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I. Introduction
Value-added tax (VAT) issues should not be underestimated when doing business in and with China, as VAT is not always a “cash neutral pass-through”. It is far more complex, may be effectively cost-incurring and therefore potentially riskier than you might expect.
China’s VAT law changed a lot in the past years. The Chinese Business Tax (BT) regime which had been co-existing with the VAT regime for years was entirely phased out in 2016. The abolishment of BT has led to certain complexity and confusion about the specific application of the different tax rates. The reform simplified China’s indirect tax system by abolishing the disproportionate taxation of services and unifying sales of goods, processing, repairs and replacement services, sales services, intangible properties, real estate and import of goods within China, etc. under a general VAT regime.
II. VAT rates
VAT rates were witnessing a downward adjustment in recent years to reduce the tax burden in general and to boost domestic consumption. Such an adjustment has happened almost once every year in four years from 2016 to 2019. Since then and so far, Chinese VAT has maintained four ranks of VAT rates, i.e. 13%, 9%, 6%, and 0%.
As an exception, VAT rates below 6% are also available to some specific business segments under a simplified VAT filing method (in which input VAT is not creditable), e.g. 5% for residential renting income.
Different VAT rates are applied for different taxable activities:
The VAT rate of 13% applies for taxable activities such as:
- Sales and import of goods (except those stated otherwise)
- Provision of processing, repair and replacement services
- Leasing services of tangible and moveable assets
The VAT rate of 9% applies for:
- Sales and import of specified goods such as agricultural products (including grains), tab water, heat, liquefied petroleum gas, natural gas, edible vegetable oil, air conditioning, hot water, coal gas, coal products for residential use, edible salt, agricultural machinery, feed, pesticide, agricultural film, fertilizer, methane, dimethyl ether, books, newspapers, magazines, audio and visual products and electronic publications
- Leasing of immoveable property
- Transportation services
- Sales of land use rights or immovable property
- Construction services
- Transfer of land use right
- Postal and basic telecommunication services
The VAT rate of 6% applies for:
- Value-added telecommunication services
- Financial services
- Modern services (such as research and development services, technology consulting services, information technology services, cultural and creative services, logistics support services, certification and consulting services, broadcasting and filming services, commercial supporting services and other modern services.)
- Lifestyle services
- Sales of intangible assets other than land use rights
The VAT rate of 0% applies for:
- Exports of goods (except those stated otherwise)
- Cross-border sales of state-specified services or intellectual properties by entities or individuals in China.
III. VAT refund mechanism
In general, the Chinese VAT system is comparable to many other VAT systems in the world. In particular, it mitigates the burden of VAT on transactions between businesses by applying an input VAT credit mechanism.
The VAT a company paid when buying or importing goods from a general taxpayer (with a proper fapiao) is called input VAT. The VAT a company adds when selling goods to buyers in China (with a proper invoice, so-called “Fapiao”) is the VAT that the company receives and collects on behalf of the government, called the output VAT. This does not constitute the company’s revenue but must be transferred to the Chinese government after offsetting with input VAT.
In most cases, the input VAT can be offset against the output VAT. The surplus of the output VAT over the input VAT is the amount that a company is obliged to declare and transfer to the Revenue Department monthly. If the difference between the output and input VAT is negative, the company may carry forward the input VAT credits to the next periods (unutilized input VAT credit refund is possible if meeting certain criteria and applicable only to manufacturing and small and micro-scale enterprises).
This can be summarized as follows:
Output VAT – Input VAT < 0
à VAT credit carried forward to the next period(s) or refund (if applicable)
Output VAT – Input VAT > 0
à VAT payable to the Revenue Department
IV. Import of goods
The import of goods is subject to VAT which is payable to the Chinese Revenue/Customs Department. This must not be confused with the obligation to pay import duty at specific rates which is payable additionally. It increases the value base of the product, leading to a higher VAT.
For example:
Effective landing cost (CIF) of a good imported into China= 100
Duty: 5%
The basis for the final VAT (13%) calculation is therefore 105:
13% x 105 = 13.65 VAT
So basically, both VAT as well as duty have to be paid on the importation of goods into China (except in duty-free situations).
Foreign companies aiming to sell goods to consumers in China via online sales will need to appoint a customs agent or broker to handle the import VAT payment.
VAT on importation has to be paid within 15 days of the issuance of a tax payment certificate by the Customs Department.
