input VAT credit for the purchase of the new motor vehicle. No output VAT is payable on the supply of the motor vehicle to the insured For these purposes, a cash settlement of a claim includes not only the payment of physical currency, but also a cheque, money order, crediting to a bank account or similar. The following worked examples highlight the operation of Method A and Method B: Method A - supply of general insurance Let us assume an insurance company sells taxable insurance policies for RMB 1,060,000 during October RMB 600,000 of those policies was sold to taxpayers who are general VAT taxpayers and the balance of RMB 460,000 was sold to private individuals. During October 2014, the insurer pays out total cash settlements of RMB 954,000, of which RMB 500,000 was paid to general VAT taxpayers and RMB 454,000 was paid to private individuals. Assume the VAT rate is 6 percent. Ignore local taxes and surcharges. On payment of the premium: Insurer s VAT is = 1,060,000 x 0.06/ ,000 Insured s input VAT credit is = 600,000 x 0.06/1.06 (33,962) On cash settlement of the claims: Insurer s input VAT credit is = 454,000 x 0.06/1.06 (25,698) VAT Liability 340 Result Only the margin of RMB 6,000 attributable to sales to private individuals is subject to VAT of RMB 340 (being 6,000 x 0.06/1.06) No VAT is payable in relation to sales to general VAT taxpayers, which is consistent with a B2B revenue neutral approach.

21 Proposed Introduction of VAT for the Insurance Sector in China 21 Method B - supply of general insurance Let us assume an insurance company sells taxable insurance policies for RMB1,060,000 October RMB 600,000 of those policies was sold to taxpayers who are general VAT taxpayers and the balance of RMB 460,000 was sold to private individuals. During October 2014, the insurer pays out total cash settlements of RMB 954,000, of which RMB 500,000 was paid to general VAT taxpayers and RMB 454,000 was paid to private individuals. Assume the VAT rate is 6 percent. Ignore local taxes and surcharges. On payment of the premium: Insurer s VAT is = 1,060,000 x 0.06 / ,000 Insured s input VAT credit is =600,000 x 0.06/1.06 (33,962) On cash settlement of the claims: Insured s VAT is = 500,000 x 0.06/ ,302 Insurer s deemed input VAT credit = 954,000 x 0.06/1.06 (54,000) VAT Liability 340 Result Only the margin of RMB 6,000 attributable to sales to private individuals is subject to VAT of RM 340 (being 6,000 x 0.06/1.06) No VAT is payable in relation to sales to general VAT taxpayers, which is consistent with a B2B revenue neutral approach. As these two examples highlight, the same amount of VAT is payable under both Method A and Method B. Simply put, the main difference is in the obligations placed on each of the parties.

22 22 Proposed Introduction of VAT for the Insurance Sector in China A comparison of these two methodologies is set out in the table below: Method A Australia and Singapore Advantages Disadvantages A higher level of compliance is generally achieved because the primary VAT compliance obligations arising on settlement of claims are placed on insurers (who are relatively smaller in number, but generally have more sophisticated systems and processes) as compared with Method B,which places the obligations on a broader range of insured s who are registered as general VAT taxpayers Method A should be simpler to implement and audit from an administrative perspective The insurer can only claim a deemed input VAT credit on payment of a claim to an insured who is not a general VAT taxpayer. This effectively requires the insurer to know the VAT status of the insured. In Australia, insurers have had to put in place procedures to capture information about the VAT status of the insured. In Singapore, the information is accessible on a publicly available database Method B New Zealand and South Africa Advantages The insurer does not need to know whether the insured is, or is not, a general VAT taxpayer Disadvantages The experience in both New Zealand and South Africa is that there are relatively high levels of non-compliance this most often arises because an insured who is a general VAT taxpayer is unaware of the need to remit VAT. Because the receipt of insurance proceeds is not an everyday transaction, the obligation is often overlooked In some instances, the insured may direct that the insurance settlement proceeds be paid to a different party, or alternatively, the party indemnified for the loss may not be the insured for example, an employee suffering loss under a policy held by an employer. Under Method B, the risks of non-compliance are even greater in this instance because the employer may be required to remit output VAT, and that obligation will be less obvious where they are not the payee of the settlement proceeds Source: KPMG

