An overview of the VAT Reform
The Value-Added Tax (VAT) has been carefully introduced in China since 2012, starting in Shanghai and spreading in the whole country. After 2 years and more than 500 regulation changes, the VAT reform is about to enter its very last phase, seeing the total removal of the Business Tax (BT). Understanding how the VAT works has, therefore, never been so important, as this tax bears both high risks and opportunities.
Current state of the reforms
General and Small-scale Taxpayers
VAT is an internationally used tax, believed to be neutral for Businesses. BT has the severe drawback of charging every step of good conception while VAT aims at only charging the value added at each step: output VAT – basically tax on the goods you sell – can be offset by input VAT – tax on good you buy. This calculation is true if you are a General Taxpayer, which concern about 20% of VAT payers. The tax rate applied varies between 6% and 17%, depending on the company’s industry.
Another regime is available under the VAT reforms: the small-scale taxpayer. By default, a company is considered as Small-scale Taxpayer by the State Administration of Tax (SAT). However, the company has to change status when its revenues exceed RMB 5 million, turning into a General Taxpayer. If tax burden may be lower under the small-scale status, it is not neutral anymore as the VAT becomes a 3% tax on gross sale.
It is worth to note that being a VAT taxpayer means a lot of paperwork: companies have to justify the VAT refunds they want to apply for, therefore needing extra acquisition of data by the company’s fiscal services. As a stunning example, the annual VAT filling for export tax refund is composed of 140 forms with more than 10,000 data fields.
VAT exemption and zero rating
Both taxpayers described in the previous paragraphs can access preferential treatment depending on their business activities. Both those treatments enable companies to optimize their tax burden, leading to substantial savings for whoever gets a deeper look into it.
VAT Exemption is a regime under which the company doesn’t have to pay the output VAT but can’t have its input VAT refunded. It can make sense to apply for such a treatment if your output VAT is high and input VAT is low: check it with your tax department. However, beneficiating from this regime asks for extra paperwork as it is more closely followed up by the SAT. Also, note that only certain industries can apply, such as consulting services, IT services or outsourcing services.
The best regime a company can dream of is the VAT zero rating one: output VAT is null and input VAT can be refunded. It is used by the government to promote certain activities, such as R&D and design services. The application is, however, difficult as different administrations need to be approached. The company will also need to meet extra requirements that may be difficult to handle.
Implications of future reforms
As stated in the 12th Five Year Plan, concerning the 2011-2015 period, the VAT reform should be completed by the end of 2015. This objective has been reasserted by the State Council in a circular released this July. Therefore, it is certain that the last remaining industries, currently subject to BT, will have to start using the VAT by the end of next year: Financial services, construction, real estates and lifestyle services. They were kept aside from the previous reforms as these industries are directly related to consumers, therefore impacting directly Chinese daily life. An ill-implemented VAT reform on real estates, for example, could increase prices of an already-inflated market.
Apart from its impact on Chinese and expats daily lives, the reform may also deeply challenge the way those businesses are conducted. In Financial services, it will change tax rates and tax burden in general, probably leading to further development of the industry and at least easing the way transactions are handled. For construction and real estate, tax alleviation is expected, but a mishandling of the reforms may lead to rising prices and increase housing burden on Chinese families.
VAT reforms are believed to be at the same time an incredible opportunity and a risk generator for businesses. As tax services have to comply with new sets of rules, mistakes can appear which can result in either false losses or fines. Adapting requires extra cost of training and tighter follow-up of the company’s activities. However, the reforms are designed to ease the tax burden and tax-related costs in the long term and further incentives can provide you with advantages that couldn’t have existed before. Studying your tax department activities has never been more important than today: check the VAT practices and look for points of optimization.
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