China: China Tax Reform 2016

Several significant changes to China's tax policies took place in the first half of 2016. These changes are no surprise given the Chinese government's directions on how the economy should be carried forward.

With its intention to transform the nation into a service-oriented economy, the government has progressively rolled out the business tax (BT) to value added tax (VAT) reform, and the final stage was implemented on 1 May 2016.

In the meantime, the buzz on cross-border e-commerce has also caught the attention of the tax authorities. The switch from parcel tax to a combination of import tax, import VAT and consumption tax on cross-border e-commerce retail goods aims to facilitate sustainable development of the market by creating a fairer environment for all players.

Final stage of VAT roll-out to boost service sector

The last phase of BT-to-VAT reform applies to companies in four sectors: construction, real estate, financial services and consumer services (such as retail). Manufacturers, which already operate under the VAT regime, will now be eligible for tax breaks on research and development. With this measure, the state council aims to encourage manufacturers to modernise.

By understanding the different VAT rates charged for each industry, companies can better position and strategise their business operations under the reform. The following table illustrates the applicable VAT rates for different industries:

Apart from these VAT tax rates, there is also an assessable tax rate of 3%/5% for small-scale tax payers.

While VAT may be seen as preferable to BT, since the former is a deductible tax while the latter is cascading, the reform will create certain challenges. For example, how would businesses claim input VAT credit and pass on output VAT to customers? Another challenge, more specific to the financial services industry, would be the IT upgrade needed to adjust to the change.

Meanwhile, given the complexity of tax structuring, collection and administration for the four affected sectors, businesses will incur additional compliance requirements and, consequently, extra costs in the short term. This could include having to review, segment and categorise their operations to determine which areas are subject to VAT and cater to specific VAT requirements.

Despite the burden on vendors in the short term, the BT-to-VAT replacement aims to make life easier for services companies in the long run and encourage factories to upgrade and innovate.

For consumers, the application of VAT will be a valid concern. If products, especially real estate, are in high demand and relatively price inelastic, the tax burden may well be passed on to the end consumer. The government's role in this case is to ensure the smooth transition of the reform, enhancing cash flow efficiency and social welfare.

Overseas e-commerce: regulatory and tax changes are designed to encourage local spending

Regulatory changes in China's cross-border e-commerce policy have also drawn widespread attention. It seems the government has decided to balance the market to ensure its sustainability.

According to the e-commerce tax circular, goods purchased online from overseas merchants will no longer be considered personal postal articles subject to a parcel tax (usually 10%) but rather imported goods subject to import tax, import VAT and consumption tax.

In the meantime, the introduction of an annual limit of RMB 20,000 per individual consumer aims to deter local consumers' reliance on foreign goods.  Alongside these financial changes, a 'positive' list has been released, specifying goods that do not need additional import licences and documents.

As well as creating a heavier tax burden for exporters, these changes may cause complications as they apply differently to different types of product. For example, beauty products (such as eye creams and moisturising gels) are now subject to less tax, while healthcare and childcare products have become more expensive.

For foreign retailers, the tax and regulatory changes make China a less attractive platform than before. While the size of the Chinese market will continue to draw overseas enterprises, if the Chinese consumer is subject to more tax then their purchasing power decreases. The government hopes this will encourage consumers to buy local products, creating a fairer environment and more balanced market.

Agile businesses should prepare for future changes

It is important for managers and decision-makers to keep a keen eye on both central and local government policy. Items not on a 'positive' list are probably under close monitoring by the government and might be banned in the future.

Vendors should be aware of the commercial risks and be prepared to switch business direction if the need arises. They should also know support is available. Alongside government guidance, external service providers are on hand to advise on the new tax policies and streamline business processes, helping their clients manage the transition.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.