China's New VAT Law

China's new Value-Added Tax (VAT) Law was passed during the National People's Congress Standing Committee session on December 25, 2024 and will take effect on January 1, 2026. The new VAT law consolidates the existing regulations into a single legal framework. With the new VAT law taking effect, the Interim Regulations on Value-Added Tax will be abolished.

In China, VAT is the largest tax category which accounts for about 38% of the national tax revenue in 2023. It covers almost all sectors and stages of economic activities, having a broad impact on the economy and society. VAT is shared between the central and local governments on a 50-50 split, meaning that the central government and local governments each receive 50% of the VAT revenue, a significant source of revenue for central and government in China.

The new VAT law defines the legislative purpose for the first time and the law is intended to improve the efficiency and neutrality for the benefit of taxpayers and the administrators. The law explicitly defines the scope of VAT, taxable transactions, and tax incentives, making it easier for businesses to understand their obligations.

 

Highlights

The VAT legislation follows the principles of maintaining the overall framework of the current tax system and keeping the current level of tax burden unchanged. Accordingly, the VAT rates and other aspects are largely consistent with the existing tax system, with certain innovations and improvements in specific policies. We have highlighted the following main changes introduced by the new VAT law.

1. Scope of taxable transactions

The scope of VAT taxable transactions under the new VAT law generally follows the provisions under the existing VAT regime and includes the sale of goods, services, intangible assets, or real estate within China.

With respect to the provision of services and transfer of intangible assets, the new VAT law clarifies that, the "taxable transactions within China" shall refer to the situation where the services or intangible assets are consumed within China, or the seller is an entity or individual within China. Instead of referring to the purchaser's location as a criterion under the existing VAT regime, the new law focuses on the location where the services or intangible assets are consumed in determining if a transaction is a taxable transaction in China. This change aligns with the destination principle, a widely accepted standard in international trade for levying VAT in the place where final consumption occurs.

Based on the new VAT law, for services and intangible assets provided by a non-PRC seller, VAT will be imposed if the services or intangible assets are used or consumed in China, regardless of where the purchaser is located. The existing VAT regime requires VAT to be paid in China if the seller or the buyer is in China with certain exceptions of the Chinese purchaser procuring from foreign seller services or intangible assets that are entirely consumed outside of China. Compared with the existing VAT regime. the new VAT law could potentially capture the taxable situation where both parties to the service or intangible assets provision are not based in China but the underlying services or intangible assets are rendered or used in China.

2. Clarification of "deemed sales" activities and their VAT treatment

The new VAT law has limited the scope of deemed taxable transactions to the following:

• Entities and individual businesses using self-produced or commissioned-processed goods for collective welfare or personal consumption;
• Entities and individual businesses transferring goods free of charge; and
• Entities and individuals transferring intangible assets, real estate, or financial products free of charge.

This means that transactions such as consignment sales, cross-county (city) transfer of goods, and applying goods for non-VAT taxable purpose, external investment, distribution, etc. that are deemed taxable transactions under the current VAT regime are all removed. But removing them does not mean that such transactions are all exempt from taxation. Most of the changes are for simplification of drafting as the relevant tax treatments have been covered by other tax provisions in the new VAT law.

It is important to note that taxpayers providing free services will no longer be required to treat the services as taxable transactions. This is a big change compared with the position taken under the current VAT regime. There reasons behind such change may be driven by improving tax administration efficiency as it will involve excessive tax administration cost to monitor free services in practice. In addition, where free services involve provision of goods, the goods are subject to VAT based on the deemed sale requirements.

3. Non-taxable items specified

The new VAT law specifies non-taxable items as follows:

• Services provided by employees to their employing units or employers for the purpose of receiving wages or salaries.
• Collection of administrative and public service fees, and government funds.
• Compensation obtained due to expropriation or requisition in accordance with the law.
• Interest income from deposits.

The above activities are not considered business related activities and therefore not subject to VAT. Taxpayers do not need to recognize taxable income for payments arising from such events.

It is worth noting that the transfer of goods, real estate, and land use rights involved in business reorganization is excluded from the non-taxable scope under the new VAT law. Such change may require taxpayers to reconsider their strategies in business restructuring.

4. Tax rates

The VAT law maintains the current three-tier tax rate structure:

• 13% for general goods sales and imports
• 9% for services like transportation, telecommunications, and utilities
• 6% for modern services

The new VAT law adopts the unified VAT levy rate of 3% for simplified taxation method, i.e., no input tax credit to be claimed by taxpayers. The 5% levy rate provided under the existing VAT regime will be abolished, aiming to reduce tax burden of taxpayers.

