China’s New VAT Law: A major shift towards a clearer and more predictable tax system

1. Clearer Criteria for Domestic Taxable Transactions

In the past, the definition of “domestic taxable transactions” was often ambiguous, leading to confusion among businesses. The new law provides clearer guidelines, detailing that taxable domestic transactions include the sale of goods, services, intangible assets, and real estate. A significant change is the treatment of “processing, repair, and assembly services”, previously treated as separate labor services, which are now categorized as general services, reducing compliance risks for businesses, especially those involved in international trade.

2. VAT Rates: No Change, But More Benefits for Small Businesses

While the VAT rates of 13%, 9%, and 6% remain unchanged, the new law further simplifies the simplified tax system for small businesses and certain industries. Under the old system, businesses could be subject to either a 3% or 5% levy, depending on the industry. With the removal of the 5% rate, small businesses will now pay a lower tax rate, improving their competitiveness and enhancing their growth potential in the long run.

3. Simplified definitions of taxable and non-taxable transactions

The new law replaces the term “deemed sales” with “deemed taxable transactions.” These are situations where VAT is due even if no actual sale occurs. The law now clearly defines three categories of deemed taxable transactions:

• Self-produced or processed goods used for collective welfare or personal consumption.
• Transfers of goods, intangible assets, or real estate without compensation.
• Transfers of financial products without compensation.

The law also removes goods consignment, inter-branch transfers, and deemed sale of services from the taxable scope. These updates aim to reduce confusion and ensure businesses only face tax obligations for clear taxable events.

Article 6 of the new law outlines four main non-taxable items, which include:

• Services provided by employees in exchange for wages.
• Administrative charges and government funds.
• Compensation for expropriation or requisition.
• Interest income from deposits.

These clarifications offer greater transparency for businesses and reduce potential tax disputes.

4. Adjustments to Sales Prices

Article 20 of the new VAT law empowers tax authorities to adjust the sales price if it is considered significantly too high or too low. This adjustment is allowed if the price is deemed “without legitimate reasons”, although the exact definition of this phrase is not yet clear. This could lead to varying interpretations by local tax authorities, potentially adding some complexity to compliance.

5. Expanded Input VAT Deductions

The new law expands the scope of input VAT deductions. Previously, businesses could not deduct VAT on loan services, but this restriction has now been removed. This change will particularly benefit capital-intensive industries, such as manufacturing, where businesses rely heavily on loans for funding. However, businesses still cannot deduct VAT on three specific items: catering services, residents’ daily services, and entertainment services.

6. VAT Credit Refunds

The new VAT law formalizes the VAT credit refund process, allowing businesses to claim refunds if the VAT paid on their purchases exceeds the VAT due on their sales. Businesses can now choose to carry forward excess VAT to offset future tax liabilities or apply for a refund directly, improving cash flow. These updates will particularly benefit businesses engaged in large-scale projects or bulk procurement.

7. Simplified Tax Filing with Electronic Invoices

The new VAT law promotes the use of electronic invoices to streamline the tax filing process. Businesses are encouraged to adopt digital receipts, which will simplify tax reporting and reduce the need for paper records. This shift not only makes tax filings faster and more efficient but also supports the growing trend of data-driven tax management, in line with global tax practices.  However, businesses must ensure the integrity and compliance of their data when using electronic invoices, to avoid errors or misuse. The use of e-invoices will make it easier for multinational enterprises to share financial data across borders, aiding in centralized management and improving operational efficiency.