23 Proposed Introduction of VAT for the Insurance Sector in China 23 In KPMG s recent consultation meetings with the MoF and the CIRC, they expressed a view that Method B, currently applicable in New Zealand and South Africa, is the preferred methodology to be introduced into China. While KPMG is supportive of the general insurance sector being taxed on a value added basis (in preference to the other approaches considered by the government), we do have reservations about the use of Method B in China. Our primary reservations are: The experience in both New Zealand and South Africa is that high levels of non-compliance can arise, whereby the insured fails to remit VAT on receipt of the settlement proceeds. Several reasons may be given for this. First, the settlement of an insurance claim is not an everyday event for most taxpayers, and falls outside their normal systems and processes. No invoice is typically issued by the insured in respect of the insurance proceeds, so the normal trigger events which ensure VAT is captured do not arise. Second, to many laypersons, they would not consider that they have supplied a good or a service to an insurer in return for which they receive the proceeds of an insurance claim. In other words, it is not within their expectations that VAT would apply. In China, the existence of multiple VAT rates is likely to give rise to additional confusion. For example, if a general VAT taxpayer who pays VAT on their sales at the rate of 17 percent receives an insurance settlement, the question arises as to whether the 17 percent VAT rate applies to the insurance settlement, or the VAT rate applicable to insurance. The correct policy answer is that it should be the VAT rate applicable to the insurance sector because this is the means by which VAT is paid on the value added in insurance policies. The concern, however, is that many insured s may mistakenly pay VAT at the wrong rate, again because it may be different from the usual VAT rate they pay on their goods or services. In New Zealand, South Africa, Australia and Singapore, the entitlement of an insurer to an input VAT credit upon settlement of a claim with an insured arises on a deemed basis. That is, the insured does not need to issue a special VAT invoice to the insurer. The insurer is simply entitled to claim an input VAT credit upon payment of the claim, and generally speaking, is merely required to keep records evidencing the payment (and possibly the details of the policy and claim more generally) in the event of an audit. Importantly, the invoicing systems in each of these countries differ considerably from the regulated invoicing which occurs in China. There may be a temptation for the MoF and the CIRC to require, in the implementation of Method B in China, the insured to issue a special VAT invoice to the insurer, and make the receipt of such a special VAT invoice a precondition to the insurer claiming an input VAT credit. If that occurs, the potential cost to insurers in terms of lost input VAT credits may be significant if, as we expect, there is a relatively high level of non-compliance. Put simply, insurers would need, in all likelihood, to then put in place processes to require insured s to provide special VAT invoices for claims settlements as a pre-condition to receipt of payment. In turn, this would require the insurers to also know whether the insured is or is not a general VAT taxpayer.

24 24 Proposed Introduction of VAT for the Insurance Sector in China Under Method B, the insured may direct that the insurance settlement proceeds be paid to a different party, or alternatively, the party indemnified for the loss may not be the insured for example, an employee may suffer loss under a policy held by an employer with an insurer. In these situations the risks of non-compliance by the insured (employer) may be even greater because of the disconnect between the recipient of the settlement proceeds and the party liable to remit output VAT. In China, there is generally a strong linkage between cash and accounting systems and VAT obligations, and the implementation of Method B will heighten the risks of non-compliance. The same problem does not arise under Method A. Interestingly, both Australia and Malaysia (proposed) considered Method B during their consultation processes leading up to the introduction of VAT. Both Australia and Malaysia (proposed) have decided to apply Method A instead. What is the appropriate VAT rate for general insurance in China? In considering the appropriate VAT rate to apply to general insurance products in China, it is a false comparison to simply look at VAT rates for insurance products around the world. This is because insurance products are often subject to a range of other indirect taxes either instead of, or as well as, a VAT. For example, throughout the EU, insurance is exempt from VAT. However, many EU member states impose an Insurance Premium Tax, which acts as a substitute for a VAT. Alternatively, many countries impose stamp duties or a range of different levies, either instead of, or as well as, a VAT. The question of the appropriate VAT rate for general insurance products in China is a matter for government economic policy, and moreover, would require economic modelling to take place before a realistic assessment can be made of the appropriate VAT rate. The MoF and the CIRC have also not shared with us their objectives in terms of what they are seeking to raise by way of revenue collections from the insurance sector. As such, KPMG is not in a position to provide a properly based assessment of the appropriate VAT rate. However, we can make some general observations. Under the current VAT pilot program, the State Council has approved two new VAT rates 6 percent and 11 percent, along with the existing general VAT rate of 17 percent, which applies to the sale and importation of most goods, as well as the leasing of tangible movable property. Therefore, assuming that the VAT rate for the general insurance sector would be selected from among these alternatives, we have rated the likelihood of each rate being adopted as follows: 6 percent - this rate currently applies to the modern services industry. In our experience, it has typically been applied mostly to businesses with a high proportion of labour costs relative to goods or fixed assets used in their business. For example, most businesses in the consulting services industry have a cost structure which comprises labour and rent (currently not subject to VAT) as the two major costs of their business. The higher the proportion of labour and rent to the total costs of the business, the lower the benefit of input VAT credits in transitioning to VAT, at least at present while rent is not within the VAT net. The cost structure of a general insurance business deviates somewhat from that of many consulting businesses, by reason of the input VAT credits available on payment of claims, or the purchase of goods

