In November 2008, the State Council issued the newly-revised Provisional Regulations on Value- Added Tax of the PRC (State Council Order (2008) 538, the New Regulations). The New Regulations take effect January 1, 2009. The New Regulations revise several provisions of the Provisional Regulations on Value-Added Tax of the PRC (the Old Regulations), which was promulgated in 1993 and took effect on January 1, 1994. The New Regulations incorporate rules that have been piloted in several provinces since 2004.
The New Regulations will transform China’s VAT system from a production VAT to a consumption VAT system. Unlike the Old Regulations, the New Regulations will allow a full deduction of the input VAT for purchased fixed assets. This change will substantially lighten the tax burden and improve the cash flow of VAT taxpayers. Under the Old Regulations, VAT taxpayers were not allowed to deduct any input VAT for purchased fixed assets when they calculated their VAT payable according to the formula “VAT payable = output VAT – input VAT,” though they had to pay VAT to the seller of such fixed assets when purchasing them. Since 2004, the pilot VAT reform has been implemented in northeast China, central China, eastern Inner Mongolia, and some areas of Sichuan. The pilot allowed deductions of the input VAT for purchased fixed assets in the aforementioned areas, but imposed conditions such as industry restrictions and incremental VAT payable requirements for the use of such deductions.
The New Regulations provide for a universal input VAT deduction on purchased fixed assets throughout China and across all industries, and removes the incremental VAT payable requirements. Under the New Regulations, if a company purchases a number of fixed assets upfront, it will not have to pay any VAT in the following several years as long as the amount of the output VAT generated during these years is less than the input VAT for such fixed assets.
Another major change brought by the New Regulations is the lowering of the VAT rate for smallscale VAT taxpayers from 6 percent to 3 percent. Since 1998, the State Council has divided smallscale VAT taxpayers into two categories through other regulations: industrial small-scale VAT taxpayers and commercial small-scale VAT taxpayers. Previously, the State Council lowered the VAT rate for commercial small-scale VAT taxpayers to 4 percent. The New Regulations now provide a uniform 3 percent VAT rate for all small-scale VAT taxpayers, both industrial and commercial.
In addition, the New Regulations retain some existing VAT policies, namely the deduction rates for agricultural produce and transportation charges; provisions listing the qualifications for a general VAT taxpayer; and the abolition of tax exemption for imported equipment used in export processing involving supplied materials, export processing with samples, and compensation trade.
Notably, the New Regulations do not allow deduction of the input VAT for durable consumer goods (e.g., vehicles and yachts). The rationale behind this change is that, though it can be difficult to distinguish between corporate consumption and personal consumption, personal consumption is less relevant to the technological improvement of an enterprise.
Under the Old Regulations, taxpayers pay their VAT on one-, three-, five-, ten-, and fifteen-day, or one-month intervals based on the size of VAT payables and the tax authorities’ verification. The New Regulations add a quarterly interval. For taxpayers who pay their VAT on monthly or quarterly intervals, they must file to pay the VAT within 15 days after the interval ends. All other taxpayers must pre-pay their VAT within five days after the interval ends and file for and settle the previous month’s VAT payment within 15 days after the end of each month. The regulations also clarify certain issues for foreign-based VAT taxpayers, specifically how to determine the appropriate VAT withholding agent, the time in which VAT liabilities arise, and the location and the time limit for paying the VAT payable.
Since China’s implementation of the VAT system in 1994, there have been talks about transforming China’s VAT system to a consumption VAT system. However, the government was concerned that such a tax cut reform would make the economy overheat, and would lead to sharp declines in tax revenues. The central government finally decided to implement a nationwide VAT reform this year to stimulate industry investments and technological growth amidst the economic slow-down. The surplus of government revenue from other sources will help the government offset the future reduction in VAT revenue.