Import VAT is subject to the VAT credit/refund mechanism as part of input VAT, using two different methods (see section 3 below)
V. Export of goods
1. General
When exporting goods and services, the general rule is that no VAT will apply. There are two categories of exported goods and services: zero-rated (VAT rate = 0%) or generally VAT-exempt.
2. Export refunds
If a good is considered VAT zero-rated, it is technically subject to VAT, but the VAT rate is set at 0%. Therefore, any input VAT is, in general, refundable.
However, the official refund rate can be lower than the input VAT rate. Therefore, the adjustment of VAT refund rates for exports has been part of China’s macroeconomic controlling measures in encouraging or discouraging the export of certain goods (such as agricultural products or rare earth).
By not refunding the full amount of the paid input VAT, exporters will only get part of the VAT back and may intend to export at a higher price, or could be less motivated to export them.
The VAT refund rates can range from 0% to 13%. A full list of approximately 11,000 refund rates can be found on the State Administration for Taxation website (with easy google translation and HS numbers, respectively the Chinese Commodity Code Numbers).[1]
For example, the VAT refund rate is set to:
- 0% for most agricultural products and many kinds of papers (to rather keep them in China),
- 5% for screws and pins,
- 6% for meat of domestic cattle,
- 13% for cartons, cutting pads, styrofoam or silicone pads or for any kind of fabric.
If an exported good or service is considered VAT exempt, the already paid input VAT cannot be refunded at all nor used to deduct the output VAT from domestically sold goods or services. The VAT paid can only be added to the cost of the exported goods. However, this category does not apply to many cases. Exempt goods include e.g. oral contraceptives, ancient books, imported equipment directly used in scientific research, experiments or teaching, imported materials for charitable foreign aid and assistance from foreign governments and international organizations or imported articles for persons with disabilities by supporting organizations.
3. Methods of implementing VAT refunds
In principle, there are two methods of calculating VAT refunds, depending on the business of the company.
For production companies that produce goods that are exported or sold in China, the input VAT on raw materials and machines, either imported or bought in China for the production process, can be fully offset (credited) against the output VAT on sales within China.
After this offset, any excess amount of input VAT is refundable for exports, which means that the surplus amount will be re-paid by the Revenue Department to the local Chinese exporters.
For trading companies with no producing capabilities, when they export, the input VAT (VAT paid when buying goods in China) is directly refundable in cash, as export is not subject to output VAT (and therefore, there is nothing to offset/credit).
It is important to note that authorities require export documentation to support an export VAT refund claim. Different types of exporters have to comply with different specific requirements applicable to their business activity. The export VAT refund system has been substantially improved in recent years, by making online submission possible for the whole process, and less documents are required.
VI. Import and Export of Services
In general, VAT applies if either the service supplier or the service recipient is domiciled in China. If the service provider does not have an establishment in China, the recipient is required to pay the VAT on a withholding basis which means that the VAT is withheld from the total sales price and filed by the recipient in China. The service recipient (service importer in China) is also entitled to an input VAT credit if it is registered as general VAT taxpayer.
This represents a significant difference to the German (or other) VAT system(s), as the service provider has to pay the VAT at the end – and not the service recipient in the so-called reverse charge procedure, as is normally the case. In addition, the Chinese service recipient can still claim an input tax deduction (although he does not have to pay the VAT himself).
Therefore, if selling goods or services to China, the seller should bear in mind this Chinese VAT liability (unless exempted) is to be deducted and withheld from the sales income originating from China.
The export of the following services is zero-rated:
- International transportation services
- Aero transportation services
- Services provided to foreign entities and consumed entirely overseas (i.e. R&D services, energy management services, design services, production and publication of broadcasting and filming, software services, electrical circuit design and testing services, IT system services, business process management services, and offshore outsourcing services)
The following services may qualify for VAT exemption:
- Construction, supervision or exploration services for offshore projects
- Exhibition services for offshore executions
- Warehousing services for offshore warehouses
- Leasing of tangible movable property located outside China
- Broadcasting services in overseas
- Cultural, education and healthcare and travel services provided outside China
- Listed services which are sold to foreign entities and entirely consumed in overseas (i.e. telecom services, IP services, logistic support services, certification and consultation services, technical services, commercial support services, advertising services where the advertisement is released outside China, and provision of IPs)
- Postage services, delivery services and insurance for exported goods
- International transportation brokerage services (without providing transportation vehicles)
- Financial services provided to foreign entities’ financing activities
VII. General Taxpayer and Small-scale VAT payer status
There are two classifications of taxpayers under the new VAT rules: the general taxpayers and small-scale taxpayers. A manufacturing or trading company whose annual taxable sales reaching the threshold of RMB 5,000,000 (approx. EUR 700,000) must register as a general VAT payer. Any business below this threshold should be a small-scale payer, without the right to claim input VAT credits but enjoy a much lower VAT rate. However, small-scale payers still have the option to register as a general VAT payer if they can demonstrate a the possession of a sound and well-established accounting system and the maintenance of a fixed place of business in China, subject to the approval by the tax authorities.
