China’s 13th Five Year Plan states that the Chinese Government will pursue stronger fiscal and taxation system reforms and establish a modern fiscal and taxation system that facilitates the transformation of economic development. The Plan focuses on forming a unified national market that promotes social justice and establishes a tax system with an optimal structure, fairer legislation and regulations, and effective tax administration. Further, the Plan aims to advance the initiative to balance the distribution of revenue between the central and local governments.
Being one of the most important fiscal levers available to the government, the tax reforms outlined in the Plan play a crucial role in China’s overall economic development. The Government’s development goal for sustainability and the initiative to reduce the Government’s role in economic administration coincides with the current supply-side structural reforms. The following highlights some of the key changes that are anticipated to occur in the coming years.
Adopting the modern VAT system
The Business Tax to Value Added Tax Pilot Reform (the VAT Reform) is an important tax reduction measure that will boost China’s economy. The VAT Reform measures will commence on 1 May 2016 with the extension of the VAT Reform to the remaining four industries: construction, real estate, financial services and consumer services. The last chapter of the VAT Reform marks the end of Business Tax in China. Although the tax rates for different industries range between 6% and 17% (which is higher than the comparable Business Tax rate as it takes into account allowances under the credit system of the VAT regime), the tax reduction under the VAT reform is expected to reach hundreds of billions of dollars according to the Government’s estimation.
The main characteristic of Business Tax is that it is a tax on the full transaction value. Consequently, the more transactions that are carried out, the more that double taxation occurs. The main purpose of the VAT Reform is to unify the different tax systems between the manufacturing and services industries to allow for more tax efficient transactions. Although some VAT costs in the supply chain will not be creditable under the VAT Reform plan (for example, VAT relating to interest expense is not creditable), the last chapter of the VAT Reform now allows most industries to claim VAT input credits for costs incurred while being subject to VAT on their business income (previously, the VAT Reform did not adopt a ‘complete’ VAT credit system for all industries). This will reduce double taxation throughout the vast majority of supply chains, leading to lower overall transaction costs for businesses.
Improving the individual income tax system with better tax administration
The Plan also proposes individual income tax reforms (IIT Reforms), which have been submitted to the State Council for review. The IIT Reforms constitute a comprehensive plan covering proposed changes to the current individual income tax (IIT) system. There have been discussions that the IIT Reforms may include a proposal to adopt an IIT system that allows for deductions of certain costs under a comprehensive categorised tax scheme for certain income. The new system would operate alongside revisions to the Tax Administration Law that improve the tax administration regime for high income individuals, with the purpose of balancing social wealth distribution and ensuring sustainable economic growth.
Implementing Real Estate Tax
There has been a fierce debate over the past five or so years on whether or not there is a solid ground to enact and implement a Real Estate Tax. Although no details of any Real Estate Tax are provided in the Plan, it does allude to the inevitable introduction of some form of Real Estate Tax.
The Chinese economy had been largely reliant on the development of the real estate market. Whilst it brought great opportunities to the economy, there are also potential risks associated with a real estate bubble. Further, following the VAT reform, local Governments are aware of the need to identify a steady tax revenue stream to replace the loss of tax revenues resulting from the elimination of Business Tax revenues, which had been a very important source of local tax revenues in the past. Accordingly, the adoption of a Real Estate Tax is likely to be part of the solution to further balance the revenue distribution between the central and local Governments.
Enhancing the tax administration system
In addition to what has been included in the Plan in relation to enhancing global cooperation in tackling tax avoidance schemes, the whole tax administration system will significantly change when the revised Tax Administration Law is approved and becomes effective.
Among many proposed changes, the new tax administration system will connect each individual to their personal ID number, resulting in a more transparent tax filing system which is easier to use for tax administrative appeals and dispute resolution. The personal ID number reform will also improve the accuracy and reliability of China’s credit regime in view of China’s rising middle class.
In light of the continuous fight against corruption, changing the tax administration system represents a significant effort by the Chinese Government to change the role it plays in the facilitation of the economic growth of China. The changes will improve tax transparency and bring greater certainty to businesses operating in China. Thus, it is an important opportunity and milestone for China.
In addition to the changes discussed above, the enactment of an environmental tax, changes to resources and consumption taxes and the possible abolishment of the Land Value Added Tax are likely to be the subject of tax reform discussions in the near future. Overall, the Plan aims to implement a structured reduction of tax with an improved tax administration system. We look forward to seeing these changes being implemented to shape the foundation of economic development in China.