25 Proposed Introduction of VAT for the Insurance Sector in China 25 and services used in settling claims. As such, we would consider it relatively improbable for the government to apply a VAT rate of 6 percent for the general insurance sector. Having said that, if insurance is seen as a sector which is to be encouraged in terms of its growth and development, then a modest VAT rate of 6 percent would seem to be more appropriate. 11 percent - this rate currently applies to the transportation sector, and it is expected to also be applied to several other industries yet to transition to VAT, such as telecommunications and real estate and construction services. The insurance sector exhibits some of the same characteristics of these other sectors in that general insurers will get the benefit of input VAT credits for any goods (or services) purchased in settling claims with insured s, or deemed input VAT credits for any cash settlements. In our view, there is a relatively high probability that this is the VAT rate to apply to the general insurance sector. 17 percent - this rate currently applies to the sale and importation of most goods in China. Recently, this VAT rate has also been applied to leasing of tangible movable goods, presumably on the basis of equity that is, the same VAT rate applies irrespective of whether the goods are purchased outright, imported, or leased. Potentially, this same rationale could be applied to the insurance sector too. If VAT applies to the sale of goods at 17 percent, then there is certain equity in applying VAT at the rate of 17 percent to the premium paid to compensate for the loss of those goods. Furthermore, if a different VAT rate applies to the sale of goods as compared with insuring those goods, the potential for value shifting between the price of the goods and the insurance of those goods will arise. Notwithstanding this, we still consider it unlikely for the government to apply a VAT rate of 17 percent for the general insurance sector given that it would result in a significant additional tax burden on a developing industry. This analysis simply highlights the difficulties involved in reliably predicting the VAT rate applicable to the general insurance sector. Suggested VAT treatment of life insurance in China Our analysis below in relation to the appropriate treatment of life insurance under a VAT in China is relatively brief to due the fact that: Life insurance is currently exempt from BT in China Life insurance is exempt from VAT in all of the countries surveyed as part of this report The policy rationale for exemption is sound one of the main components of life insurance is savings, which is also exempt from BT (and VAT in other countries) In the first phase of the VAT pilot program, the government has shown a willingness to manage the transition to VAT for different industries by allowing for the continuation of many concessions and exemptions previously applicable under the BT regime.

26 26 Proposed Introduction of VAT for the Insurance Sector in China On this basis, there seems little doubt that life insurance will be exempted from VAT in China. Our only comments in relation to the recommended treatment of life insurance in China are to draw attention to certain compliance issues arising from the availability of an exemption: 1. Consideration will need to be given as to whether an exemption for life insurance should also be extended to related services, such as life insurance administration, and brokerage or agency services in selling life insurance. In the absence of such an exemption for related services, some tax cascading will arise. 2. In a similar vein, it will be desirable to ensure there is a very clear definition of what constitutes exempt life insurance, so that non-life insurance riders which may be sold together with life insurance policies do not receive exempt treatment. We note that Circular Caishui [2013] 37 already deals with this to some extent, by requiring the highest VAT rate to apply where products with different VAT rates are bundled together. 3. Consideration will need to be given to appropriate apportionment principles for input VAT credits for insurers who sell exempt life insurance, as well as other forms of insurance, which may be subject to VAT. Typically in China, this is undertaken using revenue-based apportionment methodologies. Are there types of insurance products which should be considered for concessional VAT treatment? In addition to life insurance products, we note that certain types of general insurance products currently benefit from concessional BT treatment in China and/ or concessional VAT treatment in many other countries. We note that the MoF and the CIRC may give consideration to applying concessional VAT treatment to the following types of products:

