The VAT incentives are meant to help vulnerable businesses overcome the difficulties of the Covid-19 pandemic and represent an extension of previous policies. A wide range of tax incentives and cuts have been put in place in China in the past few years to encourage and support economic growth.

In 2022, the country implemented record-high value-added tax credit refunds, which totalled about 2.4 trillion yuan. The new VAT exemption and reduction policies will be valid from 1 January 2023 to 31 December 2023.

If a small business has monthly sales under RMB 100,000 (approx. $14,740), or if the quarterly sales are under RMB 300,000 (approx. $44,220) for taxpayers who choose one quarter as a tax payment period, the taxpayer will not be subject to VAT.

This represents a lower threshold than in 2021 and 2022. During the period from 1 April 2021 to 31 December 2022, the VAT limit for small-scale taxpayers was RMB 150,000 (approx. $22,110) per month (or RMB 450,000 per quarter, approx. $66,300).

The VAT administration notice clarifies that small-scale taxpayers with total monthly sales of over RMB 100,000 – but whose sales when excluding real estate sales occurring in the current period is less than RMB 100,000 – will be exempt from paying VAT on the sale of goods, labour services and intangible assets.

Small businesses can choose to waive the VAT exemption incentive and instead issue special VAT invoices for a specific sale.

Between 1 January 2023 and 31 December 2023, small-scale taxpayers that are subject to a VAT levy rate of 3% can enjoy a reduced levy rate of 1%. The VAT items subject to a 3% VAT prepayment rate will enjoy a reduced prepayment rate of 1%.

An additional VAT deduction policy has also been issued for lifestyle and production-oriented services in 2023. Taxpayers in these sectors can enjoy 5% additional VAT deductions based on the deductible input VAT in the current period. Taxpayers in the lifestyle services sector can enjoy 10% additional VAT deductions based on the deductible input VAT in the current period. Production-oriented services include ‘postal services’, ‘telecommunication services’, ‘modern services’ and ‘lifestyle services’. Taxpayers in these sectors must have sales from ‘lifestyle services’ that represent more than 50% of their total sales.

Previously, taxpayers in the postal, telecommunications, modern services and lifestyle services industries were granted a 10% additional VAT deduction based on the deductible input VAT between 1 April 2019 and 31 December 2021, and taxpayers in lifestyle services enjoyed a 15% additional VAT deduction from 1 October 2019 to 31 December 2021. Tax authorities in China extended this additional VAT deduction policy to 31 December 2022.

In recent years, a key aspect of China’s new tax rules and policy directions has been tax incentives and cuts to boost the economy and encourage investment and research and development activities. At the same time, China is also making efforts to improve its tax administration environment, in particular the administration of transfer pricing issues relating to multinational enterprises.

The strict Covid-19 prevention measures imposed under China’s zero-covid policy significantly affected businesses and the economy in general. However, since the government decided to lift restrictions and quarantines, experts have raised their forecasts for China’s real GDP growth to 5.2% in 2023 (from 4.7%).

Adapting to a new reality and possible repeated surges of covid cases will be challenging for China. The government will have to consider creative ways to get the country’s economy back on track and rebuild businesses and investors’ confidence.

According to analysts, China may decide to extend most of the tax incentives that it has offered in the past, at least until the end of 2023. With respect to tax audits, there has also been a comparatively calmer tax audit environment in the past three years. However, China will continue to focus on improving its tax enforcement.

Tax authorities may become more aggressive in their enforcement activities in the future in order to plug the gap in tax revenue collection created by a slower economy and to make up for the reduction in tax revenue arising from various tax cut measures.

Call +44 (0)20 7802 2000 or email enquiries@cbbc.org now to connect with CBBC staff who can advise on company chops and other Chinese legal requirements.

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Disruption creates difficulties, but it also creates opportunities. Post Covid-19, investors have an opportunity to benefit from a first-mover advantage in this new world, and one of the ways to do this will be through international joint ventures (IJVs).

The majority of IJVs in China are manufacturing companies. This is viewed by the Chinese authorities as a preferable form of foreign investment because it provides an opportunity for the transfer of advanced technology and management skills to the Chinese economy and leads to increased exports.

