On 19 June 2007, the Ministry of Finance and the State Administration of Taxation jointly issued a circular that may significantly increase the tax burden on many exporters. The circular, issued after consultation with the National Development and Reform Commission, the Ministry of Commerce and the General Administration of Customs, imposes new lower VAT refund rates for a broad range of commodities as from 1 July 2007.
The circular makes clear that the reductions in refund rates, and even the complete elimination of the export VAT refund in some cases, will apply to a broad range of products. In fact, 2,831 specific commodities are covered, which represent 37% of the total harmonized tariff codes, and affect products that are socially or environmentally harmful (e.g. pollution-inducing, high energy or natural resource-consuming), products from low value-added industries (e.g. clothing and shoes) and some strong export products.
The adjustment, which follows previous adjustments in September 2006 and April 2007, reflects the government's continuing use of VAT export refund measures as an important tool in implementing government policies. However, the new circular differs from the earlier adjustments both in the size of the refund rate reductions and in the inclusion of a large number of low value products and controversial goods that tend to cause international trade disputes.
The more moderate rebate policy adjustments in 2006 and earlier this year lowered the VAT export refund rates for certain products and broadened the scope of goods not eligible for the benefits of the "processing trade" arrangement. The principal goal of these adjustments was to restrict the growth of industries that have an adverse effect on the environment. As such, high polluting, high energy and scarce natural resource-consuming goods were primarily affected. It appears, however, that these policy adjustments did not substantially affect China's export growth
The VAT export tax refund has been fully repealed for 553 "high energy consuming, high polluting and scarce resource-consuming" products, as a result of which there will be no refund of VAT paid on inputs (currently eligible for export refund rates between 5% and 13%). For these commodities, it is also expected that output VAT will be required even though the products are exports. Products affected are: leather, chlorine, dyes and other chemical products, certain industrial chemicals (not including refined chemical products), some fertilizers, metal carbide and activated carbon products, certain lumber and one-time-use wooden products, unalloyed aluminium poles and other non-ferrous metal processed goods, segmented ships and non-mechanical boats.
The VAT export refund rate has been reduced for 2,268 commodities likely to trigger trade disputes. These include: some machinery, clothing, shoes and hats, bags/luggage, toys, plastics, rubber and rubber products, certain chemical products, some base metals and their products, bicycles, motorcycles and other auto vehicles, vegetable oils, etc. These products will have their VAT export refund rates reduced by percentages ranging from 2% to 8%.
The VAT export tax refund has been fully repealed for 10 items, but their export sale will still be VAT-exempt. These items include: peanut kernels, oil paintings, engraved plaques, etc.
All of the above changes are effective from 1 July 2007, using the export date listed on the "Customs Declaration Form (Export Rebate Only)" as the date of reference.
No transition rules apply to the changes in the VAT export refund policy, except in the case of contracts covering the export of ships and equipment and building materials involved in long-term construction projects. Where such contracts have been bid on or signed before 1 July 2007 without the possibility of any price adjustments and have been registered with the relevant tax authorities before 20 July 2007, the original VAT export refund rates will apply. In the absence of meeting these requirements, the new lower refund rates will apply.
Effect of the Adjustments
The export refund rate schedule has been altered from the original 17%, 13%, 11%, 8% and 5% to 17%, 13%, 11%, 9% and 5% post-adjustment. In general, these adjustments are extensive in commodity coverage and material in rate reduction, which will increase the tax cost for many exporting enterprises. Considering the extent of some of the decreases in the refund rates (as much as 8%), the profit and loss of some exporters could be devastated.
Further, repealing the export refund means that exports will be treated as domestic sales and output VAT will be imposed. The reduction of refund rates may mean that the maximum additional tax burden could be as high as the difference between the applicable VAT rate and the refund rate applying to the FOB value of the product. This obviously will increase export costs and reduces profit margins. On the other hand, changing the export rebate to an exemption will mean that input VAT on domestic purchases and supplies will not be recoverable, again increasing export costs.
Based on the principles of a circular issued in 2006, it is expected that commodities no longer qualifying for a VAT export refund may be added in the near future to the list of products prohibited from the processing trade procedure. They may also have import tariffs and import link taxes imposed in the process of importation. Accordingly, enterprises engaged in the processing trade for these items may confront a higher tax burden.
Exporters affected by the reduced VAT refund rates and other changes may be able to plan to minimise the detrimental effects of the new policy. Aside from simply raising the prices to foreign customers, the following are possible actions to consider:
- review of tariff codes;
- supply chain efficiency review;
- transfer pricing review;
- function and risk review of China operation;
- use of designated special purpose zones or special purpose vehicles;
- increase of bonded imports;
- vertical integration / segregation, i.e. change in the operations undertaken in China;
Owing to the complexity of the subject, professional advice is strongly recommended when enterprises are conducting such reviews.
In cooperation with our Chinese Deloitte office, we would be pleased to assist you in reviewing your position and in contributing to reducing your potential increased business expenditures. Should you wish to discuss this further, please do not hesitate to contact us.
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.