New Policy of "Financial Sale-and-Lease-back": An Icebreaker for Financial Leasing Business?
David Yu & Clare Lu Llinks Law Offices
Since the value added tax ("VAT") reform in 2009, the financial leasing industry has been severely struck. The industry's appeal has finally obtained response from the competent authority. The State Administration of Taxation ("SAT") on September 8, 2010 issued Announcement No. 13, clarifying the tax treatment on a lessee's sale of a target asset in a finance-driven sale-and-lease-back transaction. Such announcement brought some "warmth" to the "severe winter" from which the financial leasing business had been suffering.
1. When a lessee sells a target asset as part of a financial sale-and-lease-back transaction, such sale should fall outside the scope of business tax ("BT") or VAT, as it does not involve transfer of ownership or all the risks and benefits related to ownership of the asset.
2. A lessee's sale during a financial sale-and-lease-back transaction should be treated as a financing mechanism. The lessee is not required to recognize any sales income or to pay the enterprise income tax ("EIT"). Rather, the asset should be depreciated based on the lessees' book value recorded before the sale. Meanwhile, the interest expenses paid by the lessee for financing should be deductible for EIT purposes.
3. Announcement No. 13 became effective on October 1, 2010. Lessees may seek tax refunds for VAT or BT paid on a basis different from that provided by Announcement No. 13.
1. Applicability of Announcement No. 13
Under Announcement No. 13, a "financial sale-and-lease-back" refers to a transaction where, for financing purposes, a lessee sells its assets to an approved financial leasing company and then leases the assets back under a financial leasing arrangement. The eligibility of the lessor is a point worth noting; only approved financial leasing enterprises are eligible. Therefore, in principle sale-and-lease-back transactions without eligible lessors shall not be subject to Announcement No. 13.
2. To avoid additional tax burden for financial sale-and-lease-back after the turnover tax reform
Before the promulgation of Announcement No. 13, the tax implications of a financial sale-and-lease-back transaction were unclear, and such transaction was often treated as separate sales and leases for tax purposes and thus subject to different tax treatments. However, the turnover tax reform brought additional tax burden for lessees. One example is the sale-and-lease-back of old equipment. According to the Circular on Several Policies of Value-added Tax and Business Tax (Caishuizi (94) No. 026), units and individuals selling their used fixed assets as goods are temporarily exempted from VAT. Under this circular, a lessee will not incur VAT for the sale during a sale-and-lease-back transaction. However, after the 2009 VAT reform, the abovementioned policy has been practically abolished. Based on the Circular on Certain Issues Concerning National Implementation of the VAT Reform (Caishui 2008 No. 170), the tax authorities in certain regions began to require that lessees pay VAT. This is undoubtedly an additional tax burden to the financial leasing business. Under the principle of "tax by substance", Announcement No. 13 confirms that at the point of the lessee's sale, "not all the benefits and risks in connection with ownership of assets are fully transferred". Therefore, it should not be subject to VAT or BT because no de facto sale of assets took place from a tax perspective.
3. Financial sale-and-lease-back could be a preferred model of financial leasing
After the VAT reform in 2009, financial leasing companies have been haunted by the fact that they cannot issue VAT invoices and therefore lessees cannot credit against input VAT. Announcement No. 13 provides a solution for part of financial leasing projects: lessees are not liable to VAT or BT at the stage of the sales of equipment to financial leasing company, whereby not all benefits and risks attached to ownership of assets are fully transferred. As lessees would have already obtained certificates to substantiate its VAT credit, it is not necessary for lessors to obtain another certificate issued by financial leasing companies. Hence, the difficulty for lessees to credit against input VAT is practically solved. We understand that, for merely VAT saving purposes, the sale-and-lease-back structure could be a preferred model under a financial leasing arrangement.
4. Issues to be clarified
Announcement No. 13 applies substantive tax principles to the sale-and-lease-back transaction, assisting in the development of financial leasing. Such policy deserves applause but some aspects still call for further clarification:
• According to Announcement No. 13, lessors may deduct financing interests as financial expenses. But there are no specific provisions on the nature of financing interests and its specific scope.
• Announcement No. 13 lacks clear instructions on the BT treatment of lessors. Under financial leasings, the balance after the actual costs borne by lessors for the leased goods is subtracted from all the prices and additional expenses (including the scrap value) collected from lessees are regarded as turnovers. In circumstances where there lacks a "transfer of the ownership or the risks and benefits related to ownership of the assets", how "actual costs borne by lessors for the leasing goods" are identified is still an issue to be resolved.
At present, there remain some gaps between the development of the financial leasing industry in China and its international counterparts. Tax, as one of the key elements of consideration for financial leasing transactions, undoubtedly plays a vital role in the development of the financial leasing industry. Since the VAT reform in 2009, the financial leasing industry has been unexpectedly impacted. Nevertheless, SAT has begun to solve relevant problems in financial leasing transactions, as mentioned above. We hope further tax reform may effectively resolve the difficulties currently faced by the financial leasing industry.