27 Proposed Introduction of VAT for the Insurance Sector in China 27 Health insurance this is currently exempt from BT for plans of one year or more duration, pursuant to Circular Caishuizi [1994] No.2. In Australia, health insurance is zero rated for VAT purposes. Given the lower cost to the community health system if people have insurance, consideration should be given to concessional VAT policies for health insurance products. Social endowment insurance and children s education insurance these types of insurance are a form of savings product. As such, consideration should be given to concessional VAT policies for these types of products. Agricultural insurance at present, there are a range of taxation concessions and subsidies applicable to the agriculture sector to encourage its development. Consideration may be given to similar VAT concessions to agricultural insurance. Other forms of compulsory insurance it is noted that there are a range of insurance products which are compulsory,.e.g., motor vehicle insurance and industrial injury insurance. Given the compulsory nature of those products, and the fact that in some respects, the premiums already act as a quasi-form of tax, it may be appropriate for the government to consider concessional VAT policies for these types of products. Other aspects affecting VAT and general insurance Applying VAT to general insurance policies also gives rise to a number of flow-on effects, which insurers and their customers need to consider. Here is a sample of some of the issues which can arise in practice. Excesses/deductibles It is relatively commonplace in the general insurance sector for an insured to be required to pay an excess or deductible in the event of an insurance claim being made. That excess or deductible reduces the amount payable by the insurer in accordance with the indemnity they provide. On that basis, the excess or deductible must also reduce the amount of the deemed input VAT credit available to the insurer on settlement of a claim. Where Method B applies, the payment of an excess or deductible by the insured should also reduce the output VAT liability of the insured. Complications potentially arise in relation to excesses or deductibles when they are paid by the insured directly to a repairer or other third party replacing the damaged goods. In this instance, the issue which arises is whether the insured is eligible for an input VAT credit for their contribution towards the cost of the repair, assuming the insured is a general VAT taxpayer. The problem is complicated by the fact that the repairer may only issue a single special VAT invoice to the insurer. Given the dependency in China on invoices as a means of validating entitlement to input VAT credits (more so than in many other countries), consideration will need to be given as to whether a repairer would be entitled to issue separate special VAT invoices to each of the insurer and the insured for their respective components. This is the position in countries such as Singapore and South Africa. Where the excess or deductible is paid by the insured to the insurer, the position in Australia and South Africa is that this transaction is not subject to VAT. However, in Singapore, it is subject to VAT. This raises questions about the appropriate VAT treatment to be applied in China where an excess or deductible is paid by the insured directly to the insurer. Structuring excesses and deductibles appropriately may impact on the overall tax burden of the insurer and the insured.

28 28 Proposed Introduction of VAT for the Insurance Sector in China Rights of subrogation A right of subrogation arises where one person takes over the rights of another against a third party. Typically, it arises where an insurer pays out a claim to their insured, and then takes over the insured s rights against a third party. For example, if an insured has comprehensive motor vehicle insurance and their vehicle is damaged as a result of the negligence of a third party, the insured may claim for damages from their insurer, and their insurer can then seek to recover from the third party. From a VAT perspective, where an insurer exercises its rights of subrogation so that a third party (or even another insurer) pays damages to the insurer, there should be no VAT consequences. This is the position adopted in Singapore, South Africa and Australia. It would seem to produce the appropriate VAT policy outcome as between all of the parties and should therefore be applied in China. Distinguishing insurance from other products If the insurance sector is to be subject to VAT at a different rate, or uses different methodologies from other types of financial and other services, then it is necessary to ensure there is a clear distinction drawn between insurance and other services. Internationally, common areas of difficulty have arisen in distinguishing insurance from: Warranties Guarantees Contractual indemnities provided by non-insurers. In some countries such as the UK, the distinction has been drawn at a practical level by restricting the range of taxpayers eligible to apply the specific VAT treatment of insurance to companies which are regulated as insurers for general legal purposes. A similar distinction could be implemented in China given the close regulation of the insurance sector. Linkages with the accounting treatment of insurance products would also be useful given the general usage of accounting standards in guiding the treatment applicable for tax purposes. Reinsurance The VAT treatment of reinsurance raises a number of issues which industry, as well as the MoF and the CIRC, will need to carefully consider. In terms of international experience, the position may be summarised as follows: Reinsurance of life insurance is exempt from VAT in all of the countries surveyed Reinsurance of general insurance follows the same VAT treatment as general insurance, with the exception of Singapore. That is, if the supply of general insurance is exempt from VAT, then reinsurance of general insurance is also exempt from VAT. If the supply of general insurance is subject to VAT, then (with the exception of Singapore), reinsurance of general insurance is also subject to VAT. The main qualification to the above statements is that frequently reinsurance transactions will involve an offshore reinsurer, so the cross-border nature of these transactions needs to be overlaid on this analysis.

29 Proposed Introduction of VAT for the Insurance Sector in China 29 As noted above, Singapore is the exception. In Singapore, the supply of reinsurance is exempt from VAT, even in circumstances where general insurance is subject to VAT. Importantly, the treatment in Singapore can lead to tax cascading between the reinsurer (who may be denied input VAT credits) and the general insurer. Furthermore, Singapore s reverse charge rules are currently suspended, so that where there is an offshore reinsurer, no VAT currently applies. KPMG s discussions with reinsurers suggest they support the implementation of the following principles: If life insurance is exempt from VAT, then reinsurance of life insurance should also be exempt from VAT If general insurance is subject to VAT, then reinsurance of general insurance should also be subject to VAT. From a policy perspective, the implementation of these principles would seem to be appropriate because reinsurance is simply a form of insurance for insurers. Therefore, logically it should have the same indirect tax attributes as the underlying insurance offered to consumers. This approach also seeks to remove the problem of VAT being embedded in the supply chain between reinsurers and insurers. From a practical perspective, we understand that it is relatively common for an insurer to receive a commission for placing a policy with a reinsurer. Commercially, that commission amount is often offset, or netted off, against the premium payable to the reinsurer. The issue this raises from a VAT perspective is whether they should be treated as two separate transactions for VAT purposes (with special VAT invoices being issued by the parties to each other), or may be amalgamated as a single transaction for VAT purposes. Consider the following example: Reinsurance example An insurer underwrites a property insurance cover with a premium of RMB 20,000 (plus VAT) for one year. The insurer decides to proportionally reinsure the policy as follows: Reinsurer A 15 percent Reinsurer B 25 percent Reinsurer C 10 percent The insurer will receive 20 percent commission for placing this policy. Assume a VAT rate of six percent and ignore local taxes and surcharges. Reinsurer A Reinsurer B Reinsurer C Premium 3,000 5,000 2,000 VAT on premium Commission 600 1, VAT on commission Issue: Will this be treated as two separate transactions premium and the commission - or can the transactions be netted off for VAT purposes?

