Why’s China’s Tax Law So Complex?

China’s tax system can be bewildering for foreign investors. Despite recent efforts to streamline the tax system, the World Bank ranked China 131 out of 190 jurisdictions for ease of paying taxes in 2017–down from 127 in 2016.

Tax law

China’s low ranking for ease of paying taxes can partially be explained by the fact that it is still a developing country, but that alone does not explain its complexity. While China’s World Bank ranking for paying taxes is higher than other booming Asian economies like India (172) and Vietnam (167), it ranks below other developing Asian countries such as Malaysia (61) and Indonesia (104), and is a far cry from Hong Kong (3).

There are multiple types of fapiao—including electronic ones—and complicated systems for their management, issuance, and verification. With all these considerations, China’s fapiao system invariably causes confusion and accounting issues for foreigners unfamiliar with the concept.

According to the World Bank, it takes 263 hours annually to prepare taxes in China, compared to an average of 198 hours in East Asia and the Pacific and 163.4 hours in the OECD. Post-filing in China is particularly time-consuming, as shown by its 48.6 post-filing index rating (where zero is the least efficient and 100 the most), which also lags behind the regional average (59.6) and OECD average (85.1).

Business Graphic

Transition to VAT
China’s tax system underwent an overhaul with the 1994 Tax System Reform Act, which brought it more in line with China’s market-based reforms, and in 2016 with the business tax (BT) to VAT transition.

The VAT reform, besides aiming to reduce the tax burden of companies in the service sector, sought to streamline China’s tax system by applying VAT to essentially all industries. Although this will simplify China’s tax system in the end, the transition has inevitably introduced some growing pains.

The State Administration of Taxation has recognized this issue, recently cutting the 17 percent VAT bracket to lower the tax burden and simplify the system. However, many businesses remain uncertain about which VAT category applies to their goods and services.

Fapiao
This is a legal receipt that serves as proof of purchase for goods and services, and is unique to China. Businesses in China must purchase fapiao from the government in advance of their sales, meaning that they essentially pay taxes before actually making sales.

There can therefore be an element of guesswork in the process, as businesses might under—or over—estimate the amount of fapiao they need. Increasing one’s fapiao quota can be a costly and time-consuming process.

Individuals must collect fapiao to obtain business expense reimbursements, while businesses need special VAT fapiao to claim tax deductions. Businesses unable to produce a fapiao upon request face legal jeopardy, making it essential for their fapiao systems to be well organized.

There are multiple types of fapiao—including electronic ones—and complicated systems for their management, issuance, and verification. With all these considerations, China’s fapiao system invariably causes confusion and accounting issues for foreigners unfamiliar with the concept.

Chinese GAAP and CIT regulations
Chinese Generally Accepted Accounting Principles (GAAP), also known as Chinese Accounting Standards (CAS), are increasingly in line with US GAAP and International Financial Reporting Standards (IFRS), but not completely.

For example, Chinese GAAP prescribes that sales revenue and cost of sales should be recognized when the risks and rewards associated with the product have been transferred to the buyer. In practice, however, accountants prioritize issuing or receiving special VAT fapiao as the basis for deciding when to record a transaction, as this offers more practical resource to determine when a transaction has been completed. Such practices, however, do not technically follow Chinese GAAP and can cause issues in fapiao management.

Transfer pricing
Reforms to China’s transfer pricing regime in 2016 have increased reporting requirements, making transfer pricing a more important—and more time consuming—tax consideration for businesses in China. China supports the international Base Erosion and Profit Shifting (BEPS) Action Plan, which aims to curb tax avoidance.

The new transfer pricing regulations increase the number of related-party filing forms from nine to 22, requiring far more information about entities on both sides of a given transaction than before in both English and Chinese. Further, all entities must prepare their contemporaneous documentation in Chinese before May 31 of the following year and be prepared to submit them to authorities within 20 days of a request. Enterprises that display certain risk characteristics may be subject to an investigation by China’s special BEPS task force.

Transfer pricing is an issue of particular note for foreign businesses in China, as they often transfer money across related parties and branches in other jurisdictions. Beyond simply complying with transfer pricing regulations, businesses must walk the line between strategic tax optimization and illegal tax avoidance.

Ensuring compliance in a complex environment

Besides the challenges noted above, other requirements—such as strict foreign exchange controls—can complicate accounting and audits in China. While China’s tax regime can be complicated, and sometimes inefficient, recent reforms should streamline the system in the long term.

Category Business