China plans to apply its value added tax (VAT) to all industries starting May 1.
The VAT will replace the business tax and apply to the industries that were previously subject to that tax, including the construction, real estate, and finance and consumer services industries. China will be among the first countries in the world to apply the VAT broadly to the financial services industry.
The replacement of the business tax with the VAT will ensure that the indirect tax burdens on all industries in China are reduced, said Premier Li Keqiang in a government work report to the national legislature.
The application of VAT broadly to the financial services industry means that interest on loans made to businesses and consumers will be subject to the tax.
China currently has a turnover tax system consisting of the following three taxes:
- The VAT, applicable to the sale of goods and the provision of repairs, replacement, and processing services;
- The business tax, applicable to the provision of other services and the transfer of intangible assets and immovable property; and
- The consumption tax, applicable to the sale of luxury and environmentally unfriendly goods (for example, cigarettes).
To mitigate the multiple indirect tax issues associated with goods and services, China introduced a pilot program to replace the business tax with the VAT in 2012. From 2012 to the first half of 2015, the measure resulted in tax savings of more than $75 billion, accounting for 0.2% of gross domestic product (GDP) in the period, according to a report from China International Capital Corp. Ltd., a joint venture investment bank.
What the Move Could Mean
The European Union has spent years studying whether the VAT could be applied to financial services and hasn’t been able to implement it. It would not be a surprise to see other countries follow suit if the Chinese do it successfully, according to some observers.
While there will inevitably be some short-term challenges to businesses in getting ready for the transition to the VAT, over time the adoption of a more modern system is expected to benefit the economy as a whole, according to some analysts.