30 30 Proposed Introduction of VAT for the Insurance Sector in China When a claim is made against an insurer, and in turn, they seek contribution from a reinsurer, the same basic principles apply to the settlement of claims. That is, under Method A used in Australia and Singapore, if the insurer was eligible for a full input VAT credit in relation to the payment of the premium (as is usually the case), then no further VAT consequences arise. However, under Method B used in New Zealand and South Africa, the insurer would be required to remit VAT upon receipt of payment from the reinsurer, and the reinsurer would be entitled to claim an input VAT credit. Insurance agents, brokers and other intermediaries Many countries have special VAT rules applicable to insurance agents, brokers and other intermediaries. Those special rules typically exist for a variety of purposes: To alleviate the obligation on agents or brokers to register and pay VAT for example, India s service tax regime has a reverse charge rule, which effectively places many of the compliance obligations on insurers for the actions of their agents and brokers To delay the time that the insurer must account for output VAT until such time as their agent notifies them of the policy being sold, or to allow agents or brokers to issue special VAT invoices on behalf of insurers To allow insurers to engage in self-invoicing for the payment of commission income this simply reflects the fact that the insurer is ordinarily the party who calculates the commission or other remuneration payable to the agent or broker, and therefore for convenience, the insurer is entitled to issue the invoice upon which they can claim an input VAT credit. The use of self-invoicing by insurers (and by reinsurers in respect of their reinsurance contracts with insurers) is permitted in countries such as Australia, Malaysia, India and Singapore. Special challenges will arise in implementing these same rules in China because of the strictly regulated invoicing system. A further question which arises is the choice of the appropriate VAT rate for agents, brokers and intermediaries. Given that their cost structure is typically very similar to that of other businesses in the consulting sector, a 6 percent VAT rate would seem to be the appropriate rate. The only concern with this is the potential for confusion if the VAT rate for agents and brokers differs from that of the underlying insurance they are selling. In addition, if VAT is to apply to the services of agents or brokers in selling exempt life insurance products, then the VAT liability is effectively embedded in the cost. This may create an incentive for life insurers to engage employees in preference to agents or brokers. As such, consideration may be given to exempting from VAT the services of agents or brokers in selling life insurance products.

31 Proposed Introduction of VAT for the Insurance Sector in China 31 Cross-border insurance transactions The analysis and examples set out earlier in this report apply where insurance transactions occur entirely within China. However, it is relatively common that insurance transactions will have an international element to them. Different considerations arise where the insurance transaction is an export, as compared with an import, as set out below. Exported insurance transactions Most countries zero rate the export of insurance products, consistent with OECD Guidelines and the application of what is known as the destination principle. Under the destination principle, VAT should only be levied in the place where the service is consumed. In China, the destination principle has recently been applied to the first phase of the VAT pilot program, meaning that the export of many services qualifies for either zero rating or VAT exemption. In the context of insurance products, an export may arise in either of the following ways: Where the insurance product is supplied to a person who is outside China (for use outside of China); or Where the insurance product indemnifies against risks or events which may take place outside of China. Examples of these situations would include international transportation insurance, to protect against loss or damage to goods being transported outside of China; or international travel insurance, to protect against loss, damage, ill-health or other events outside of China. It is recommended that the MoF and the CIRC allow insurers to zero rate or exempt insurance, which is supplied to persons outside of China, or where the insurance indemnifies against risks or events taking place outside of China. The same principles should apply to reinsurance. Such an approach is consistent with the categories of exported services which are zero rated or exempt from VAT, as set out in Circular Caishui [2013] 37. It is also consistent with the underlying principles of VAT, which is that tax should only be payable in the place of consumption of the service. One area where complexity can arise is in relation to insurance for the international transportation of goods. Technically, the policyholder is insured against loss or damage from the place in which the goods are collected to the port, and then on to the place of delivery. Similarly, international travel insurance ordinarily insures persons from their home to their local point of departure, and then to overseas and back again. In each case, there is usually a small domestic component to the insurance cover and in many countries (for example, Australia, Malaysia and Singapore), that domestic component is effectively disregarded for VAT purposes. The same principle should be applied in China. In addition to the above, insurers should be eligible to apportion premiums for insurance, which insure against risks or events which take place partly in China, and partly outside of China. An example would include worldwide property and casualty policies obtained by multinational companies, or by Chinese companies with offices or branches outside of China.

