Chinese VAT: improve gross margin

March 18, 2009 by Thuy

VAT ... but with Chinese characteristics

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VAT in China: Oft tweaked instrument of industrial policy

VAT in China is a key instrument of industrial policy. The state intervenes frequently, at national and provincial levels, to refine or change the scope of VAT. To illustrate, major changes in the treatment of fixed asset VAT were implemented in January 2009. But further changes are considered this month.

When the economy was overheating in 2006-2007, the government tried to move away from process manufacturing and basic industries. It used VAT policy changes to drive companies further up the food chain.

How things have changed. Some of the 2006 changes have been reversed, and skills upgrades are now encouraged by VAT refunds on fixed assets and local demand props.

Chinese VAT is different

The most significant differences are:

• Company VAT status depends on size: small companies pay a simplified non deductible version.
• Slightly different scope for services: maintenance / repair are differentiated and subject to different rates
• Deductibility rules: most important, only the ingredients of company main activity are refundable (ie, traded goods and since 2009 related fixed asset investments), and not always 100%. This highlights the need to define the “right” scope of operation when setting up a company in China.
• Export treatment: VAT is refunded at varying rates. This is a key state policy driver.

Here is how the rules impact China import and export

Selling to China (from abroad)

If you sell into China, you will be subject to import VAT at 17%. Local competitors will be subject to VAT on purchases inside China at varying rates, most likely from a lower cost base. They will also have a choice in how much VAT they charge on sales, depending on (tweakable by maintaining good relations with the tax office) goods and sales classification.

Buying from China (from abroad)

If you buy from China some form of VAT deductibility is possible for the exporter. Check product harmonized customs code.  Also spend time to evaluate deductibility on supplier purchases.  This seems trivial but if your contractor is not totally forthcoming with this information they can walk with 13% of your buy price. A 13% cost decrease is nice to have any time.

An extra word on trade: China importing and exporting require a license. Companies that do not have a license must proceed through an agent such as government owned Cosco, who will handle permits, declarations and payments.

Mountains are high and the emperor is far away

VAT is collected and organized at central government level. Rule interpretation and enforcement is at the local level, sometimes leading to tweaking (seen by local officials as “discounts” on “their area” of tax revenue). Remember that Chinese provincial government officials are paid on GDP growth and that a Chinese province can have a population of 100 million. This gives scope for local interpretation and “negotiation”.

To illustrate how much scope provincial officials have in China: The central government decreed the end of free trade zones in China in 2008. Officials from the main Shanghai Free Trade Zone (WaiGaoQiao, in Pudong) were then seen offering ’discounts’ to their ‘loyal customers’ to retain business inside the free trade zone and negate the effect of those pesky central government meddlers.

VAT is a work in process. China is a work in progress. Over 300 changes were brought to VAT law at all levels since 2005. It is not over.

For example, the Ministry of Finance announced late December 2008 that China would resume charging the 17% VAT rate on metallic and non-metallic mineral products, up from 13 percent, as of January 1, 2009. However in the face of collapsing demand, this measure may be scrapped by the end of march 2009.

VAT rates

• Basic rate varying from 4-6%, since January 1^st 2009 unified at 5%
• Normal rate of 17%

Fixed assets and R&D treatment

Until January 2009, fixed asset investment was non-deductible. It now is, subject to conditions and scales depending on asset types, to drive local R&D investment.

VAT refunds

Export VAT refunds are subject to application as part of monthly declaration.

Deduction rates are set by customs codes category. Some products have no deductibility. Deductible rates are 5%, 9%, 11%, 13%, 14%, 17%. Classification can have a major impact.

January 2009 changes

Rises in tax rebate rates varied among different items. For example, the rate on tires was raised from 5 to 9% while glassware was up 5 to 11%. Rates on labor-intensive products such as luggage, shoes and umbrellas were elevated from 11 to 13%.

The 3,770 items modified in January accounted for 27.9% of China’s exports, according to a government statement at the time.

The statement said the government would also eliminate export duties on certain types of steel, chemical and grain products and reduce export duties on some fertilizer products.

Other taxes

The PRC also levies import duties. Some non renewable natural resources are also subject to export duty (eg: oil, gas, minerals).

Certain products are also subject to an additional consumption tax, reserved for consumption inside China. You will not encounter it when importing from China.

Further Action

• Investigate with your China partners which customs codes are used, and seek to optimize them. You can make this a win-win situation.
• Investigate whether the full benefit of tax deductibility on exports is passed on to you.
• Be aware of these peculiar VAT rules when negotiating with Chinese suppliers, especially if working with non process trade manufacturing partners.
• Contact Asquance to learn more on optimizing your Asia purchase costs.

In: Asquance Newsletter 

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