Foreign companies have a particular interest in manufacturing in China, as it gives them access to the large Chinese market and to potentially low production costs. The international economic slowdown has also created a high degree of market uncertainty. When uncertainty is high, joint ventures become more attractive because they require less initial investment than the alternatives and can be set up with a clear exit mechanism in mind.

According to a study done by Deloitte, the Covid-19 pandemic is creating conditions that increasingly favour JVs. IJVs also offer an advantage in accessing markets with heavy regulatory restrictions. This is the case in China which effectively limits foreign investment in certain industries if the foreign investor does not partner with a local firm. However, there is a notable trend towards opening more industries to foreign investment, with the Chinese government recently reducing foreign ownership restrictions on investments in finance and the automobile industry.

The rising risks and costs of products due to supply chain disruptions, inflation and tariffs are also pushing companies to consider a JV, which would allow both sides to share the increasing burden.

Another way for both the foreign buyer and its Chinese manufacturing partner to reduce risks and increase sales and profits is to have the manufacturer sell the foreign buyer’s products in China.

Many experts consider JVs in China to favour the local partner and believe that it rarely makes sense for the foreign company. Joint ventures with Chinese suppliers have their own special issues/problems, and they expose the foreign side to risks such as IP theft and battles for control over the business.

Chinese factories usually know little about how to market products (even their own) in China, and when they are your factory and your JV partner, it can be difficult for you to monitor the joint venture’s sales and profits.

It usually does not make sense for a foreign company to become a co-owner of a joint venture entity with its Chinese manufacturer before it knows how good that factory will be at selling their product in China. Therefore, a China-centric distribution agreement could be a better option to set forth sales goals. It also allows the foreign company to walk away if the Chinese factory does not meet those goals. Having a trademark licensing agreement with the distributor also makes sense.

IJV manufacturers in China face many challenges, such as difficulty with recruiting and training suitable employees;  supplier management; problems with achieving high-quality output; and creating an effective IJV business culture.

Investments in IJV manufacturing are often thought worthwhile because of the strategic benefits they can bring to both local and foreign partners. But despite their apparent advantages, IJVs in China are not always successful, and parent companies are often dissatisfied with IJV performance. Poor financial performance is often related to operational problems.

IJVs are a way for businesses to get a foot in the door and establish themselves in a new market. Consequently, measuring the success of an IJV should take into consideration what the stated objectives of the venture were at the time of signing and ask whether the IJV achieved them.

Over 90% of ventures in China under the age of 15 are still operating today. Remarkably, nearly 70% of ventures over 25 years old are still legally operating. It is worth noting, though, that some of this high survival rate could be attributable to the legal difficulty of winding down a company in the country.

IJVs make up a substantial proportion of foreign investment in China. Since 2010, roughly 40% of foreign-funded capital into China has come via JVs. IJVs also allow the foreign partner to make use of the local know-how, and get access to the capital, business relationships and talent of its local Chinese counterpart.

According to Deloitte, Chinese-based IJVs will continue to be attractive to Western companies after Covid-19. American and European firms will seek to leverage the relatively high growth rates possible in the Chinese market. Firms investing in China can take advantage of the increasingly skilled and sizeable workforce and its comprehensive supply chains.

Much of the success of an IJV in China hinges on finding the right partner from the beginning. Western companies seeking to undertake joint ventures in China need to consider the idiosyncrasies of the Chinese market and take the time to understand the market and business culture. Above all, firms need to take the time to assess if their potential partner has an alignment of goals, has the necessary business capability, and is trustworthy.

Get immediate access to the China market with Launchpad, CBBC’s flagship market entry service. Call +44 (0)20 7802 2000 or email enquiries@cbbc.org now to find out more.

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In January, China’s State Council, chaired by Premier Li Keqiang, announced support for the country’s main job creators, micro- and small-sized enterprises (MSEs), in the form of tax cuts to both Value Added Tax (VAT) and Corporate Income Tax (CIT).

MSEs are defined as businesses with less than RMB three million in annual taxable income (revenue minus deductible costs), less than 300 employees, and total assets worth less than RMB 50 million.

