A Shanghai-based company ("Company A") secured a major contract from an Italian customer to supply a complete set of equipment and perform installation services. As Company A has no legal entity or operational presence in Europe, it subcontracted the entire project to a local Italian supplier ("Supplier B"), who procured the equipment locally and completed the on-site installation in Italy.

Throughout the transaction, the goods never entered or exited Chinese customs, while the funds flowed across national borders. Under the newly effective VAT Law of the People's Republic of China, how should this typical offshore transaction, with both the origin and destination outside China, be treated from a tax compliance perspective? The analysis can be divided into two stages.

Stage 1: Is Company A required to withhold and remit taxes when paying the Italian supplier?

The answer is: No.

When a Chinese enterprise makes payments to an overseas company, withholding tax obligations often need to be considered. However, in this case, both the equipment supplied and the installation services performed by Supplier B were physically delivered and consumed entirely within Italy.

Under the territorial taxation principle clarified by the new tax law, since both the place of dispatch of the goods and the place where the services were performed and consumed are outside China, the transaction falls outside the scope of both Chinese Value-Added Tax (VAT) and Corporate Income Tax (CIT). Therefore, when remitting payment to Supplier B, Company A is not required to withhold or remit any Chinese taxes.

Stage 2: Can Company A claim an export VAT refund on the payment received from the Italian customer?

The payment received from the Italian customer should be separated into two distinct components for accounting and tax purposes, as each has a different tax treatment.

1. Equipment Revenue: Outside the Scope of Chinese VAT and Not Eligible for Export VAT Refund

Under the new VAT Law, the sale of goods is subject to Chinese VAT only if the goods are dispatched from, or located within, China. Since the equipment was purchased, delivered, and transferred entirely outside China, the transaction constitutes offshore revenue that is outside the scope of Chinese VAT.

Furthermore, because the goods never passed through Chinese customs and no Export Customs Declaration Form was issued, the transaction lacks the key statutory document required to apply for an export VAT refund. Consequently, no export VAT refund is available. For VAT reporting purposes, this revenue should be classified as offshore trading income outside the scope of VAT.

2. Installation Service Revenue: VAT-Exempt Income

China's new VAT Law continues to encourage the export of services. As a Chinese resident enterprise, Company A provides installation services to an overseas customer, with the services performed and consumed entirely outside China. Accordingly, this portion of the revenue qualifies for VAT exemption.

It is important to distinguish VAT exemption from zero-rated VAT treatment. Under the exemption policy, any directly attributable input VAT incurred within China (such as domestic travel expenses of employees) cannot be credited and must instead be transferred out as non-creditable input VAT.

Final Reminder

Although no Chinese VAT is payable on this transaction, the net profit generated from the project remains taxable in China. The profit must be included in Company A's taxable income and is subject to Corporate Income Tax at the standard rate of 25%.

At PHC Advisory, we can offer you full support on matters regarding doing business in China, or any other issues your business may face. If you would like to know more about policies relevant to your business in Italy or Asia, please contact us at info@phcadvisory.com.  

PHC Advisory is a company of  DP Group: an international professional services conglomerate of companies with approximately 100 experienced professionals worldwide. We offer comprehensive services in tax, accounting, and financial consulting, including financial supervision, financial audit, internal audit, internal control over financial reporting, and support for audited financial statements and annual audits, ensuring clients' financial transparency and compliance. 

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The content of this article is provided for informational purposes only, financial advice must be tailored to the specific circumstances on a case-by-case basis, and the contents of this article do not legally bind PHC Advisory with the reader in any way. 

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