China: Value-added Tax (“VAT”) Taxpayer Status in the PRC - Legal Requirements and Practical Consequences

VAT is a turnover tax levied on all units and individuals engaged in the sale of goods, the provision of processing, repair and replacement services (together referred to as "taxable labour services") and the importation of goods to the PRC.

The standard VAT rate is 17%, and a reduced rate of 13% or even 0% applies to certain items.

PRC regulations categorise taxpayers as general VAT taxpayers and small-scale VAT taxpayers, depending on sales volume and the soundness of their accounting system. General VAT taxpayer status is not granted automatically but subject to the approval of the tax authorities.

General VAT taxpayers with an adequate accounting system are allowed to reduce their VAT burden by crediting input VAT against Output VAT, which is demonstrated by a special VAT invoice.

Small-scale VAT taxpayers are generally entities that have insignificant VAT transactions or are unable to properly account for their input and output VAT due to an inadequate accounting system. They are subject to a simplified VAT calculation method, with a VAT rate of 4% for trading enterprises and 6% for production-oriented and other enterprises. No credit or deduction is allowed for input VAT.

General VAT taxpayers are entitled to use VAT invoices for crediting input VAT against output VAT. The VAT payable by general VAT taxpayers on the sale of goods or supply of taxable labour services is calculated according to the following formula:

Tax Payable = output VAT for the current period – input VAT for the current period

Output VAT = sales revenue (VAT exclusive) * VAT rate

Input VAT = VAT payable on purchase of goods or receipt of taxable labour services

Where the input VAT is higher than the output VAT for any given month, the excess amount can be carried over to the next month and offset against VAT liabilities. There is no time limit for carrying over the excess, and the taxpayer cannot obtain a refund if it remains unused.

According to Article 10 of the PRC VAT Provisional Regulations, effective as of 1 January 1994 ("Provisional VAT Regulations"), input VAT credit cannot be claimed for the following: purchase of fixed assets; activities subject to business tax; tax-exempt items; goods or taxable labour services used for group welfare or personal consumption and abnormal or extraordinary losses

Pursuant to the Circular on the Issues of Deduction of Input VAT Invoices Issued by the VAT Control System Received by General VAT Taxpayers, effective as of 1 March 2003, a general VAT taxpayer will only obtain a credit for input VAT if it applies to the tax authority for certification within 90 days after the VAT Control System issues a special VAT invoice.

The certified VAT invoice must be filed for credit against output VAT during the month it is certified.

The Provisional VAT Regulations require all VAT taxpayers who concurrently engage in (1) provision of non-taxable services (e.g., transportation, finance, insurance, construction, installation, culture and sports, entertainment and other non-taxable services) and (2) the sale of goods and/or the provision of taxable labour services to account for these two categories of activities separately. In such cases the non-taxable services are subject to business tax ("BT"), whereas the sale of goods and the provision of taxable labour services are subject to VAT. Where no accurate separate accounting can be performed, the non-taxable services will be subject to VAT together with the sale of goods and the provision of taxable labour services.

A mixed sales activity refers to a single transaction that involves both the sale of goods (subject to VAT) and the provision of non-taxable labour services (subject to BT).

According to the Provisional VAT Regulations, whether mixed sales activities are subject to VAT or BT depends on the nature of the enterprise:

1. Mixed sales activities conducted by an enterprise or an individual business operator that is principally engaged in the production or sale of goods (wholesale or retail) as its main business are regarded as sales of goods and subject to VAT, and
2. Mixed sales activities conducted by other units or individuals are regarded as sales of non-taxable labour services and subject to BT.

An enterprise will be considered "principally engaged in the production or sale of goods (wholesale or retail) as its main business" if its annual income from sales of goods and taxable labour services exceeds 50% of its total annual sales income.

The law treats an enterprise as a small-scale VAT taxpayer unless it fulfils the criteria for being recognised as a general VAT taxpayer.

