A Handbook of Taxes in China for Foreigner: Part 1 - Understanding VAT

Asomerit Consulting will introduce a series of blogs for you to understand taxes in China. The first one will focus on Value Added Tax (VAT), the most common tax item in business operation.

Introduction

When doing business in China, taxes are one of the critical aspects you need to consider. For foreign investors planning to establish a Wholly Foreign-Owned Enterprise (WFOE) in China, understanding China's tax environment is crucial for compliance and optimizing financial structure.

In China, businesses typically involve Value Added Tax (VAT), Corporate Income Tax (CIT), and need to withhold Individual Income Tax (IIT) for employees. To help you better understand the tax system in China, Asomerit Consulting will introduce the major taxes in China through a series of blog posts.

In this blog, we will focus on Value Added Tax (VAT), the most common tax item in business operation.

What is VAT?

Value Added Tax (VAT) is a tax levied on the added value of goods or services during their production and circulation. It is taxed on the value added at each stage of production and circulation.

The VAT payer is the buyer of goods or services. For example, when a business sells goods or provides services, it collects VAT from consumers. In contrast, when purchasing goods, the business pays VAT. In the transaction process, the seller collects VAT from the buyer and remits it to the tax authorities.

VAT applies widely to goods sales, services, construction, leasing, imports, and exports. Therefore, understanding VAT is particularly important for foreign businesses, especially when operating in China. Properly handling VAT-related matters is crucial to avoiding tax risks.

Types of VAT Payers: General vs. Small-Scale

There are two types of VAT payers in China: General VAT Payer and Small-Scale VAT Payer. Understanding the differences between these two types is important for foreign businesses to choose the most appropriate tax payer status.

1. Small-Scale VAT Payer

A small-scale VAT payer refers to businesses with a smaller annual sales volume. In general cases, newly established companies are typically registered as small-scale VAT payers. Compared to general VAT payers, small-scale VAT payers have a simpler VAT calculation and reporting process.

• Annual sales requirement: Annual sales must not exceed RMB 5 million. If this threshold is exceeded, the company must switch to general VAT payer status.
• Tax Rate: 3% tax rate applies to small-scale VAT payers.

Advantages of Small-Scale VAT Payer

• Simpler reporting process: Small-scale VAT payers do not need to deal with complex input and output tax deductions, simplifying tax reporting. This means accounting fees for small-scale VAT payers are lower than for general VAT payers.
• Lower tax burden: Since there are no input tax deductions, accounting and tax reporting are simpler, and the tax burden may be lower, especially for businesses with fewer input tax credits, such as service industries.

Tax Calculation Method

The VAT calculation for small-scale VAT payers is based on sales volume, not the difference between input and output taxes. The calculation method is:

• VAT payable = Sales volume × 3%

For example: If Company A (small-scale VAT payer) sells goods for RMB 10,000, the VAT payable is:

• VAT payable = 10,000 × 3% = 300 RMB 

The actual price paid by the buyer = Product price + VAT payable = 10,000 + 300 = 10,300 RMB.

2. General VAT Payer

A general VAT payer refers to businesses with higher annual sales volume. After meeting the required annual sales, businesses are required to register as a general VAT payer. General VAT payers can deduct input tax and are typically suitable for larger businesses requiring bulk procurement, such as manufacturers, large commodity trading companies, and export enterprises.

• Annual sales requirement: Businesses with annual sales exceeding RMB 5 million are required to register as general VAT payers. However, newly established businesses can apply to register as a general VAT payer from the outset.
• Tax Rates: General VAT payers are subject to higher VAT rates, including:
  • 13%: Applies to general goods sales, such as agricultural products and transportation vehicles;
  • 9%: Applies to certain goods and industries, such as energy products and infrastructure;
  • 6%: Applies to service industries, such as technical services and consulting.

Advantages of General VAT Payer

• Input tax deduction: General VAT payers can receive and issue VAT invoices, reducing tax burden through input tax deductions. For example, input VAT paid on raw materials can be deducted from the VAT collected on sales, reducing the overall tax burden.
• More tax incentives: Certain industries (such as high-tech enterprises and export businesses) can enjoy additional tax benefits, such as export VAT refunds.

How to Choose Between Small-Scale VAT Payer and General VAT Payer

In general, if your business mainly involves providing technology, services, consulting, or other similar activities, becoming a small-scale VAT payer will be a better choice. You can benefit from the simple management and lower tax burden associated with small-scale VAT payer status.

However, in the following cases, even for a startup, becoming a general VAT payer may be the better choice:

• Significant input tax (requiring bulk purchases of raw materials, equipment, etc.)
  If your business incurs substantial VAT on purchases of goods or raw materials, registering as a general VAT payer allows you to deduct the VAT paid on these purchases from the VAT collected on sales, greatly reducing your tax burden.
• Import/export business or export VAT refunds
  If your business is involved in international trade, especially exports, registering as a general VAT payer enables you to apply for VAT refunds, which allows you to deduct input VAT and lower your overall tax burden.

Case Study: VAT Taxpayer Selection for an Exporting Enterprise

Company A, which specializes in exporting electronic products, chose to register as a general VAT payer. During procurement, Company A collaborates with another general VAT payer and spends RMB 1 million annually on purchasing electronic components, receiving VAT invoices at a 13% tax rate. After processing, Company A exports the electronic equipment at a price of RMB 2 million.

Procurement Phase

Company A receives a 13% VAT invoice. The non-tax price is:

• Non-tax price = 1,000,000 / (1+13%) = 885,000 RMB

The VAT paid is:

• 1,000,000 - 885,000 = 115,000 RMB

Export Phase

Since exports are not subject to VAT, no output VAT is payable.

Result

Using the VAT formula, we calculate that Company A’s tax payable is:

• Tax payable = Output VAT - Input VAT = 0 - 115,000 = -115,000 RMB

Conclusion

Understanding China’s Value Added Tax (VAT) system is crucial for foreign investors. Depending on your business size and nature, choosing the right VAT payer status can help optimize your financial structure and reduce tax risks. Whether you choose a small-scale VAT payer or a general VAT payer, the key is to make an informed decision based on your specific needs and future growth. Start focusing on VAT now to ensure smooth operations for your business in China! If you have any questions, feel free to contact Asomerit Consulting. We offer professional tax consulting and tailored services to help you easily navigate the tax challenges of the Chinese market!