Value added tax

1. Value Added Tax (VAT)

2. General VAT Accounting Treatment

3. Special VAT Accounting Treatment

4. VAT Planning

 

Value Added Tax (VAT)

Scope of activities subject to VAT: -

1. Sale of goods within the Mainland China by business units or individuals; 
2. Import of goods into the Mainland China by business units or individuals; 
3. 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

Tax item	Person to bear VAT	Person to withhold and pay
Sale of goods	Buyer	Seller
Import of goods	Importer	Customs
Provision of taxable service	Service user	Service provider

Deemed sales

1. The taxpayer delivers goods to third party for re-sale on its behalf;
2. The agent who sells goods for its principle receives the goods;
3. Transfer of goods between head office and branch, or between branches;
4. Investor contributes self-made goods, or goods processed under contract, or goods purchased as capital injection to a newly incorporated entity;
5. Distribution of self-made goods to shareholders, or staff as benefits in kind;
6. Application of self-made goods to non-taxable items;
7. Donation of self-made goods, or goods subcontracted, or goods purchased to other party.

Exempted taxable activities

1. Agricultural producer sells own-made produce;
2. 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.

(a) 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 0.5 million or less; and the taxpayers engaged in wholesale or retail of goods with an annual taxable sales amount of RMB 0.8 million or less.

(b) 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 3%, without the right to deduct input VAT credit from the VAT output taxable amount.

(c) 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 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 full export rebate on VAT paid for input materials in the manufacture of export goods. 

To be eligible for export rebate, the general taxpayer, who should get registered as "foreign trade operator" as per requirement laid down in decree no. 14 [2004] of the Ministry of Commerce, must satisfy following conditions: 

(1) The goods have physically left the country, except for those shipped to export processing zones or entering the bonded logistic parks where customs export declaration (export refund copy) has been issued; 
(2) The nature of the export transaction is treated as sale in the books of accounts for the exporter (as evidenced by bill of lading or airway bills); 
(3) The goods are subject to VAT under the Chinese tax regulations; and 
(4) The exporter provides evidence showing that the foreign exchange verification procedure governing the export collections has been completed. 

Functions of tax invoices

A tax invoice serves 4 functions: 
(i) Recognition of sales; 
(ii) Base of tax computation, i.e. VAT or business tax;; 
(iii) Supporting documents for accounting entries; 
(iv) Being receipt for payments 

Use of VAT and ordinary invoices

	General taxpayer	Small scale taxpayer
VAT special invoices	Yes	No (note 1)
Ordinary invoices	Yes	Yes

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 (for general taxpayer)

	Tax rate	Items	Taxable activities
I.	17%	Goods	Sale of goods, import of goods other than the goods listed in categories II and III below.
II.	13%	Goods	Sale of grains, edible vegetable oil;  Sale of tap water, central heating, air-conditioning, hot water, coal gas, liquid petroleum gas, natural gas methane, and coal for residential use;  Sale of books, newspaper, magazines;  Sale of feed, chemical fertilizer, agrochemicals, agricultural machinery, agricultural film; and  Other goods specified by the State Council.
III.	0%	Goods	Goods exported by taxpayer, except for those as determined by the State Council.
IV.	17%	Taxable labor services	Services provided on processing, repairing, and replacement by taxpayers.

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 VAT at the tax office.

(2) VAT special invoices are only used 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, ordinary tax invoices inclusive of taxes at 3% 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:

DR		Account Receivable	5,850
DR		COS (CT charged to cost)	400
	CR	Sales		5,000
	CR	VAT payable		850
	CR	CT Payable		400

Input VAT: 4,000*17%=680

DR		COS	4,000
DR		VAT payable	680
	CR	Account payable		4,680

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

VAT payable = Output VAT - input VAT
170 = 850-680 [Note: (5,000-4,000) x 17% = 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

DR		Raw materials	18,000
DR		VAT payable (input)	2,000
	CR	Bank		20,000

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

DR		LT investment	2,374,000
	CR	VAT payable*		374,000
	CR	Raw materials		2,000,000

* Adopting fair value to compute VAT.