32 32 Proposed Introduction of VAT for the Insurance Sector in China Imported insurance transactions Insurance transactions can also be imported when the insurer is located outside of China, and the insurer insures against risks or events taking place in China. A common example of this is reinsurance provided by offshore reinsurers. Generally speaking, in applying the OECD Guidelines, which recommend the use of the destination principle, most countries will apply a reverse charge to collect VAT from the insured party in receipt of the insurance cover. An exception to this is Singapore, where the reverse charge rule is currently suspended for all transactions. In principle, the general VAT withholding rules contained in Circular Caishui [2013] 37 could be applied to the insurance sector. That is, if the insurer is overseas, the insured should be required to withhold VAT and if the insured is also a general VAT taxpayer, claim an input VAT credit. The main concern with this approach is that if the insured withholds VAT, they have effectively short paid the premium for the insurance, and the insurer may then deny cover, or deny part of the liability. It is noted that other countries do not have this problem under their VAT systems because they apply a reverse charge rather than a withholding system. This issue will need to be carefully considered by the insurance industry, together with the MoF and CIRC. As noted above, a common example where insurance is imported arises where reinsurance is provided by an offshore reinsurer. By way of example, the VAT withholding rules may apply as follows: China Overseas Insurer reinsurance Reinsurer Withhold output VAT China Tax Authority Claim input credit Points to note: If existing VAT pilot program rules apply, recipient in China would have to withhold VAT on the amounts it pays to overseas reinsurer If the Insurer is a general VAT taxpayer, it will be eligible to claim an input VAT credit The Recipient must provide certain documentation to validate the input VAT credit claim (since no special VAT invoice is issued) Source: KPMG

33 Proposed Introduction of VAT for the Insurance Sector in China 33 The MOF and the CIRC will need to ensure that the VAT withholding rules do not apply to insurance or reinsurance provided by overseas parties in relation to life insurance or other exempt or zero rated types of insurance. In other words, just because the supplier is overseas should not trigger a VAT withholding obligation if VAT would not have applied had the insurance been offered by an insurer in China. Transitional provisions A critical issue that the MoF and the CIRC will need to consider is the date of effect upon which insurance contracts become subject to VAT. There are a range of potential trigger points : VAT could apply to new insurance contracts entered into, or renewed, on or after the date of commencement of VAT; or VAT could apply to premiums for insurance contracts paid, or invoiced, on or after the date of commencement of VAT. The method by which VAT applies to general insurance will likely dictate the way in which any transitional provisions apply to the insurance sector. For example, if general insurance is to be subject to VAT on the basis of the value added being the difference between premium income and claims paid, then it would be anomalous to allow an insurer to deduct input VAT credits for claims paid in relation to policies where the premium was not subject to output VAT. As such, we consider that VAT should only apply to those policies newly entered into, or renewed, on or after the date of commencement of the introduction of VAT for the insurance sector. For example, if the insurance sector is to be subject to VAT from 1 September 2014, then only new policies entered into, or existing policies renewed, on or after 1 September 2014 should be subject to VAT. This will necessitate insurers to keep track of claims paid so as to only claim input VAT credits for policies where premiums were subject to VAT. This approach to implementation of VAT is very similar to what applied in Australia when GST was first introduced, and in New Zealand when the VAT rate was increased from 12.5 percent to 15 percent. Key recommendations for the MoF and the CIRC Based on KPMG s analysis of the international treatment of the insurance sector under a VAT as well as our understanding of the current system in China, together with feedback from both SOE and foreign insurers and reinsurers, we recommend the following: 1. Life insurance 1.1 Life insurance should be exempt from VAT, consistent with international experience, the existing BT treatment in China, and reflecting the savings nature of these policies.

