China’s tax reforms move at a slow pace
Print Edition
Coming into the New Year, China has set tax reform targets, among them plans to create a more integrated system for individual income tax and the much-delayed expansion of value-added tax.
For some reasons, tax reforms always seemed complicated and moved at a snail’s pace. Even an initiative can take a decade to materialize.
In 1995, the government proposed setting up a comprehensive individual income tax system that would take into account both individual income and household spending. It has been two decades since then but there are still gray areas that an income tax does not cover, and essential spending is not even given a thought.
Except for basic social security insurance and pension funds, employees will be allowed to pay as much as 200 yuan (US$31) a month pre-tax on designated commercial health insurance this year. For an employee with a monthly pre-tax salary of 10,000 yuan, he can save 20 yuan a month on individual income tax (IIT)!
The tax-deferred pension program that Shanghai first proposed in 2007 is also up in the air.
Last month, Finance Minister Lou Jiwei reiterated his intentions of setting up a comprehensive and classified individual income tax system this year.
Experts believe that something concrete may be on its way.
“At the Fifth Plenary Session of the 18th CPC Central Committee last October, the importance of establishing a comprehensive and classified IIT system was highlighted again. It is believed that IIT reform will be further accelerated and the scope and the standard of IIT deduction might be further relaxed,” said Walter Tong, managing partner of EY tax services in China.
“The IIT reform would further streamline the individual taxpayer’s self-reporting requirements and enhance the withholding and reporting mechanism in light of tax source management requirements.”
Draft policies
Tong said China’s National People’s Congress, the Ministry of Finance, State Administration of Taxation and other related government departments were still working on the reform agenda, but detailed reform steps or schedules have yet to be announced.
The Economic Observer newspaper cited an unidentified source close to the Ministry of Finance as saying that a draft of new individual income tax policies was already ready.
The current individual income tax threshold of 3,500 yuan per month is unlikely to be raised, and the changes will mainly be administrative.
The first step would be to classify income into categories — labor, business and investment — with different layers of taxation for different categories. This involves monitoring individuals’ income from various sources and improvement in tax declaration system.
Since 2007, China has required all individuals with annual income exceeding 120,000 yuan to declare their income tax online. But while the rules are in place, there is no competent monitoring authority.
The second step would offer employees pre-tax deduction for spending and caring for seniors, children’s education and interests on mortgage.
The third step would be household tax declaration, allowing couples to share pre-tax deduction. It would not only improve the tax rate structure but also set reasonable and comprehensive tax rates.
Lou said the state will accelerate setting up individual income and assets information system as the first step, meaning it would be a while before for tax payers see any benefits coming for them.
For companies, talks of value-added tax reforms are always a source of concern.
Since 2012, Shanghai tried to replace business tax with a more transparent and fairer VAT system for the services industries. As per the original plan, all industries were to complete the shift nationwide by the end of last year. But four industries — financial services, real estate, construction, and consumer services, are still out of the loop.
Unlike the business tax, which is applied on a company’s total revenue without considering its costs, the VAT is imposed only on the new value created by a company.
The new VAT plan will allow more services companies to claim “input VAT credits” on operating costs, such as the purchase of machines, fuel and other goods and services that are currently subjected to VAT.
Shifting to VAT could mean different things to different companies, but overall, the country lost 110 billion yuan in tax revenue in the first half of last year, according to the State Administration of Taxation.
Besides the challenges from reduced tax revenue especially during economic slowdown, administration and compliance costs are also factors that slow down reform plans.
The complexity of VAT reform, especially on the real estate industry and financial services with their complicated business models, is the major reason for the slow pace of changes.
“Despite that, the measures are still under review and the further expansion of VAT reform has been confirmed by the State Council,” Tong of EY said. “We have every reason to believe that the central government will implement the plan when both administration and taxpayers are ready.”
He said the VAT reforms may be ready by April 1 this year for real estate, construction, and consumer services industries but the financial services sector may need more time to ensure the readiness of the system.
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