Financial world watches China to assess effect of the tax reform

Previously, when banks purchased computers, they simply needed to choose a provider that asked for the lowest price. But now they have to consider which provider could issue VAT invoices at better rates, in addition to the price.

Leung said the tax reform requires the new VAT taxpayers to invest on additional resources such as experienced people and IT systems. Some of the large financial institutions would need to invest more than 400 million yuan ($62 million) to transform their business operation.

"But the tax burden on banks could be reduced if they can manage input VAT credits well," he said.

Lachlan Wolfers, head of indirect taxes at KPMG China, said while the change from BT to VAT may seem like a tax increase, in reality it is not because BT is usually levied on the gross revenue earned by financial institutions, whereas VAT is levied on the "value added".

"Financial institutions will now be able to claim input VAT credits for their costs and expenses for the first time. So in an overall sense, it is expected that the tax burden on financial institutions may actually fall as a result of these changes," he said.

The other benefit of these changes is that under the current BT system, tax was applied at each stage of the supply chain without credit, so if one business supplied to another and then to another, the amount of tax cascaded or snowballed.

Under a VAT system, however, those businesses can typically claim a credit for their costs, so the amount of tax does not usually cascade. As a result, the new VAT system produces a much more competitive and equitable outcome for business, he said.

China is among the first countries in the world to introduce a VAT for the financial services sector.

"Most countries exempt financial services from a VAT because historically it has been very difficult to measure the 'value added' to financial services on a transaction by transaction basis. However, over the past 10 years or so, a number of countries, including the European Union countries, have explored the possibility of introducing a VAT for the financial services sector, but have not been able to do so successfully.

"So what is taking place in China from May 1 is very much a world's leading approach which many other countries are watching closely. If China does this successfully, you can expect many other countries will follow," Wolfers said.