China, one of the world’s most powerful economies, has recently implemented a significant tax reform. In May 2016, the Chinese business tax (BT) was effectively replaced with value-added tax (VAT). The tax reform aims to ease the tax burden on companies and assist the Chinese economy in shifting from labor-intensive manufacturing to service-oriented industries.
For a long time, the Chinese economy was based on manufacturing. However, the Chinese government decided to stimulate the rapid growth of the service sectors. In 2015, they produced 50% of the GDP. The Chinese government expects that the recent VAT reform would increase the GDP growth even more. In addition, the introduction of VAT should encourage manufacturers to upgrade their outdated technology and make bigger investments in research and development.
Chinese tax system
China has had its VAT system since 1979 when the country entered into the global trade arena. However, only industrial businesses and manufacturers operated under the VAT regime, whereas service providers were subject to pay Chinese business tax. Consequently, service providers had to pay higher revenue-based taxes and were not able to benefit from VAT deductions. On 1st of May 2016, a bundle of Chinese service sectors (e.g., construction, finances, lifestyle, real estate, telecommunication, postal, and transportation sectors) were included under the VAT regime. Consequently, companies engaged in such activities were no longer obliged to pay business tax.
Key features of VAT reform
In China, the business activities that are subject to VAT are categorized into three groups, namely, (1) supply of real estate, (2) supply of services, and (3) supply of intangible assets, including virtual products (e.g., computer games and domain names). Each sector is subject to different VAT rates ranging between 6% and 17%. For example, 11% VAT applies to companies in the real estate and construction sectors, whereas companies in the financial sector are subject to 6% VAT.
Another important element of the Chinese VAT reform is the differentiation between VAT payers. More specifically, there are two types of VAT payers, namely, large-scale taxpayers having revenue exceeding RMB 500.000 (about EUR 67.300) and small-scale VAT payers having revenue under RMB 500.000. The small-scale taxpayers can benefit from a reduced VAT rate of 3%, whereas large-scale taxpayers are liable to pay VAT of 6-17%, depending on the industry.
Despite lower VAT rates applicable to small-scale tax payers, the current VAT regime treats large-scale businesses more preferentially. Although subject to higher VAT rates, large-scale taxpayers are entitled to VAT export exemptions and refunds. Moreover, they are allowed to issue special VAT invoices allowing deduction of input VAT. Consequently, buyers may prefer making transactions with large-scale tax payers in order to offset their taxes.
To conclude, the Chinese VAT reform is anticipated to be one of the major pathways in country’s transition from a production-based economy into a more service-oriented economy. Nevertheless, due to the discrimination between taxpayers, the reform may harm the economic development of China.