BOFIT Viikkokatsaus / BOFIT Weekly 2016/18

China further expanded its value-added taxation (VAT) reform on May 1 to major service branches, including construction, real estate, finance, insurance and a variety of consumer services. These industries were earlier subject to the Business Tax (BT), a tax based on each firm’s gross revenues. The shift to VAT in service branches began in 2012. Initially, the pilot programmes only involved certain cities and branches. The VAT trial has been expanded nationally since 2013 to include e.g. logistics, postal and telecommunication services.

Most financial services are now subject to a 6 % VAT rate. These include income from interest on consumer and business loans; gains made from trading equities, debt securities and foreign currency; fees for financial services and insurance premia. VAT exemptions will include deposit interest, interest commercial banks pay to the central bank, interbank loans and public and local government debt.

The basic VAT rate for real estate services and construction is 11 %. Small businesses are eligible for a simplified tax scheme with a lower tax rate, but are then not entitled to tax deductions. VAT applies in real estate deals and the sale, purchase or rental of properties by firms or private individuals. VAT generally will not be collected from private individuals selling an apartment that they have owned for over two years, but sales of expensive apartments in big cities will still involve some amount of VAT. A reduced 5 % tax rate of the sale price is applied to other private apartment sales.

The basic VAT rate is 6  % for consumer services such as tourism, hotels, the hospitality, food & beverage branch, training, healthcare, cultural events and entertainment. There are exceptions, however. Tax exemptions have been granted e.g. to healthcare services, elder care, child care and training provided by approved agencies and up to certain levels of accreditation.

Companies have had only a short time to prepare for the tax reform as premier Li Keqiang announced only at the National People’s Congress in March that the expanded VAT reform would enter into force at the beginning of May. VAT revenues will be shared between the central government and local governments. BT revenues earlier went directly to the local government and accounted for about 40 % of local government revenues. Officials say the tax reform this year will reduce the overall tax burden on companies by more than 500 billion yuan (€70 billion), which, in turn, will reduce revenues to local governments. The shortfall has been factored into this year’s central government budget.

VAT was already applied before the extension to manufacturing and trade. The newly implemented tax reform harmonises tax practices for goods and services and allows

tax deduction for semi-finished goods and procurement of services across branches. Several VAT rates are currently applied in China and the Chinese tax system is still quite complicated. VAT rates typically range between 3 % and 17 %. In 2014, for example, the average VAT rate in OECD countries was 19 %. China’s VAT system is set for further reforms until in practice there are only two tax rates in use.