China has modified its tax laws. As of January 1 1994 China introduced a comprehensive turnover tax system, including a business tax (levied on the income from services) and a value added tax (VAT, levied on the proceeds from sale of products). It provided special incentives for export-oriented enterprises:
- income received from exports of products is not subject to
any export VAT; and
- a refund or credit for input VAT paid when purchasing raw
materials and parts is also given for export products.
However, not all the input VAT paid is refundable. Whereas the regular amount of input VAT is 17% with other rates for specific products, the recoverable amount has been changed several times. The difference between 17% and the set percentage is the amount of irrecoverable VAT. So-called Exempt, Set-Off and Refund methods were established to deal with VAT refunds for a specific period. Thereby, two systems were introduced; one for foreign investment enterprises established before 1994 and one for similar enterprises established thereafter.
When VAT was introduced in 1994, the tax rate for export goods was 0%. As a result the full amount of input VAT was recoverable — as long as it was recoverable under general VAT provisions (input VAT paid for the acquisition of fixed assets, for example, is not recoverable). Subsequently, the general rebate rate was reduced from 17% input VAT to 14% and then 9%, thus leaving the exporter with an 8% irrecoverable amount.
Recently China has raised the recoverable input tax rate for selected export products such as machinery, electronics, textiles, raw materials (to 11%), and ships and textile machinery (to 14%). This change was qualified as a form of export subsidy by many in the international financial community though in fact it is less than what was introduced in 1994 when a full refund was still available. In July 1998 the State Taxation Bureau explicitly stated in a notice that if the tax refunds received in connection with exports exceed the legally stipulated amount, the difference must be paid back. This does not mean that VAT liabilities suddenly have been back-dated but that an adjustment must be made. It had been made clear over the years that the full amount of input VAT is not creditable, even though it was not always fully implemented by regional governments. This now leads to significant concerns by foreign investment enterprises which have not been provided with an accurate calculation over the last two years.
With respect to business tax levied on services the Chinese legislator clarified that business tax also is due on income received from royalties under licence arrangement. This was a grey area in the past and foreign enterprises are now faced with a retroactive levying of the business tax dating back as far as January 1 1994 when business tax was introduced. However, one can expect a soothing statement from the central government assuring foreign enterprises that retroactive tax levying will not be implemented.