China modernises its VAT regime with single 2026 VAT Law
The Value-Added Tax (VAT) Law of the People’s Republic of China, set to take effect on 1 January 2026, represents a significant step in modernising China’s tax framework. It consolidates decades of reforms and serves as the culmination of efforts to codify the VAT system, the new law aims to streamline tax compliance and incorporate international standards
Historical Evolution of China’s VAT System
China’s VAT system has undergone major transformations since its inception:
- 2009 Reform: Transitioned from a production-based VAT system to a consumption-based model, allowing input VAT on fixed assets to be deducted.
- 2016 Reform: Unified VAT and Business Tax, first through a pilot program and later through nationwide implementation, eliminating overlapping taxes and improving the neutrality of VAT.
Features and Innovations of the New VAT Law
While maintaining much of the existing framework, the new law incorporates significant refinements:
1. Scope of Taxable Transactions
The scope covers the sale of goods, services, intangible assets, and real estate within China. A notable change aligns the law with the destination principle, taxing services and intangible assets where consumed, irrespective of the purchaser’s or seller’s location. This approach harmonizes China’s VAT system with global practices and provides clearer guidelines for cross-border transactions.
2. Deemed Sales and Free Transactions
The scope of “deemed taxable transactions” has been narrowed, now covering:
- Self-produced goods for personal or collective welfare.
- Free transfers of goods, intangible assets, or real estate.
Free services, previously taxable, are now exempt, streamlining tax administration and reducing compliance burdens. However, transactions excluded from “deemed sales” remain taxable under other provisions.
3. Non-Taxable Activities
Certain activities are explicitly excluded from VAT, including:
- Employee services provided for wages.
- Administrative fees, public service charges, and interest from deposits.
- Compensation for expropriation or requisition.
However, business reorganizations involving the transfer of goods or real estate remain taxable, requiring careful planning by affected entities.
4. Tax Rates
The three-tier VAT rate structure is retained:
- 13% for general goods and imports.
- 9% for services such as transportation and utilities.
- 6% for modern services.
The simplified taxation levy rate is unified at 3%, replacing the previous 5% rate to ease compliance and reduce taxpayer burdens. Further details on implementation will be clarified in Detailed Implementation Regulations, expected in late 2025.
5. Mixed Sales Transactions
The tax rate for mixed transactions is determined by the main transaction rather than the taxpayer’s primary business. This requires careful structuring and documentation of contracts to determine the applicable rate.
6. Calculation of Taxable Income
Taxable income is defined as the total consideration, excluding VAT, received for taxable transactions. This eliminates ambiguity surrounding “out-of-pocket expenses” and strengthens the correlation between transactions and taxable income.
7. Input VAT and Non-Creditable Items
The new law retains the principle that input VAT on specific transactions (e.g., exempt activities or abnormal loss projects) is non-creditable. Loan services, however, are no longer categorized as non-creditable, reducing the tax burden for businesses reliant on external financing. Fixed asset purchases require more detailed treatment of input VAT, as preferential policies are streamlined.
8. Excessive Input VAT Refunds
Taxpayers with excess input VAT can either carry it forward to future periods or apply for refunds. This codified policy, introduced in 2018 as a pilot program, enhances certainty and improves cash flow management.
9. Tax Incentives
Exemptions remain for sectors such as agriculture, research, and welfare institutions. The State Council is authorized to introduce additional tax incentives to support specific industries and stimulate economic development.
10. Interdepartmental Collaboration
The new law emphasizes collaboration between tax authorities and other government bodies, enhancing data sharing and administrative efficiency. The Golden Tax Phase IV system will further improve transparency and compliance.
Conclusion
The new VAT law represents a significant modernisation of China’s tax system, incorporating international standards and addressing domestic economic complexities. While maintaining the stability of the current system, it introduces refinements to enhance efficiency and clarity, providing a robust framework for the future of taxation in China.
