China implements tax measures to stimulate economy and facilitate FDI

In response to the slowdown, the Chinese government has already introduced a string of stimulatory tax-cut measures, such as corporate income tax (CIT) reductions for small enterprises. During the 'two-sessions meeting' of China's Parliament in March, China unveiled further tax cut measures worth RMB 2 trillion ($297 billion) for 2019.

We discuss below the VAT rate reductions and the measures to improve the tax treatment for foreign personnel in China. These constitute parallel efforts to support the economy through stimulating domestic consumption, while also facilitating further inbound enterprise activity.

From April 1 2019, the main VAT rate, which is applied to manufacturing and many other sectors, was reduced from 16% to 13%.

The 10% rate, which applies to transportation, construction, telecoms, and other sectors, has been reduced to 9%. The rate of 6%, which applies to a wide range of services, remains unchanged.

These come on top of recent reductions in the VAT rates, with the standard rate already down from 17%. The middle rate was previously 13% and 11% for different services. It is expected that in 2019 and 2020, the number of VAT rates will be consolidated from three (6%, 9% and 13%) to two.

In a further step, the authorities have moved to better align China VAT rules with OECD principles and best practices, particularly in relation to refunds for excess input VAT credits.

A long-standing challenge with China VAT management has been the inability to claim refunds of excess input VAT credits, except to the extent those exports are zero-rated. Generally, it has only been possible to carry forward excess input VAT credits to offset output VAT in future tax periods.

Careful tax advisory is needed to avoid entities or branches within corporate groups that end up with 'trapped' input credit balances that can never be used. This would mean a real business cost from VAT, which in principle is supposed to be a tax on end consumption, simply collected by businesses.

The situation has also caused considerable cash flow issues for businesses, particularly for innovative start-ups that the government views as the lifeblood of China's new economy.

To address this, a new trial basis VAT refund mechanism has come into effect from April 1 2019. Eligibility criteria for refunds have been detailed to include that a taxpayer must have a high tax credit rating. This is based on a record of good taxpayer compliance behaviour and the existence of a robust tax management system.

This more formalised VAT refund mechanism, which covers all enterprises, builds on a 2018 initiative to provide an one-off refund for excess VAT input credits to certain targeted innovative industries.

In a novel rule which seems to have no international precedent, from April 1 2019 to December 31 2021, a 10% VAT 'super deduction' will be provided for certain industries.

Taxpayers in the postal services, telecommunications services, modern services and lifestyle services industries may be eligible to increase their input VAT credits by a bonus 10%. There are implications on interaction with CIT on which more guidance is expected.

In addition, the Chinese government is also looking to stimulate inbound business activity by improving the tax treatment of foreign personnel in China.

China's revised Individual Income Tax (IIT) Law is effective from January 1 2019. In March 2019, the authorities provided further beneficial guidance on the provisions affecting foreign individuals working in China.

A key provision of the new IIT Law is that foreigners can live long-term in China, but still not suffer Chinese IIT on their foreign-sourced income. This is as long as they can demonstrate a continuous 31-day absence once in a six-year period. This six-year rule has replaced an earlier five-year rule.

However, while in the past, a presence in China for part of a day constituted presence for a whole day in this calculation, it is now required that a full 24 hours is needed. Furthermore, the six-year rule is to start from January 1 2019, meaning this will reset the clock for foreigners who have already run up some years in China.

At the same time, preferential IIT treatment is provided to foreign nationals including persons from Hong Kong SAR, Macau SAR and Taiwan regions, who work in nine cities in the Greater Bay Area (GBA) of South China.

At present, certain cities in Guangdong look to give certain 'foreign talents' subsidies that bring their after-tax income in line with what they would get in Hong Kong (i.e. a 15% IIT outcome). The preferential IIT treatment exempts these subsidies in order to facilitate these after-tax outcomes, and runs from 2019 to 2023 for the cities of Guangzhou, Shenzhen, Zhuhai, Foshan, Huizhou, Dongguan, Zhongshan, Jiangmen and Zhaoqing.

It should be noted that while much recent policy work has focused on tax-cut measures to boost the economy, this by no means implies that China is lessening the rigour of its tax enforcement.

For example, the Customs authorities announced in March measures to ensure that a customs duty is paid on cross-border royalties connected with goods imports. The new reporting requirements on this matter sit alongside the increasing use of big data tax analysis, taxpayer credit rating, exchange of tax information, and other tools to drive high compliance, alongside an optimised tax environment.