34 34 Proposed Introduction of VAT for the Insurance Sector in China 2. General insurance 2.1 Premiums for general insurance policies shall be subject to VAT based on the value added by insurers. 2.2 The preferred methodology by which the value added should be taxed under a VAT is by applying Method A, currently used in Australia and Singapore. This is on the basis that we consider that the alternative Method B may give rise to relatively high levels of non-compliance. 2.3 Alternatively, if the MoF and the CIRC wish to proceed with Method B, which is currently used in New Zealand and South Africa, upon cash settlement of a claim under a general insurance policy, the supply of which is subject to VAT: Where the insured is a general VAT taxpayer, they would be required to pay VAT on the proceeds based on the formula: insurance proceeds x VAT rate / (1 + VAT rate), with the applicable VAT rate being that of the insurance sector rather than the VAT rate applicable to the goods or services the insured ordinarily supplies The insurer would be entitled to claim a corresponding deemed input VAT credit upon payment of the proceeds without the need for a special VAT invoice. Instead, the insurer would be required to provide the tax authority with documentation to substantiate any claim for an input VAT credit such as the policy, and evidence of payment. 2.4 Consistent with the position applicable in New Zealand and South Africa, where the insurer supplies goods or services in settlement of a claim, the supply of those goods or services is not subject to VAT or deemed sales rule. Furthermore, the purchase of the good or service by the insurer in settling the claim should be eligible for an input VAT credit. These rules are needed to ensure that the value added is taxed. 3. Reinsurance 3.1 Reinsurance should follow the same VAT treatment as the underlying insurance. That is, reinsurance of life insurance should be exempt; reinsurance of general insurance products which are subject to VAT should also be subject to VAT. 4. Exports 4.1 The export of an insurance product should be zero rated in the following situations: The insured is an overseas entity; or Substantially all of the risks under the policy arise outside of China. 4.2 Examples include, but are not limited to, international transportation, overseas travel insurance and export credit insurance. Apportionment of the VAT on premiums would be needed where part of the risks arise outside of China, and part in China, e.g., group worldwide policies.

35 Proposed Introduction of VAT for the Insurance Sector in China Insurance agents 5.1 For agents or brokers selling general insurance: Agents who are general VAT taxpayers should be subject to VAT at the rate of 6 percent. Agents who are small scale VAT taxpayers should be subject to VAT at the rate of 3 percent Insurers should be entitled to use self-invoicing in order to claim input VAT credits for invoices issued to agents in payment of their commission. Self-invoicing should also be permitted between insurers and reinsurers. 5.2 For agents or brokers selling life insurance or reinsurance of life insurance: Their services should be exempt from VAT. This is needed to ensure VAT does not become embedded in the costs of an insurance business, and to ensure insurers do not incur additional costs of engaging agents or brokers in preference to employees. 6. Transition to VAT 6.1 VAT should only apply to premiums and claims under insurance policies where a new policy is entered into, or there is a renewal or extension of an existing policy after the transition date. This is needed to ensure that insurers cannot reduce their VAT burden by reference to the payment of claims under policies which preceded the commencement of VAT. 7. Concessional treatment under certain policies 7.1 Consideration should be given to zero rating or exempting certain types of policies such as medical and healthcare insurance, social endowment insurance, children s education insurance and compulsory insurances such as industrial injury insurance. 8. Mixed sales 8.1 Where insurance is provided along with other goods or services, then the VAT rate for insurance should apply to the insurance component where the premium can be separately identified. This is needed to ensure that the part of the total price representing the insurance component is subject to the appropriate VAT rate for insurance, and not a higher or lower rate. 9. VAT withholding 9.1 There should be no VAT withholding where insurance or reinsurance supplied from overseas is in relation to exempt life insurance or other exempt or zero rated types of insurance.

36 36 Proposed Introduction of VAT for the Insurance Sector in China How KPMG can help The key challenge in implementing the VAT reforms for the insurance sector is how to convert detailed rules into a series of business processes, which can be implemented by a broad range of stakeholders such as agents, brokers, claims managers, IT professionals, finance teams, legal teams and tax professionals. Ultimately, simple business rules need to be written, transactions coded in accounting systems, escalation procedures agreed upon, and processes automated as far as possible. This requires experience. KPMG has a dedicated team of tax and advisory professionals that is experienced in implementing these reforms, both in China and internationally. Here is a sample of how we can assist: Phase I Preparation The key business issue to understand in preparing for the VAT reforms is the overall financial impact on the business in China. As part of the initial preparation phase, we would generally undertake a review of the major revenue and expense items the insurer has in China to determine how VAT will impact on those items. We similarly recommend a review of major (or sample) contracts to ascertain whether VAT can be passed on, and if not able to be passed on, the impact and duration of any VAT that needs to be absorbed. This review process would enable the business to understand: Whether VAT will apply to each revenue item, and if so, at what rate The likely VAT status of policyholders by policy type, either end-consumers, small scale taxpayers or general VAT taxpayers Whether any revenue items are likely to qualify for VAT exemptions, concessions or withholding obligations Whether the amount of any major expenses currently includes BT and the likely impact once VAT is introduced Whether there are any areas of ambiguity which should be raised for consideration with the MoF and the CIRC. From this process, we can then seek to generate an overall financial impact assessment of the VAT reforms so that the insurer is in a position to understand the real financial impact, and to take steps to address areas where there may be a VAT exposure, or an opportunity to secure savings from key suppliers. Phase II Implementation Based on our experiences in advising insurers and reinsurers in transitioning to VAT, perhaps the most critical step is to convert technical VAT rules into a series of processes and procedures that can be followed and easily applied by claims managers, agents, brokers, assessors, finance, tax, and IT professionals. For example: If VAT is to be applied to certain policies but not to others, what coding can be applied to those taxable policies to ensure ease of implementation by finance staff and the entry of correct VAT treatment into your systems?

