Upcoming Mallesons seminarsAny foreign invested enterprise that enjoys the current VAT import exemption, or the VAT refund for the purchase of domestically-made equipment.
What do you need to do?Prepare to adjust accounting and business structures to account for the removal of preferential VAT treatment and to take advantage of the VAT deductibility for fixed asset purchases.
Nicolas Groffman (郭愷)
Senior Associate
John Shi (史衛)
Partner
T +86 10 5927 2168
Christopher Tung
(董彥華)
Partner
T +852 3443 1082
On 11 November 2008 the State Council issued the Interim Regulation of the People’s Republic of China on Value Added Tax (the new “VAT Rules”). The new VAT Rules take effect from 1 January 2009 and are part of the greater tax transformation plan (“Transformation Plan”).
Removal of VAT exemption on imported equipment
The new VAT Rules remove the exemption that applied to machinery and equipment imported for contract processing, assembly and compensation (otherwise referred to as fixed assets). On 11 November 2008, the State Administration of Taxation (“SAT”) held a question and answer session (“Tax Q&A”) in which they stated that VAT import exemptions available under the Circular for Adjustment on Imported Equipment would be removed as part of the Transformation Plan (the new VAT rules are silent on some of the specific changes outlined in the Tax Q&A).
This circular included VAT exemptions afforded to foreign invested enterprises (“FIEs”) importing equipment (most of which can be classified as fixed assets) that involved technology transfers and fell within the encouraged category of Import Industries Catalogue. The encouraged category includes industry sectors such as manufacturing (e.g. the development and utilisation of products using clean coal techniques), as well as the production and supply of electricity, gas and water (e.g. construction and operation of new energy power stations including solar energy). The justification provided in the Tax Q&A for the removal of import VAT exemptions was that because fixed assets will be deductable as of 1 January 2009, there is no need for these exemptions to continue.
What this means is that although FIEs will now pay Input VAT (the VAT paid by the purchaser when purchasing the equipment) on imported equipment, that Input VAT can be deducted from their Output VAT. For example, if an FIE develops a clean energy project, then the Input VAT paid for imports could be (pending implementing regulations) deducted from the Output VAT they pay on the goods they sell, for example, electricity. The rate provided in the VAT Rules for Input VAT for imports is 17%, but this may change with the implementing regulations.
It was also noted that part of the reason for the reform was to even out the tax burden between FIEs and domestic entities.
The implementing regulations for the new VAT Rules are expected to be issued in December 2008 and are intended to clarify some of the above statements made in the Tax Q&A.
What this means is that FIEs and domestic entities will be subject to the same VAT regime in relation to the importation of equipment. It will be necessary to wait for the implementing regulations before it can be determined whether FIEs that benefited from the preferential treatment will experience an increase in their tax liabilities. In other words, whether the tax saved by being able to deduct the Input VAT on equipment will be less than that saved by previous refunds applicable to purchases of domestically-made equipment, or exemptions on imported equipment, is yet to be determined and in any case will probably vary project by project.
Cancellation of the VAT refund treatment on domestically-made equipment
The Tax Q&A was also explicit about the cancellation of the preferential treatment enjoyed by FIEs under 1999’s Tax Circular 73. This treatment allowed FIEs to receive a refund for the purchase of domestic-manufactured equipment, provided that equipment was within the scope of the Tax Exemption Catalogue. The scope in this catalogue works by allowing all the items not listed on the ‘Catalogue of Projects Not Exempted from Tax’ to be refundable. Again, it is necessary to wait for the implementing regulations for clarification on the cancellation of this FIE refund.
Similar to the removal of the VAT import exemption, it was noted in the Tax Q&A that the cancellation of this preferential treatment will be offset because under the new VAT Rules, VAT paid on fixed assets can now be deducted from Output VAT. Therefore, Input VAT, although not refundable, can be offset against the Output VAT paid by FIEs when selling their goods, for example, electricity.
Determining the costs for FIEs that currently enjoy this preferential treatment will mean comparing the value of the refund against the value of being able to use VAT paid on fixed assets as a deduction against Output VAT.
VAT recovery allowed for the purchase of fixed assets
Input VAT on the purchase of fixed assets is now permitted to be deducted from Output VAT. This is the most significant change in the new VAT Rules and is part of the justification for removing the VAT exemption on imported equipment as well as the refund available to FIEs for the purchase of domestically-made equipment. In other words, although FIEs lose their VAT preferential treatment (exemption from VAT on imports, and refunds for VAT paid on domestically-made equipment), being able to deduct Input VAT paid on fixed assets from Output VAT should offset the increase in price (although it is unclear to what extent).
Previously, domestic entities had to pay VAT for equipment purchases, but under the new VAT Rules, domestic entities benefit by being able to deduct such equipment from their Output VAT. This means domestic entities and FIES are now equally subject to VAT.
Other changes
- The VAT rate for mineral products has been raised from 13% to 17%.
- Small-scale commercial, manufacturing and other enterprises will now enjoy a uniform VAT rate of 3%. This means a reduction from the original rates of 4% for small-scale commercial enterprises, and 6% for small-scale manufacturing and other enterprises.
What can be done?
FIEs and domestic entities should ensure that all the VAT special invoices are received when purchasing fixed assets as well as insuring the Input VAT paid on such assets is properly accounted for in the company books.
If an aforementioned FIE or domestic entity plans on buying fixed assets, then plans should be made to purchase and procure such assets post 1 January 2009, once the rules are in force. They could thus take advantage of the deductable cost of the fixed asset under the new law.
For both FIEs and domestic entities in the energy industry, appropriate accountancy structures need to be in place so Input VAT paid on purchased fixed assets can be deducted from Output VAT paid on different types of energy sold. Where the Input VAT is greater than the Output VAT, the remaining Input VAT can be carried forward.
It is our view that the release of the implementing regulations will take place in December 2008 and both the new VAT Rules and the implementing regulations will be in force as of 1 January 2009. This is similar to how the Enterprise Income Tax Law (“EITL”) was issued, with its implementing regulations coming later, but both the EITL and the implementing regulations taking effect on the same date.
Disclaimer
The views set out in this publication are based on our experience as international counsel representing clients in their business activities in China. As is the case for all international law firms licensed in China, we are authorised to provide information concerning the effect of the Chinese legal environment. However we are not admitted to practice Chinese law and so are unable to issue opinions on matters of Chinese law.
This publication is only a general outline. It is not legal advice. You should seek professional advice before taking any action based on its contents.