VIII. Invoices for VAT (Fapiao)
1. General
Chinese authorities require businesses to issue Fapiaos (official VAT invoices/receipts) to oblige companies to pay VAT for their sales. Fapiaos validate the sales and purchase of goods and services in China. The Chinese government has introduced them to track tax payments and deter tax evasion. Fapiaos are printed, distributed and administered by the Chinese tax authorities (under the leadership of State Administhe tration of Tax) but provided by the seller of goods or services. They are registered with the relevant tax authority which audits the issuance in order to determine the appropriate amount of tax payable.
There are two types of Fapiaos: special VAT Fapiaos and general VAT Fapiaos.
2. Special VAT Fapiaos
Special VAT Fapiaos are issued by general taxpayers when goods or services are sold to other businesses or non-consumers. General taxpayers, as a buyer, when receiving the Fapiaos, are thereby allowed to credit their input VAT. This does not apply to small-scale VAT payers.
Special VAT Fapiaos contain detailed information including the seller’s
- tax code,
- address,
- telephone number and
- bank account information.
Fapiaos have to show the correct description of taxable and non-taxable activities and the exact tax rate and amount in CNY, the Chinese currency. They also need to be stamped with the issuer’s special Fapiao chop.
When issuing a special VAT Fapiao, the following three basic copies have to be provided:
- A copy for accounting purposes of the issuer (supplier)
- A copy for tax deduction for the customer who made the purchase
- A copy for accounting purposes of the customer
The number of blank Fapiaos that may be collected by a company and the maximum value of each Fapiao are subject to quotas determined by the local tax bureau based on the taxpayer’s business scope and business volume. If the tax bureau approves the quotas, a general taxpayer can print and issue the invoices using authority-certified software and printer.
3. General Fapiaos
General Fapiaos are only used as evidence of payment where special VAT Fapiaos are not applicable. For example, small-scale taxpayers or general commercial taxpayers who retail cigarettes, alcohol, food, clothing, shoes, makeup and other consumer goods cannot issue special VAT Fapiaos.
IX. Foreign companies and VAT
Foreign companies cannot register for VAT purposes in China, nor to issue VAT invoices (Fapiaos) in China. If they are aiming to enter the Chinese market, foreign entities have to establish, for example, a Chinese foreign-invested commercial enterprise (FICE), a wholly foreign-owned entity (WFOE) or a Joint Venture. They may also operate within a free trade zone.
When they sell services or goods to China and are subject to VAT, their VAT liability will be withheld and filed by the Chinese customers or withholding agents.
X. Risks
Companies with a presence in China or doing business with China have to be careful if there is no proper Fapiao issued by the suppliers for their purchases. In some cases, Fapiaos were faked or from other companies, which is a straight-forward tax evasion and crime. Tough tax audits and judicial measures have been stepped up by the Chinese authorities to curb VAT invasion.
When setting the prices of the goods, it is very important to make the right comparison with the price components of the Chinese competitors. Some of these competitors might simply do not charge any VAT nor issue any VAT invoices (which are obviously not compliant), making their sales price apparently cheaper than others’.
From the perspective of foreign companies selling services to China in particular, Chinese VAT cost should be taken into account in advance. In principle, they cannot register in the VAT system and at the same time have to pay Chinese VAT themselves (for example, if they sell services to China) without being able to claim an input tax deduction.
For the foreign service provider, a practical option is to use the input tax deduction (from which the Chinese licensee benefits) as a basis for price negotiation with the Chinese customers in advance.
This article is co-authored by Lorenz & Partners and WTS China.
We hope that the information provided in this brochure was helpful for you. If you have any further questions, please do not hesitate to contact us.
WTS China
Unit 906-07, Financial Street Hailun Center, No.440 Hailun Road, Shanghai, China 200080
Tel.: +86 21 5047 8665
Email: [email protected]