The new VAT law does not provide clarification on the transition to the unified 3% levy rate. There may be a phase-in period to allow taxpayers to transit to the unified 3% levy rate, and guidance will be provided by the legislator before the new VAT law take effect.

5. Handling of mixed sales transactions

A mixed sale transaction is defined to be a taxable transaction that involves different tax rates or levy rate. Based on the new VAT law, the applicable tax rate on a mixed sale transaction shall be determined based on the main transaction of the underlying mixed sale transaction, rather than the main business of the taxpayer.

This means a taxpayer may apply different VAT rate for different mixed sale transactions, and the decision should be made based on how the business transaction is structure. Then how the business contract is drafted to support the transaction becomes a key factor in determining the appliable tax rate for the income generated by the transaction.

6. Calculation of taxable income

The new VAT law defines sales revenue to be the price obtained by taxpayers from taxable transactions, including cash and in-kind consideration, but excluding VAT. This definition removes the controversial "out of pocket expenses" that are provided under the existing VAT regime but emphasizing that the taxable income shall include all considerations, in cash or in-kind forms, related to the taxable transaction, strengthening the correlation between transactions and consideration.

The new VAT law only sets out the general principle for determining VAT taxable income. It is expected that further guidance on allowable deductions for taxpayers adopting different business models and in different industries will be introduced in its implementation regulations.

7. Non-creditable input VAT

The new VAT law generally follows the current practice that input VAT incurred for specified transactions (Specified Transactions), including transactions that are (i) subject to simplified taxation method, (ii) exempted from VAT, (iii) corresponding to abnormal loss projects or (iv) corresponding to items used for collective welfare or personal consumption, are not creditable for calculating VAT payable by taxpayers.

However, the way the new VAT law is drafted seems to suggest the removal of the current preferential treatment that taxpayers are allowed to claim full tax deduction for input VAT incurred for fixed assets unless the fixed assets are solely used for the Specified Transactions. This means under the new VAT law, for fixed asset purchased, taxpayers are required to separate those VAT incurred for Specified transaction and have them expensed on books.

It is also worth noting that the new VAT law has removed loan services from the scope of Specified Transactions. Allowing the deduction of input VAT for loan services will effectively reduce the tax burden on enterprises that rely on external financing. However, the position is still uncertain given that the new VAT law empowers the State Counsel to issue tax regulations on including additional non-creditable VAT.

8. Excessive input VAT

A taxpayer is required to pay VAT if its total output VAT is greater than total input VAT for a given taxable period. The new VAT law stipulates that when the input VAT amount of the current period is greater than the output VAT amount of the current period, taxpayers can choose to carry it forward to the next period for deduction or apply for a refund of the excessive input VAT.

The policy of excessive input VAT refund was introduced in 2018 via a pilot program and has now been implemented as a nationwide policy. With this tax refund policy formally set out in the new VAT law, it will give taxpayers more certainty in claiming tax refund and effectively improve their cash flow position.

9. Tax incentives

The new VAT law includes exemptions for specific sectors, such as agriculture, research, and welfare institutions (including daycares and nursing homes). The State Counsel is empowered to formulate policies to expand tax preferential policies to support specific sectors or businesses.

10. Collaboration across departments

The new VAT Law requires VAT information sharing system be implemented by tax authority and other government bodies, and empower tax authorities to request cooperation from other agencies and departments, providing more sources of information and support for tax administration. With the launch of the 'Golden Tax Phase IV' system, VAT tax administration will become more precise and efficient, making tax matters of taxpayers more transparent in front of tax authorities.

 

Closing comments

The new VAT law will take effect on 1 January 2026, one year from its publication. It provides ample time for businesses to assess the potential impact of the changes introduced by the new VAT law and prepare the business for the transition. Tax authority can also use this opportunity to understand and adapt to the new regulations and update its tax collection system. It also leaves room and flexibility for the legislators to formulate implementation regulations, guidelines, and administrative measures to support the new law.

To prepare for China's new VAT law, foreign investors may consider the following actions:

• familiarize themselves with the specifics of the new VAT law, including the definitions of taxable transactions, the determination of the place of supply, and the rules for deemed sales, etc;
• provide training for finance and accounting teams to ensure they understand the new VAT regulations and can implement them correctly;
• engage with tax advisors or consultants to get tailored advice and ensure compliance with the new law;
• assess existing contracts and pricing strategies to ensure they align with the new VAT requirements;
• check if accounting system needs adjustment or update; and
• establish internal controls and monitoring systems to ensure ongoing compliance with the new VAT law.

By taking the above steps, foreign investors can better navigate the changes brought by the new VAT law and minimize potential disruptions to their operations in China.