In B's book

DR		Raw materials	2,000,000
DR		VAT payable (input)	374,000
	CR	Capital		2,374,000

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.

DR		Staff benefits	5,935*
	CR	VAT payable (17%)		935
	CR	Inventory		5,000

* VAT charged to staff benefits is not recorded as input VAT. VAT is computed on selling price (5,500 x 17% = 935).

Example 4

Accounting for purchase of fixed assets

(Before 2009-01-01)
An FIE buys a piece of equipment and paid VAT of RMB510,000. Equipment costs 3 million.

DR		Fixed assets	3,510,000
	CR	Bank		3,510,000

*Fixed assets are non-taxable items, and the VAT of RMB510,000 is charged to costs.

(On or after 2009-01-01)

DR		Fixed assets	3,000,000
DR		VAT payable	510,000
	CR	Bank		3,510,000

*The VAT for purchased asset is deductible against output VAT as input credit.

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?

(Bought before 2009-01-01)
If the fixed asset is bought before 2009-01-01, it will attract a 4%* VAT if sold at above original cost. No VAT liability if it is sold at below cost.
(*) Note that 4% is reduced by half to 2%.

(Bought on or after 2009-01-01)
If the fixed asset is bought after 2009, the FIE that sells the fixed assets is liable to pay VAT at 17%. If sold at 2.5 million, the accounting treatment will be as below:

DR		Bank	2,925,000
	CR	VAT payable		425,000
	CR	Other income		2,500,000

Sale of fixed asset will attract VAT whether it is sold at below or above the original costs.

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 at 17%. The RM is first delivered to the warehouse, but later is put to use in the construction of its own warehouse.

Upon receipt

DR		Raw materials	1,200,000
DR		VAT payable	204,000
	CR	Bank		1,404,000

Upon issue for internal use

DR		Construction project	1,404,000
	CR	VAT payable		204,000
	CR	Raw materials		1,200,000

Note: the reversal of input VAT must be shown separately in compliance with VAT rules. Otherwise, it will result in penalty.

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

DR		Fixed assets	970,000
	CR	Inventory(NBV)		800,000
	CR	VAT payable		170,000

*The book value of the asset given up is adopted as the value of the asset received under the Chinese accounting rules. VAT is calculated as: 170,000 = 1 million x 17%. Note also that exchange of goods will also attract corporate income tax, which will deem the exchange as disposal of inventory at fair value.

 

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?

Option (A) 30% discount

VAT payable = output VAT - input 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 25% = 2.14 [CIT rate is 25% as from 1st Jan 2008] 
After-tax profit = 8.55 - 2.14 = 6.41

Option (B) gift valued at 30 

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

VAT on gifts as deemed sale at 40% margin: 
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 *Customer is required to pay Individual income tax (IIT).
Withholding IIT is 7.5. That is, 30 / (1-20%) x 20% = 7.5.

Corporate income tax (CIT)
= (100 / (1 + 17%) - 60 / (1 + 17%))x 25% = 8.55 (Gift and tax paid on behalf not deductible against income) 

Profit after CIT
= 11.31 - 8.55 = 2.76

Option (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. 
That is, 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 25% = 8.55 
After-tax profit (loss) = -3.31 - 8.55 = -11.86

A Comparison of tax effectiveness on sales promotion is shown below:

	Option A (Discount)	Option B (Gift)	Option C (Cash)
VAT	1.45	7.55	5.81
CIT	2.82	8.55	8.55
Profit before tax	8.55	11.31	-3.31
Profit after tax	5.73	2.76	-11.86

Note that offering discounts is the most tax-efficient among all the available options. Another example will be a choice between "buy-one-get-one-free" and a 50% discount. Buy-one-get-one-free is a quantity discount while a 50% is a price discount. A quantity discount is deemed to be a sale in the same way as gifts, which is not as tax-efficient as that for a price discount.

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 5% 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 is 170-136=34 while B's additional tax payment is 10-34 = -24.

The net saving is 10.