(A) Business sales tax and VAT
The Company is subject to a 5% business sales tax on revenue. It is the Company’s continuing practice to recognize the 5% business sales tax based on revenue as a cost of sales as the revenue is recognized. As of September 30, 2017, the Company had business sales tax payable of $14,143,444 (2016 - $13,453,236), which is expected to be paid when the projects are completed and assessed by the local tax authority. In May of 2016, the Business Tax has been incorporated into Value Added Tax in China, which means there will be no more Business Tax and accordingly some business operations previously taxed in the name of Business Tax will be taxed in the manner of VAT thereafter. The Company is subject to 5% of VAT for its all existing real estate project based on the local tax authority’s practice.
(B) Corporate income taxes (“CIT”)
The Company’s PRC subsidiaries and VIE are governed by the Income Tax Law of the People’s Republic of China concerning the privately run enterprises, which are generally subject to income tax at a statutory rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments. However, as approved by the local tax authority of Hanzhong City, the Company’s CIT was assessed annually at a pre-determined fixed rate as an incentive to stimulate the local economy and encourage entrepreneurship. The local income tax rate in Hanzhong is 2.5% and in Yang County is 1.25% on revenue. For the years ended September 30, 2017 and 2016, the Company’s income taxes were $1,294,699 and $974,688, respectively.
Although the possibility exists for reinterpretation of the application of the tax regulations by higher tax authorities in the PRC, potentially overturning the decision made by the local tax authority, the Company has not experienced any reevaluation of the income taxes for prior years. The PRC tax rules are different from the local tax rules and the Company is required to comply with local tax rules. The difference between the two tax rules will not be a liability of the Company. There will be no further tax payments for the difference. Based on a recent discussions with local tax authority, the Company will be subject to income tax rate of 25% on taxable income in fiscal 2018. The change in the income tax policy could negatively affect the Company’s net income in future years.The following table reconciles the statutory rates to the Company’s effective tax rate for the years ended September 30, 2017 and 2016:
| | | 2017 | | 2016 | |
| Chinese statutory tax rate | | | 25.0 | % | | 25.0 | % |
| Valuation allowance change | | | 0.6 | | | 0.7 | |
| Net impact of Exemption rendered by local tax authorities and other adjustments | | | (8.6) | | | (9.4) | |
| | | | | | | | |
| Effective tax rate | | | 17.0 | % | | 16.3 | % |
Income tax expense for the years ended September 30, 2017 and 2016 is summarized as follows:
| | | For the years ended September 30, | |
| | | 2017 | | 2016 | |
| Current tax provision | | $ | 1,127,692 | | $ | 343,589 | |
| Deferred tax provision | | | 167,007 | | | 631,099 | |
| | | | | | | | |
| Income tax expense | | $ | 1,294,699 | | $ | 974,688 | |
The parent Company China HGS Real Estate Inc. is incorporated in the United States. Net operating loss carry forwards for United States income tax purposes amounted to $665,160 and $533,160 as of September 30, 2017 and 2016, respectively, which are available to reduce future years’ taxable income. These carry forwards will expire in 2036. However, the change in control resulting from the reverse merger in 2010 limits the amount of loss to be utilized each year. Management doesn’t expect to remit any of its net income back to the United States in the foreseeable future. Accordingly, the Company recorded a full valuation allowance as of September 30, 2017 and 2016. The components of deferred taxes as of September 30, 2017 and 2016 consist of the following:
| | | As of September 30, | |
| | | 2017 | | 2016 | |
| Deferred tax assets: | | | | | | | |
| Deferred tax asset from net operating loss carry-forwards for parent company | | $ | 226,154 | | $ | 181,274 | |
| Valuation allowance | | | (226,154) | | | (181,274) | |
| Deferred tax asset - net | | $ | - | | $ | - | |
| Deferred tax liability: | | | | | | | |
| Revenue recognized based on percentage of completion* | | $ | 170,950 | | $ | 5,107,887 | |
| Deferred tax liability – long term | | $ | 170,950 | | $ | 5,107,887 | |
deferred tax liability of $5,107,887 as of September 30, 2016 was reclassified to tax payable – long term as of September 30, 2017 because the related real estate projects were fully completed.
Movement of valuation allowance:
| | | As of September 30, | |
| | | 2017 | | 2016 | |
| Beginning Balance | | $ | 181,274 | | $ | 136,394 | |
| Current year additions | | | 44,880 | | | 44,880 | |
| Ending Balance | | $ | 226,154 | | $ | 181,274 | |
The valuation allowance increased $44,880 for the years end September 30, 2017 and 2016, respectively.
(C) Land appreciation tax (“LAT”)
Since January 1, 1994, LAT has been applicable at progressive tax rates ranging from 30% to 60% on the appreciation of land values, with an exemption provided for the sales of ordinary residential properties if the appreciation values do not exceed certain thresholds specified in the relevant tax laws. However, the Company’s local tax authority in Hanzhong City has not imposed the regulation on real estate companies in its area of administration. Instead, the local tax authority has levied the LAT at the rate of 0.5% in Yang County and 1.0% in Hanzhong against total cash receipts from sales of real estate properties, rather than according to the progressive rates.
As at September 30, 2017, the outstanding LAT payable balance was $1,292,527 with respect to completed real estate properties sold up to September 30, 2017. As at September 30, 2016, the Company has an outstanding LAT payable balance of $1,049,401 with respect to completed real estate properties sold up to September 30, 2016.
(D) Taxes payable consisted of the following:
| | | September 30,
2017 | | September 30,
2016 | |
| | | | | | | | |
| CIT | | $ | 6,216,432 | | $ | 667,734 | |
| Business tax | | | 14,143,444 | | | 13,453,236 | |
| Other taxes and fees | | | 2,020,188 | | | 1,712,845 | |
| Total taxes payable | | | 22,380,064 | | | 15,843,815 | |
| Less: current portion | | | 17,259,202 | | | 15,843,815 | |
| Tax payable – long term * | | $ | 5,102,862 | | $ | - | |
*The Company reclassified the previous recognized deferred tax liabilities to income tax payable
in fiscal 2017
due to the completion of the related real estate projects. The Company expects to fully settle the income tax payable when related real estate projects are sold.