BEIJING – China has rapidly implemented value-added tax reform over the last two years, and it has pledged to complete the reform by finally extending it even to the financial services and real estate industries by 2015.
While value-added tax systems have grown in popularity worldwide over the last thirty years as a new source of dependable tax revenue (reportedly even US presidents Barak Obama and Richard Nixon briefly considered it), the Chinese value-added tax (VAT) system is unique and far more intricate and resource-consuming than normal. It is heavily dependent upon printed VAT invoices that can only be issued and used by resort to elaborate verification processes designed to ensure tax collection and to curtail fraud.
Failure to effectively manage the system can result in substantial tax liabilities that may wholly consume already thin profit margins.Therefore, it is critical for every foreign invested enterprise in China (i) to plan for the impact of VAT from the very beginning, (ii) to establish an independent internal (or outsourced) system to monitor and manage the company’s VAT position, and (iii) for senior enterprise leaders to stay abreast of the company’s VAT position and to consider it when transacting business.
The Chinese VAT system has numerous hazards to ensnare an unwary foreign investor, and examples of several are briefly presented here. On a very foundational level, the most important initial step to effectively managing the Chinese VAT system is for a foreign invested enterprise to attain “general taxpayer status.” Value-added tax is intended to be imposed on nearly every business transaction not specifically exempted or otherwise excluded, and the tax ranges from 3% to 17%.
However, it is possible to reduce this substantial burden through a simple process whereby “input VAT” is used to offset “output VAT.” For instance, if a trading company or manufacturing company purchases goods (and shoulders the burden of a 17% VAT), it can qualify to use such paid-out VAT (“input VAT”) as a type of credit to offset its VAT liability when it sells goods.