Milestone: VAT reform in 2015

Historical background

China has had its value-added tax (VAT) system since 1979. At first only industrial enterprises and manufacturers were involved in the VAT system. Most service sectors were subject to business tax, which meant that service industries were faced with higher costs, as business taxes were applied to revenue accumulated across supply chains.

Business tax is levied on the gross revenue of the business, while VAT taxes the difference between the sale price for a customer, minus the cost of materials and other taxable expenses, and is collected at the point of sale, making it easier to collect than individual and corporate taxes.

Service sectors produced more than half of China’s GDP for the first time in 2015, and are growing at a faster rate than any other sector of the economy. As of May 1, 2016, the construction, finance, lifestyle, and real estate sectors were introduced to the VAT system, essentially eradicating business tax from China’s tax system. Thanks to this reform, service industries can benefit from generally reduced tax rates.

Key features

In China, the business activities that are applicable to VAT are grouped into three types: supply of real estate; supply of services and supply of intangible assets (including virtual products). Each sector is subject to different VAT rates ranging from six percent to 17 percent. For example, six percent VAT applies to enterprises in the financial sector, whereas enterprises in the real estate and construction sectors are subject to 11 percent VAT.

The differentiation between VAT payers is another important characteristic of the Chinese VAT reform. To be specific, there are two kinds of VAT payers: large-scale taxpayers with revenue over 500,000 yuan ($73,806) and small-scale ones with revenue below 500,000 yuan. The former can benefit from a reduced VAT rate of 6-17 percent in accordance with the industry, whereas the latter are liable to pay VAT of three percent.

Significance

The broader introduction of the VAT has greatly encouraged low-end manufacturers to upgrade their outdated technology and invest more in research and development so as to help the Chinese economy shift from labor-intensive manufacturing to service-oriented industries.

By including real estate in the scope of deduction, a standardized consumption-oriented VAT system has been realized, which makes for expanding enterprise investment and enhancing enterprises’ vitality.

It is beneficial to improve and extend the chain of VAT deduction in the secondary and tertiary industries and promote the integrated development of the secondary and tertiary industries.

In addition, replacing the business tax with VAT is conducive to creating more jobs, establishing a VAT export rebate system for goods and services, and comprehensively improving China's export tax revenue environment.