The aim of the reform is to lessen the tax burden of China’s micro- and small-sized businesses and promote long term developments in innovation, entrepreneurship and job creation. Amongst the announcements were the following changes:

1. The VAT exemption threshold for small-scale VAT taxpayers increases from RMB 30,000 to RMB 100,000 of monthly revenue.
2. MSEs are to pay an effective CIT rate of 5 percent for taxable income less than RMB 1 million, and 10 percent for taxable income between RMB 1 – 3 million, much lower than the standard CIT rate of 25 percent.

In addition to these policies, China’s State Council released preliminary policy updates on March 5 that it will be further reducing the VAT rates, as well as other tax policies aimed at reducing the tax burden and supporting the long-term development of Chinese businesses. Changes announced include:

1. The VAT rate for manufacturing sectors is reduced from 16 percent to 13 percent.
2. The VAT rate for transportation, construction, real estate and other industries is reduced from 10 percent to 9 percent.
   3. The VAT rate for services remains unchanged at 6 percent. However, more deductions for the bracket will be introduced.
3. Mandatory pension contributions by employers are reduced to 16 percent.

As opposed to announcements made on January 8, which focused on China’s micro- and small-sized businesses, the preliminary policy updates from China’s State Council on March 5 were looked forward to by all businesses. However, there are two sides to every coin. Despite providing significant tax relief worth an estimated RMB 1.3 trillion to businesses in 2018, total tax income still grew by 8.3 percent (RMB 1.2 trillion) outpacing GDP growth. Much of the recent good news for Chinese MSEs is widely believed to be foreshadowing more stringent enforcement of tax and compliance regulations in the coming years. 

Strengthening tax administration

China is transitioning from being a Fapiao driven tax system to an information driven tax system. This information driven tax system relies on big data gathered from multiple administrative authorities to identify inaccurate financial reports and tax shortages. The current support for China’s MSEs is largely about preparing for stronger enforcement of tax compliance and other areas such as social security which is thought to be underpaid by roughly RMB 700 billion annually, according to 51 Social Security. The China State Council is using its current tax reforms to strengthen the MSE sector in order to ensure that they can sustain themselves when they will be required to comply with the full scope of applicable laws.

The current agenda is largely about preparing for stronger enforcement of tax compliance and other areas such as social security, which is thought to be underpaid by roughly RMB 700 billion annually

Monitoring personal bank accounts

The focus of much Chinese tax reform is on the use of personal bank accounts – including WeChat and Alipay – to receive business revenue. This practice allows those involved to maintain two sets of accounting books; one set of ‘external’ books for tax filing and compliance and another, of ‘internal’ books, to assess the business performance.

The Central Bank of China upped the ante for such businesses when they announced they will no longer be exercising control over the opening of new bank accounts but instead will increase the monitoring of both company and personal transactions. Transactions that exceed predetermined amounts and frequency are flagged and reported to the Central Bank of China on the second working day and the selected accounts will be passed to tax authorities or other relevant authorities for further investigation.

 New accountability measures

Another new policy concerning the Information Disclosure of Major Taxes and Untrustworthy Cases shows China’s government’s concentrated effort to build an accountability system for developing a healthy and fair business environment. Tax evasion and dishonest behaviours will result in the company’s credit level downgrading to class “D”. Should this happen, the affected company will not only face many difficulties in their business operations but the grading will also affect the owner and responsible accountant’s personal life. In addition, details of the illegal behaviour and their personal information will be made public on government-run media for three years. Thus, proper financial management and being in compliance have become very important for business owners and accountants.

With more stringent oversight, it’s increasingly common that poor-quality accounting practices will result in financial penalties due to non-compliance. In light of these recent changes in China’s tax regulations, business owners are advised to review their compliance status and correct any issues sooner rather than later. For those businesses who already comply with applicable regulation and pay their taxes, the Chinese State Council has promised support to allow them to prosper under the tax reform agenda. However, any businesses attempting to cheat the tax authorities are likely to face prosecution under China’s information-driven tax system.

Lily Li, FCCA, is managing partner and director of small business finance advisory at Axel Standard. She has an MBA in finance and has served as CFO for multiple MNCs in China. 

For more information about tax issues speak to CBBC’s Avi Nagel on avi.nagel@cbbc.org

The post What does tax reform mean for Chinese micro- and small-sized enterprises? appeared first on Focus - China Britain Business Council.