In accordance with the Measures for Recognizing the Application of General VAT Taxpayers issued by the State Administration of Taxation and effective as of 15 March 1994 ("General VAT Taxpayer Measures"), general VAT taxpayers refer to enterprises and units with the qualities of an enterprise whose annual sales subject to VAT ("Taxable Sales") exceed the threshold for small-scale taxpayers as stipulated by the Ministry of Finance ("MOF"). Enterprises that have an inadequate accounting system may not be recognised as general VAT taxpayers, even if the Taxable Sales exceed the threshold for small-scale VAT taxpayers.

Pursuant to the Detailed Rules for the Implementation of the Interim Regulations of PRC Value-added Taxes issued by the MOF and effective from 25 December 1993, the following are considered small-scale taxpayers:

1. Taxpayers that are only or mainly engaged in production or provision of taxable labour services and have Taxable Sales of less than RMB 1 million in a calendar year, and
2. Taxpayers that are engaged in wholesale or retail sales and have Taxable Sales of less than RMB 1.8 million in a calendar year.

The tax authorities may, however, recognise as a general VAT taxpayer a small-scale non-commercial or trading enterprise with annual Taxable Sales over RMB 300,000 if it maintains an adequate accounting system and files tax returns as stipulated by law.

Individuals, non-enterprise units and enterprises that are not frequently engaged in taxable activities are treated as small-scale taxpayers, regardless whether their Taxable Sales exceed the threshold for the small-scale taxpayers.

Non-commercial or trading enterprises may be recognised as general VAT taxpayers upon tax registration if their estimated Taxable Sales exceed the threshold for small-scale taxpayers.

1. Administration Rules

Newly established commercial or trading enterprises are subject to different administrative rules for general VAT taxpayer status, depending on the circumstances of such enterprises, as follows:

• Newly established small commercial or trading enterprises are treated as small-scale taxpayers upon tax registration. Such enterprises are entitled to apply for the status of general VAT taxpayers with competent tax authorities starting the month after their Taxable Sales exceed RMB 1.8 million.

• The tax authority provides guidance on the payment of tax for six months after approval of general VAT taxpayer status. At the end of the guidance period, subject to examination and approval by the relevant tax authority, the applicant enterprise is formally recognised as a general VAT taxpayer.

• Newly established retail enterprises with fixed operating premises and physical ownership of goods, or newly established medium and large commercial or trading enterprise with a registered capital of more than RMB 5 million and a staff of more than 50 people, may apply for the general VAT taxpayer status upon tax registration. Such enterprises may be approved as general VAT taxpayers and enter into the guidance period before being formally recognised as general VAT taxpayers.

• Certain qualified enterprises may even be directly recognised as general VAT taxpayers without going through the guidance period.

(2) Limited number of "special VAT invoices"

Documentary requirements for being classified as a general VAT taxpayer vary by location. An application in Chaoyang District, Beijing, for example, requires the following:

1. Application letter to the competent tax authority to obtain the "Application Form for the Approval as General VAT Taxpayer". The application letter should include the establishment date, business scope, business model and business address, status of account setting, a statement that the input VAT, output VAT and tax payable are calculated accurately, the accounting personnel status, a statement that relevant materials and filings can be submitted on time, and other conditions necessary to be presented as required by law;
2. Duplicate original of the tax registration certificate and a copy of the same;
3. Copy of the business licence;
4. Copy of the passport of the legal representative;
5. Copies of the ID cards and qualification certificates of the finance chief and the tax staff;
6. Copies of the Bank Opening Approval Certificate, Bank Account Opening Verification and special transfer credit voucher;
7. Verification of the operation address, tenancy agreement, property ownership certificate of the owner of the leased premises and copy of the rental invoice for the last three months;
8. Copies of the sales contract, articles of association and other agreements in relation to the main business;
9. VAT Anti-counterfeit Tax Control System Application Form; and
10. Other documents required by the responsible tax office.

Article 9 of the General VAT Taxpayer Measures instructs the tax authorities to complete the examination and approval of the general VAT taxpayer application within 30 days after receiving a complete application documents.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.