37 Proposed Introduction of VAT for the Insurance Sector in China 37 If certain types of policies are exempt from VAT, how can you ensure that related input VAT credits are identified and transferred out in your systems? From a systems perspective, how can you ensure that special VAT invoices are only issued under the right circumstances? For special VAT invoices you are to receive, how can you ensure they are obtained on a timely basis, validated and subsequently coded into your systems to produce the correct data for your VAT returns? Implementation also includes training for key finance and tax staff to ensure a proper understanding of the implications of the VAT reforms on the business, and simple business rules are applied to ensure compliance. Phase III Compliance Finally, once the VAT reforms are implemented, insurers and reinsurers need to continually test, retest and verify the accuracy of their systems and processes. A small breakdown in a single process or control can lead to significant VAT liabilities, interest and penalties. Experience also shows that the VAT rules are rarely stagnant typically, the rules are modified several times following their initial introduction. Furthermore, businesses are rarely stagnant in their operations new products and new sources of revenue all of which can give rise to substantially different and previously unforeseen VAT implications. With a short lead time for the commencement of VAT expected, insurers need to act now to commence their planning, implementation and compliance.

38 38 Proposed Introduction of VAT for the Insurance Sector in China

39 Proposed Introduction of VAT for the Insurance Sector in China 39 Contact us Khoonming Ho Partner in Charge, Tax China and Hong Kong SAR Tel. +86 (10) Lachlan Wolfers Partner, Tax Leader, Centre of Excellence, Indirect Taxes Tel Northern China Tracy Zhang Partner, Tax Tel. +86 (10) Shirley Shen Senior Tax Manager Tel: +86 (10) Central China Lewis Lu Partner in Charge, Tax Central China Tel. +86 (21) Jennifer Weng Partner, Tax Tel. +86 (21) Southern China Lilly Li Partner, Tax Tel. +86 (20) Jean N. Li Partner, Tax Tel. +86 (755) Hong Kong Chris Abbiss Partner, Tax Tel Darren Bowdern Partner, Tax Tel

40 Beijing 8th Floor, Tower E2, Oriental Plaza 1 East Chang An Avenue Beijing , China Tel : +86 (10) Fax : +86 (10) Shanghai 50th Floor, Plaza Nanjing West Road Shanghai , China Tel : +86 (21) Fax : +86 (21) Shenyang 27th Floor, Tower E, Fortune Plaza 59 Beizhan Road Shenyang , China Tel : +86 (24) Fax : +86 (24) Nanjing 46th Floor, Zhujiang No.1 Plaza 1 Zhujiang Road Nanjing , China Tel : +86 (25) Fax : +86 (25) Hangzhou 8th Floor, West Tower, Julong Building 9 Hangda Road Hangzhou , China Tel : +86 (571) Fax : +86 (571) Fuzhou 25th Floor, Fujian BOC Building 136 Wu Si Road Fuzhou , China Tel : +86 (591) Fax : +86 (591) Xiamen 12th Floor, International Plaza 8 Lujiang Road Xiamen , China Tel : +86 (592) Fax : +86 (592) Qingdao 4th Floor, Inter Royal Building 15 Donghai West Road Qingdao , China Tel : +86 (532) Fax : +86 (532) Guangzhou 38th Floor, Teem Tower 208 Tianhe Road Guangzhou , China Tel : +86 (20) Fax : +86 (20) Shenzhen 9th Floor, China Resources Building 5001 Shennan East Road Shenzhen , China Tel : +86 (755) Fax : +86 (755) Chengdu 18th Floor, Tower 1, Plaza Central 8 Shuncheng Avenue Chengdu , China Tel : +86 (28) Fax : +86 (28) Chongqing Unit 1507, 15th Floor Metropolitan Tower, 68 Zourong Road, Chongqing , China Tel : +86 (23) Fax : +86 (23) Hong Kong 8th Floor, Prince s Building 10 Chater Road Central, Hong Kong 23rd Floor, Hysan Place 500 Hennessy Road Causeway Bay, Hong Kong Tel : Fax : Macau 24th Floor, B&C, Bank of China Building Avenida Doutor Mario Soares Macau Tel : Fax : The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in China. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. Publication number: HK-TAX Publication date: August 2013