On November 5, 2008, the PRC State Council passed The Provisional Regulations of the People’s Republic of China on Value-Added Tax, extending VAT reforms to all industries nationwide from January 1, 2009.


Stephen Nelson, Partner, Taxation & Alice Zhang, Legal Assistant


Under the reforms, the PRC will finally allow companies to deduct input VAT for purchased fixed assets, and if the output VAT for the period is insufficient to offset the current period’s input tax for purchased fixed assets, the excess input tax amount can be carried forward to subsequent periods.

The definition of “fixed assets” as defined by the VAT regulations will not be altered by this reform. The term does not include real property such as houses or buildings (which remain subject to business tax and not VAT), nor does it include personal consumption assets such as automobiles or motorcycles.

The new VAT Regulations eliminate the import VAT exemption on imported equipment and machinery required to be imported under contract processing, contract assembly and compensation trade.

Government officials have explained that the old exemption was enacted in accordance with the old production-based VAT regulations, and since the new VAT regulation applies the consumption-based VAT, the old exemption is no longer necessary. However, details remain unclear and we are still awaiting further information on grandfathering provisions, if any.

The new VAT regulations eliminate the import VAT exemption for encouraged foreign investment enterprises (FIEs). Government officials have explained that VAT for those exempted items could still be deducted from output VAT even though the particular rule for encouraged FIEs is abolished in compliance with newly-adopted consumption-based VAT. In addition, the tax refund for the purchase of domestic equipment by encouraged FIEs has also been eliminated.

To ease the current  pressure on Chinese companies in labor intensive and highly competitive industries, MOF and SAT have jointly issued two Circulars, Caishui [2008] No. 138 and Caishui [2008] No. 144, on October 21, 2008 and November 17, 2008 respectively, to increase export VAT refund rates for certain textile, apparel, toy, ceramic, plastic, furniture and other products. The export VAT refund rates for some textile, apparel and toys increased from 13 percent to 14 percent; while other increases were from five percent to nine or 11 percent, and from 11 percent to 13 percent.

According to the old VAT regulations,  small-scale tax-paying SMEs were taxed at 6 and 4 percent for industrial and commercial companies respectively. Under the new reforms, the VAT rate for all small-scale taxpayers is reduced to a flat rate of 3 percent.

The VAT rate for mineral products will return to 17 percent from the current rate of 13 percent.

Prior to implementation of the new Enterprise Income Tax Law, business tax paid was deductible in calculating the withholding tax derived by a non-resident enterprise, as stipulated by Caishui [1998] No. 59.

However, the SAT, on September 25, 2008, issued a Circular on Issues regarding Enterprise Income Tax for Non-resident Enterprises, Caishui [2008] No. 130. In this Circular, the SAT has clarified that in computing the taxable income of non-resident enterprises, the relevant taxes paid, such as business tax, are not deductible.