For many years, China operated a dual indirect tax system consisting of value-added tax (VAT) and business tax (BT). In 2012 a pilot test began in several service sectors in Shanghai, to replace BT with VAT and on 1 May 2016 the scope of the VAT reform (Circular Caishui [2016] 36) expanded to all industries nationwide.

In China, VAT is applicable to the sale of goods and revenue from services that were previously subject to BT. BT is an indirect tax applicable to each stage in the supply chain, but it disregards the “value added” in each of them. From a Chinese tax perspective, VAT is more efficient than BT as it is collected in each business transaction, borne by the end customer.

Challenges for startup companies

Despite the advantage of VAT, most startup companies find it difficult to choose the appropriate taxpayer status. Status factors in the nature of the business and scales, VAT liability and related administrative costs, which can be different among the two types of tax payer statuses: General Tax Payer and Small Scale Tax Payer.

To mitigate unexpected administrative work or greater VAT liabilities after company formation, a newly-formed company can consider the tax impacts and related handling costs when choosing their tax payer status before investing in China.

VAT invoices (commonly known as fapiao) quota limitation is another challenge for startups. Fapiao is the official VAT invoice that the buyer is entitled to a VAT credit on its purchase. A startup company needs to understand the impact VAT fapiao quota can have on business operations in its beginning stage, to avoid delay in billing, even if the goods or service orders have been committed.

The unavailability of fapiao can also delay the collection of accounts receivable, as some customers may insist on obtaining the fapiao before the cash settlement.

Impact on business

As input VAT is now creditable to its sales output tax, overall net VAT liability can be lessened for some operations that were previously paying BT. However, the savings on tax liability may be offset with the extra administrative costs on VAT filings and special VAT fapiao.

To meet the new requirements of the VAT system, businesses in China will need to modify the below internal standard procedures.

  • Pricing strategy
  • ERP system interface with tax system
  • Input creditable tax verification
  • Fapiao quota application and purchase
  • VAT related internal control procedures.

It is important for investors to understand the common challenges as VAT payers in China. These challenges can be circumvented in advance with adequate knowledge of local rules and practices. TMF Group’s team of in-country experts can provide companies a complete set of VAT compliance services, including General VAT taxpayer registration and fapiao application management in China.