Introduction to China’s Value Added Tax (“VAT”)

1. Introduction

VAT is chargeable on the sale of goods, provision of processing and repair service, and the importation of goods within the People’s Republic of China.

Generally, output tax charged on the sales of goods may be set off against input tax incurred on the purchase of the goods or materials.

However, some input tax is not creditable, such as the goods purchased for non-taxable and tax-exempt items, or abnormal losses.

Beginning from April 1, 2002, capital equipment imported for foreign investment projects in the “Encouraged” Category and imported for self-use within the total investment limit, can be imported free of VAT and customs duty, if the capital asset is not included in the “Catalogue for Foreign Investment Project Import Items that are not Tax-exempt”.

2. Mixed Sales

A mixed sales activity involves both goods and non-taxable services. Mixed sales activities of enterprises engaged in production, wholesaling or retailing of goods shall be regarded as sales of goods which shall be subject to VAT.

Mixed sales activities of other enterprises normally shall be subject to BT.

3. Multiple Activities

If an enterprise also engaged in non-taxable services, it shall separately account for the sales amount of goods or taxable services, and non-taxable services. If separate and accurate accounting cannot be made, the non-taxable services, and goods or taxable services, shall together be subject to VAT.

4. Small-Scale Taxpayers

Small-scale taxpayers engaged in selling goods or services shall use a simplified method to calculate the VAT due. No input tax is creditable.

The criteria for small scale taxpayers are:

(1) For taxpayers engaged in the production of goods or provision of taxable services, annual taxable sales amount is less than RMB 1 million;
(2) For taxpayers engaged in the wholesaling or retailing business, the annual sales amount is less than RMB 1.8 million.

5. The “Exemption, Offset and Refund” Policy with Respect to Exported Goods Self-produced by Production Enterprises

(1) “Exemption” means the exported goods produced by the manufacturing enterprise are exempt from output tax.
(2) “Offset” means that the input tax attributable to the raw materials, spare parts, fuel, energy consumed in producing export goods by the manufacturing enterprise, can be offset against output tax attributable to domestic sales.
(3) “Refund” means that when the input tax attributable to the exported goods produced by the manufacturing enterprise is greater than the tax due, the amount that cannot be offset can be refunded.
(4) Effective as of January 1, 2002, all production enterprises, irrespective of whether the enterprises have import/export license, are eligible for the “exemption, offset, and refund” policies, if they export their self-produced goods directly or through a foreign trade company which has the import/export right.

6. Adjustment on VAT Refund Rate in 2004

Effective from January 1, 2004, there will be a major adjustment in the VAT refund rate with respect to export goods. For products encouraged by the state to be exported, the refund rate will remain the same or slightly reduced. For general export goods, the refund rate will be appropriately reduced. For products subject to export restrictions or which will consume resources, the refund rate will be reduced more, or scrapped. The average refund rate will be reduced by 3% on average.

From 2004 on, the refund burden will be shared by the Central Government and local government in the ratio of 75:25. The rationale is to expedite “old” refund overdue, while “new” refund will be paid out immediately.

With respect to the refund accumulated and overdue before the adjustment takes effect, the Central Government will bear the financial burden. For the refund not paid out after the end of 2003, the interest will be accrued from 2004 and will be paid by the state treasury.