Insights for Procure-to-Pay and Finance Leaders

China’s VAT reforms and the rise of e-invoicing

Since as early as 1984, China has been on a steady march to modernize their tax system and business processes. As they continue to modernize, understanding the nuances to compliance in China is key for global enterprises. Their series of tax reforms are fundamental components to understanding their fapiao e-invoicing initiatives. We’re going to dig deeper to make navigating Chinese business compliance simple for multinationals.

What is VAT?

Before we get to China, let’s first make some sense out of Value Added Tax (VAT). If you’re a US citizen, you probably don’t know what the VAT is. But if you buy anything in one of 193 other countries, it’s just part of life. Briefly, for the Americans, the VAT is like a retail sales tax but collected in pieces along the production chain.

For example, imagine going to your grocery store and buying a block of cheese for ten dollars. Along the supply chain, you have a dairy farmer, a cheesemaker, and your grocery store. Let’s imagine the VAT is 10 percent.

  1. The dairy farmer gets the milk and sells it to the cheesemaker for 2 dollars. The VAT is 20 cents. The cheesemaker pays the dairy farmer 2 dollars and 20 cents, and the dairy farmer sends 20 cents in VAT to the government.
  2. The cheesemaker makes the cheese and sells it to your grocery store for 6 dollars. The VAT is 60 cents. Now the supermarket pays the cheesemaker 6 dollars and 60 cents. The cheesemaker sends 40 cents to the government – the cheesemaker pays 60 cents in VAT but gets a 20 cent credit from the government.
  3. The supermarket sells the cheese to you for 10 dollars. You pay $11. The store sends the government 40 cents total – the dollar it collected in VAT on its sales, minus the 60 cents it paid the cheesemaker in VAT, which it gets back in credit. In total, the government gets 20 cents from the dairy farmer, 40 cents from the cheesemaker, and 40 cents from the store. That’s a dollar on the final sale of ten dollars – for a 10 percent VAT. See? You’re still paying 10 percent like you would with a sales tax, but the VAT is harder to evade along the supply chain than a one-time sales tax.

So that’s VAT. It’s a whole production chain tax system designed to be harder to evade and easier to provide a steady revenue stream.

The China transition

Now we can get to China. The Chinese government first began their VAT journey back in 1994, when they started three tax measures: VAT, the business tax (BT), and the consumption Tax (CT).  With these reforms, patterned after the standard European VAT, China’s goal was to “remove tax distortions and provide a stable revenue source.” And while this led to raised revenue and improved economic development, it also led to challenges and complications, including reliance on land financing, redundant tax levies on service sectors, and a patchwork of local tax policies.

That led to China’s 2014 VAT reform. The 2014 reform took multiple VAT rates and simplified them down to one single rate of 3 percent. Next came 2016’s BT-to-VAT reform, which replaced BT taxable services with VAT, opening tax credit up and eliminating a cascading effect of BT. The 2016 reform also introduced e-invoicing to facilitate business payment processes and improve supply chain infrastructure. And most recently, in 2018, the Chinese government implemented three more significant measures to further reform their VAT system.

It’s estimated that these series of reforms have helped the largest Chinese companies reduce their tax burden by RMB 400 Billion ($58 billion) in one year. Furthermore, the simplified system has allowed small and medium-sized enterprises to reduce their accounting, tax filing, and tax burden.

The Fapiao effect

Fapiao is the Chinese invoice system. In the strictest sense of the word, fapiao is both a receipt and a tax invoice. In Chinese government terms, the fapiao invoice system is an integral part of China’s tax law. China updated its system in 2016 aiming to curb tax evasion and abuse by introducing several new fapiao rules.

One of these reforms makes switching to e-invoicing mandatory for several core service-based industries. The goal is to increase fapiao compliance and reduce the cost of invoicing (including printing, transferring, and storing). As more and more industries in China implement e-invoicing either optionally or by mandate, e-invoicing and payments will increase at pace with China’s growth.

Doing business in China? Integrate.

If your enterprise is thinking about operating in China, or already is, consider evaluating your invoicing system to see if you can meet the expectations of China’s VAT regulations. So, check how well your e-invoicing system meets China’s standards, make sure you’re using a government approved tax control company, and take care to integrate your EDI infrastructure.

When you’ve got that foundation set, you’ll find it’s that much simpler to do business in China. Nothing beats the peace of mind of being compliant, except for (maybe) the ability to optimize document processing and ensure transparency in transactions.

Get a roadmap for Chinese compliance in our report on China’s tax reform.