VAT transition lowers taxes, leads the world

BEIJING - Zhou Haibin, a restaurant owner in East China's Shandong province, is more than happy with his 41 percent tax cut, thanks to a policy rolled out across the country.

He used to pay 28,800 yuan ($4,320) a month for business tax (BT), which was five percent of his revenue, but since VAT was adopted he now only pays 16,800 yuan (three percent).

Since China's transition from the BT system to VAT, which started in May, Zhou qualifies as a "small-scale taxpayer."

"We can either reinvest the 12,000 yuan we saved from tax cuts, or use it to improve our services," said Zhou.

Nationwide, the country expects the transition from BT to VAT to save businesses 500 billion yuan ($74.9 billion) in 2016, the State Administration of Taxation estimated.

China has made lowering the costs of doing business a priority to shore up its economy against continued downward pressure.

GDP grew 6.7 percent year on year from April through June, the lowest quarterly growth since the global financial crisis.

"The transition to VAT could play a significant role in lowering tax burdens to help businesses through these difficult times," said Hu Yijian, a professor at Shanghai University of Finance and Economics.

The VAT transition follows four years of experiments in designated sectors and areas, starting with transportation and certain service industries in Shanghai in 2012, and gradually expanding to cover more sectors and areas.

The taxation authorities said 5.92 million taxpayers were involved in the experiments through the end of 2015, with taxes reduced by 641.2 billion yuan compared with the BT system.

Beginning on May 1, the remaining four sectors -- construction, real estate, finance and lifestyle services -- switched over to VAT.

BT was calculated on businesses' gross revenue, while VAT allows taxpayers to deduct goods and services they purchase.

The main VAT rates in China -- 6 percent, 11 percent and 17 percent -- compare favorably with the average rate among OECD countries of 19.1 percent, according to a report by the accounting firm KPMG.

In particular, the VAT system benefits small-scale taxpayers like Zhou who are eligible for the three percent rate, who under the BT system had to pay five percent.

Global implications

Many multinational companies in China will welcome the changes, given that the adoption of a broad-based VAT system is in line with indirect tax systems in approximately 160 countries around the world, said the KPMG report.

But China is among the first countries in the world to expand the VAT to all industries, including the financial services sector.

"To the best of our knowledge, there are only one or two relatively small economies in the world that have even tried this," said Lachlan Wolfers, KPMG China's head of indirect taxes.

Under the new tax system, every time a bank charges interest on a loan to a customer, or there is a gain made from trading in financial products such as stocks, bonds or foreign exchange transactions, or an insurance premium is levied on a customer, VAT applies.

"The European Union has spent years studying whether VAT could be applied to financial services, and have not been able to implement it. However, in applying VAT to financial services in China, it shows that it is possible. It would not be a surprise to see other countries follow suit if the Chinese do it successfully." said Wolfers.

China's expansion of the VAT system will be carefully watched around the world, said Li Junsheng, deputy dean of Central University of Finance and Economics, adding that global attention comes from not only an interest in the program's feasibility, but also the angle of tax competition.

As the world's second-largest economy reforms its tax system, the competitiveness of companies that pay taxes in China, as well as the tax burden of doing business in China, will be affected, therefore, it will be of interest to other economies wanting to attract business, Li said.