China reduces VAT rates and thresholds in phase-one of tax overhaul

April 26, 2018

This article was written by David Liu, a partner of FuJae Partners, and first published on MNE Tax, Multinational Tax & Transfer Pricing News.

China’s Ministry of Finance and the State Administration of Taxation on April 4 announced a 1 percent reduction in the top two VAT rates and an increase in the threshold for determining a general VAT taxpayer.

The new measures are the first steps toward implementing major VAT reform in China, announced by Premier Li in the 2018 Government Report last month. The government aims, through a series of measures, to cut the VAT by RMB 800 billion (USD 127.3 billion) annually.

VAT reduction

The 1% VAT reduction, outlined in Circular on Changing the VAT Rates (Caishui [2018] No .32), is expected to have a significant impact in China, with some estimates predicting a double-digit increase in business profits.

Industries such as non-ferrous metal processing, chemical fiber, and railroad and ship-building related industries are expected to see profit increases by as much as 28.9%.

From the government’s perspective, the tax reduction will translate into a tax cut of over RMB 240 billion (USD 38.2 billion) in 2018 alone. Most of this money is expected to flow into manufacturing and other industries that are still suffering from the 2007 -08 world financial crisis.

Increased VAT threshold

The increased threshold for general VAT taxpayers was announced in Circular of the Ministry of Finance and the State Administration of Taxation on Unifying the Standard for Qualifying as Small-scale VAT Taxpayers (Caishui [2018] No.33).

In a nutshell, small to medium-size businesses with lower VATable revenue are treated as “small-scale VAT taxpayers” who pay VAT at 3% but cannot offset input VAT against their output VAT.

The special VAT tax rate takes into consideration that these small businesses are most likely at the bottom of the food chain and have no or little input VAT to offset their output VAT.

Before the VAT reform, the demarcation between general VAT taxpayers and small-scale VAT taxpayers in the manufacturing and service industry was RMB 500,000 (USD 79,500) in annual revenue, meaning that a manufacturing business with an annual revenue of more than RMB 500,000 would be required to pay VAT at 17%.

The reform measures increase this threshold ten-fold, to RMB 5,000,00 (USD 795,000).

The increased threshold means that more small and medium businesses will be deemed small-scale VAT taxpayers and therefore pay VAT at 3%, which would leave more money in these taxpayers’ pockets.

It is mainly a measure aimed at helping start-up businesses and businesses that are struggling.

Also, pursuant to the reform measures, enterprises with current annual revenue below the RMD 5 million threshold that are already deemed a general VAT taxpayer can choose whether to be re-characterized as small-scale taxpayers.

China’s VAT reform

It is important to note that the measures announced last week are only the first steps in achieving VAT tax reform, as announced by Premier Li.

The reform, announced on March 5, will consist of switching the VAT from a three-tiered to two-tiered rate structure. Thus, the three tax rates of 17%, 11% and 6% (excluding the 3% applicable to small-scaled VAT taxpayers) will be collapsed into two.

Given the high dependency of China on VAT in generating tax revenue, the coming reform is predicted to be even more dramatic than the recent US tax overhaul.

From an enterprise’s perspective, this VAT reform is absolutely good news. In the past, low-end manufacturing businesses have been operating at extremely low profit margins while making significant contributions to tax revenue and employment creation.

With respect to China’s overall plan to cut RMB 800 billion in taxes, the exact measures and when this goal would be achieved remain to be seen. Thankfully, we are beginning to see some reform measures already.