VAT Deduction Chain Further Optimized (Economic Focus)

(Original Title: Nearly 3 Months Since the Implementation of the VAT Law — Optimization of the VAT Deduction Chain (Economic Focus))

As China’s largest tax, VAT nearly covers all sectors of economic activity, having a broad impact on society and the economy. Since January 1st, the People’s Republic of China VAT Law has officially come into effect. The legalization of input VAT refunds, expanded scope of input deductions, and streamlined scope of deemed sales… After nearly 3 months of implementation, what changes have occurred in the tax rate structure and deduction chain? Which industries are benefiting? Our reporter conducted interviews.

— Editor

What Impact Does the Change in Tax Rate Structure Have?

Ensuring Smooth Policy Transition and More Stable Business Expectations

When it comes to VAT, many people first ask, “What is the tax rate?”

Currently, the VAT Law specifies three rates: 6%, 9%, and 13%, unchanged from before. It also stipulates a simplified tax calculation method with a levy rate of 3%.

The coexistence of VAT rates and levy rates is a system design balancing tax fairness, administrative efficiency, and industry support, mainly to accommodate different taxpayers’ accounting abilities and to moderately reduce compliance costs. For example, small-scale taxpayers often lack sufficient financial personnel and have weaker accounting capabilities. Using the levy rate and simplified calculation method, which do not require detailed input tax calculations, significantly reduces compliance costs for micro and small enterprises.

The VAT Law maintains the current framework and tax burden levels but also makes some adjustments to further improve the modern VAT system. Some recent reform achievements are now codified into law.

For instance, the VAT Law explicitly clarifies that VAT is an outside-the-price tax, requiring VAT amounts to be separately listed on transaction documents, which helps regulate market transactions; it confirms that electronic invoices have the same legal effect as paper invoices, promoting “digital tax management” and aligning with economic structural transformation.

“With the VAT Law, policies are clearer and more unified, and our business development expectations are more stable,” said Jiang Ermei, CFO of Chongqing Yuda Water Services Co., Ltd. Previously, transitional policies exempted VAT on collection compensation payments. Now, legally, collection compensation income obtained lawfully is considered VAT-exempt income, meaning the over 71 million yuan in compensation the company’s water plant relocation will receive can be separately accounted for without VAT, aligning with VAT law requirements. This will make the construction of new water plants and asset resets smoother.

How to Achieve a “Link-by-Link Deduction”?

Further Improving the VAT Deduction Chain to Enhance Certainty and Operability

Deduction rules are core to the VAT system. Through systematic design, further refining the deduction chain can effectively prevent double taxation and promote fair market competition.

“Generally, we subtract input VAT from output VAT to determine the taxable amount. If the balance is positive, tax is payable; if negative, it becomes a deductible input VAT credit, which can be applied for refund or carried forward to the next period. This deduction rule reflects the fundamental feature of the VAT ‘link-by-link’ deduction,” said Li Xuhong, Vice President of the National Accounting Institute in Beijing.

“This VAT Law states that taxpayers can choose to carry forward deductible input VAT to the next period or apply for a refund, explicitly confirming taxpayers’ right to VAT refunds. This enhances the system’s stability and authority and provides legal basis for supporting policies,” Li Xuhong added.

Notably, there are significant changes in input VAT deduction rules. For example, input VAT on purchases of catering services, daily consumer services, and entertainment services has shifted from non-deductible to deductible when directly used for consumption.

“In the past, businesses could not deduct input VAT on purchases of catering, daily services, or entertainment. Now, if a travel agency, as a general taxpayer, arranges catering for clients as part of its business activities rather than direct consumption, the corresponding input VAT can be deducted. This benefits the cultural and tourism industry by reducing tax costs for outsourced services,” said a representative from Huzhou Yixing Travel Service Co., Ltd.

The implementing regulations also adjust and improve the deduction rules for long-term assets with mixed uses. “The policy balances flexibility and regulation, encouraging investment while achieving tax fairness through subsequent adjustments. It helps companies plan long-term asset allocation more reasonably and supports sustainable development,” said Sun Jing, CFO of Jilin Siping Thermal Power Co., Ltd. For individual long-term assets with original value under 5 million yuan used for mixed purposes, full deduction is allowed, reducing operational and financial costs and accelerating equipment upgrades and technological innovation. For assets exceeding 5 million yuan, input VAT deduction is adjusted annually based on usage, making the deduction chain more complete.

Which Industries Will Benefit?

Aligning with New Changes to Provide Clear Legal Basis for Business Operations

Tax incentives are a key concern for many.

The VAT Law specifies certain VAT-exempt items, such as medical services provided by healthcare institutions; old books; personal sales of used items; imported instruments and equipment directly used for scientific research, experiments, and teaching; nursery, kindergarten, elderly care, and disability service providers; marriage agencies; funeral services; educational services provided by schools; and services related to student work-study programs.

“Exemptions are mainly designed to encourage the development of small and micro enterprises, small-scale taxpayers, and individual businesses, reducing their tax burden,” said Shi Zhengwen, Director of the Tax Law Research Center at China University of Political Science and Law.

Some previously exempt items have changed. For example, profit-making beauty medical institutions can no longer enjoy VAT exemption as medical services. “Many beauty salons are high-end consumption rather than general medical care. Increasing their tax burden is also a way to regulate the economy and ensure fairness,” Shi Zhengwen explained.

Someone asked, “I recently opened an online store. Are there any points I should pay attention to?”

A policy officer from the Wuxing District Tax Bureau of Huzhou State Taxation Bureau said that the VAT Law clarifies and improves the definition of small-scale taxpayers, especially making the rules for natural persons and non-enterprise entities clearer, reducing misjudgment and forced registration risks.

Specifically, the law states that small-scale taxpayers are those with annual VAT sales not exceeding 5 million yuan. “Annual VAT sales” refers to the total VAT payable within a continuous period of up to 12 months or four quarters, including occasional sales of intangible assets or transfer of real estate, but excluding sales outside the scope of regular business.

“Note that while the standards for distinguishing between general and small-scale taxpayers haven’t changed, the timing has,” Li Xuhong explained. The relevant regulation states that starting from 2026, if a taxpayer’s annual VAT sales exceed the threshold, the taxpayer becomes a general taxpayer from the first day of the period when the threshold is exceeded, but not earlier than January 1, 2026. If prior sales are adjusted due to risk control or audits, those sales are included in the relevant period. Once the total exceeds the threshold, the taxpayer must retroactively register as a general taxpayer, but this cannot be earlier than January 1, 2026.