Chinese walker

1. Value Added Tax (VAT)
2. General VAT Accounting Treatment
3. Special VAT Accounting Treatment
4. VAT Planning

Value Added Tax (VAT)

Legal authority
Decision of the Standing Committee of the National People’s Congress on the Application of VAT, Consumption Tax, and Business Tax Tentative Regulations to foreign investment enterprises and foreign enterprises passed and announced on 29th December 1993

The PRC VAT Tentative Regulations, promulgated by the State Council on December 13, 1993 effective from January 1, 1994

Detailed Implementation Rules of the PRC VAT Tentative Regulation, issued by the Ministry of Finance on December 25, 1993 effective from January 1, 1994

The PRC VAT Tentative Regulations, promulgated by the State Council on November 10, 2008 effective from January 1, 2009 (Chinese)

Scope of activities subject to VAT: -
Sale of goods within the Mainland China by business units or individuals;

Import of goods into the Mainland China by business units or individuals;

Provision of taxable service relating to processing, repairing and replacement within the Mainland China by business units or individuals.

Parties to the business transactions subject to VAT

Deemed sales
The taxpayer delivers goods to third party for re-sale on its behalf;

The agent who sells goods for its principle receives the goods;

Transfer of goods between head office and branch, or between branches;

Investor contributes self-made goods, or goods processed under contract, or goods purchased as capital injection to a newly incorporated entity;

Distribution of self-made goods to shareholders, or staff as benefits in kind;
Application of self-made goods to non-taxable items;

Donation of self-made goods, or goods subcontracted, or goods purchased to other party.

Exempted taxable activities
Agricultural producer sells own-made produce;

Manufacturers imports goods to be used in the manufacture of export products.

Type of VAT taxpayers
(1)  General taxpayer
General taxpayer, after completing prescribed recognition procedures, can purchase VAT special invoices from the tax bureau and issue them to buyers. Buyers who are also general taxpayers can obtain VAT input credit that is deductible from VAT output taxable amount.

(2)  Small-scale taxpayer.
Small-scale taxpayers are those engaged in production of goods or provision of taxable labor services, and whose annual sale amount subject to VAT is RMB 1 million or less; and the taxpayers engaged in wholesale or retail of goods with an annual taxable sales amount of RMB 1.8 million or less.
Small-scale taxpayers are not entitled to issue VAT special invoices. Instead, they can only use ordinary invoices, also purchased from the tax bureau. Small-scale taxpayers are subject to a lower VAT tax rate at 6%, without the right to deduct input VAT credit from the VAT output taxable amount.

Small-scale taxpayer can apply to be recognized as general taxpayer subject to examination and approval by the supervising national tax bureau at the county level or above.

VAT amount
The VAT amount for domestic sales and purchases of goods and taxable services is as follows: -
VAT amount = VAT taxable amount X 17%, and
VAT taxable amount = VAT output amount – VAT input amount;
Or VAT amount = VAT sales amount X 17% – VAT purchase amount X 17%
Note that only general taxpayers are eligible for VAT input credit (deduction).
The VAT sales amount is computed as below: -
VAT sales amount = sales before adjustment + deemed sales – exempted sales

The VAT amount for the buyer who imports goods is arrived at as per formula below.

VAT amount = (CIF value + import duty + consumption tax) X 17%

Zero-rated VAT and export rebates
Enterprises subject to zero-rated VAT are entitled to export rebate on VAT paid for input materials in the manufacture of export goods. To be eligible for export rebate, the enterprise must satisfy two conditions:

(1) The enterprise must be a general VAT taxpayer and
(2) It must have obtained a VAT rebate certificate granted by the tax bureau.

Use of VAT and ordinary invoices

VAT Special Invoices
The purchase, issue, use and custody of VAT invoices by the taxpayer are subject to stringent regulations under “the PRC Invoices Administration Method” and “the Provisions for the Use of VAT Special Invoices” as promulgated by the State Council. VAT Special Invoices are tax credit certificates. Only registered VAT taxpayer can purchase and issue VAT invoices under prescribed circumstances. Willful violation such as unlawful purchase and sale of VAT Special Invoices will invite administrative or criminal consequences.
VAT tax items and rates

Note:

(1) In order to do business with a buyer who is a general VAT taxpayer, the small-scale taxpayer may request the tax office to issue VAT special invoice on its behalf. The small-scale taxpayer pays the 17% VAT at the tax office.

(2) VAT is only payable at the wholesale chain, between the manufacturer and the wholesaler, or between manufacturers. Retailers selling goods directly to the final consumer are not to issue VAT special invoices. Instead, state ordinary invoices inclusive of taxes at 4% to 6% are used.

General VAT Accounting Treatment

Factory A sells some vehicle tyres to Company B for RMB5,000. Rubber costs RMB4,000 in domestic market. Both selling price and cost are exclusive of VAT. Assuming that VAT rate is 17% and consumption tax (CT) rate is 8%. The accounting treatment is as follows:

Gross Profit = sales – costs – CT
=5,000 – 4,000 – 400
= 600

VAT payable = 850-680
= 170

CT payable = 400

Special VAT Accounting Treatment

Example 1

Accounting for VAT-exempt goods

A food making FIE buys RMB 20,000 agricultural produce from farmers. Agricultural produce is VAT-exempt. The factory is entitled to have a 10% notional input VAT: 20,000 * 10% = 2,000

Example 2

Deemed sale: non-cash capital contribution

Company A transfers raw materials (RM) to Company B at cost as capital contribution. Cost of RM is 2 million. Fair value of the RM for VAT computation is 2.2 million. VAT rate is 17%. What’s accounting treatment for Companies A & B ?

In A’s book

* Adopting fair value to compute VAT.

Example 3

Deemed sale: distribution of own made goods

A shoe-making factory gives a pair of shoes to each of its employee for own use, costing RMB5,000. Selling price is RMB5,500.

* VAT charged to staff benefits is not recorded as input VAT. VAT is computed on selling price.

Example 4

Accounting for purchase of fixed assets

An FIE buys a piece of equipment and pays VAT of RMB510,000. Equipment costs 3 million.

*Fixed assets are non-taxable items.

Example 5

Accounting for purchase of fixed assets

1 year later, the same equipment is sold. Assume that net book value is 2.7 million. What is the VAT treatment if the asset is sold for 2.5 million, or if sold for 3.1 million?

It will attract a 4%* VAT if sold at above original cost. No VAT liability if sold below cost.

*4% is rendered by half.

Example 6

Use of purchased goods for non-taxable item

A company pays RMB1.2 million for some construction raw materials, paying VAT RMB204,000. The RM is first delivered to the warehouse, but later is put to use in the construction of its own warehouse.

Upon receipt

Example 7

Accounting for non-currency transactions

Inventory is exchanged for a piece of equipment. Assuming that both the fair value of the fixed asset and inventory are RMB1 million.

Exchange of inventory for fixed asset

*The book value of the asset given up is adopted as the value of the asset received under the Chinese accounting rules.

VAT Planning

Case 1 – sales promotion

Sales margin for product is 40%, selling price =RMB100, cost is RMB60. Seller, a general VAT taxpayer, is considering following sale promotion options:

(A) Selling product at 30% discount.
(B) Giving goods valued at 30 for free to those buying over 100 (costing18 inclusive of VAT).
(C) Offering 30 cash rebate for those who buy over 100.
Which option is more cost effective to the seller?

A) 30% discount

VAT
VAT payable = 70 / (1 + 17%) x 17% – 60 / (1 + 17%) x 17% = 1.45

Corporate income tax (CIT)
Profit = 70 / (1 + 17%) – 60 / (1 + 17%) = 8.55
CIT = 8.55 x 33% = 2.82 (Yuan)
After-tax profit = 8.55 – 2.82 = 5.73 (Yuan)

B ) gift valued at 30

VAT payable for 100 sales
= 100 / (1 + 17%) x 17% – 60 / (1 + 17%) x 17% = 5.81

Deemed sale for gift:
VAT = 30 / (1 + 17%) x 17% – 18 / (1 + 17%) x 17% = 1.74
Total VAT payable = 5.81 + 1.74 = 7.55

Profit
= 100 / (1 + 17%) – 60 / (1 + 17%) – 18 / (1+17%) – 7.5 (tax on casual income)
= 11.31

Corporate income tax
= (100 / (1 + 17%) – 60 / (1 + 17%))x 33% = 11.28 (Gift and tax paid on behalf not deductible against income)

After-tax profit
= 11.31 – 11.28 = 0.03

C) 30 cash rebate

VAT
VAT payable = 100 / (1 + 17%) x 17% – 60 / (1 + 17%) x 17% = 5.81

Customer is required to pay Individual income tax. Withholding tax is 7.5. 30/(1-20%) x 20% = 7.5.

Corporate income tax
Profit = 100 / (1 + 17%) – 60 / (1 + 17%) – 30 – 7.5 = -3.31
CIT = (100 / (1 + 17%) – 60 / (1 + 17%) ) x 33% = 11.28
After-tax profit (loss) = -3.31 – 11.28 = -14.59

A Comparison of tax effectiveness on sales promotion

Case 2 – Tax planning

Sale company vs. Commission agent

Company A and Company B are under common ownership. A is going to enter a wholesale distribution agreement with B. Option 1: B acts as A’s commission agent. Option 2: B buys from A

Option 1
Product selling price is RMB1,000.
For every item sold, Company B receives a commission of RMB200.

VAT for A: 1000*17%=170, for B (800 – 800)* 17% = 0. (Company B)

Business Tax (BT): B has to pay a BT of RMB10. (10 = 200*5%)

Total taxes = 170 + 10 =180

Option 2
VAT A: 800*17%=136

VAT B: (1,000-800)*17%=34

Total tax = 136 + 34 = 170, with no Business Tax. Saving is RMB10.

A’s saving A = 170-136=34, B’s additional tax payment is 10-34 = -24.