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  • Service: Tax, Global Indirect Tax
  • Type: Business and industry issue
  • Date: 2/25/2013

China - VAT reforms in the construction and real estate sectors 

China - VAT reforms
With the first stage of the VAT pilot program for the modern services and transportation sectors now implemented in many major commercial centers across China, attention is turning to those industries which have not yet transitioned from Business Tax (BT) to VAT.

VAT reforms to new industries in 2013 is widely known to occur. Construction and the real estate sectors are likely the next to transition. Accordingly, in Circular Caishui [2011] 110, the Chinese government announced that construction services would be subject to VAT at a rate of 11 percent. However, no announcement has been made regarding the intended treatment of real estate transactions.

Looking ahead

It is difficult to predict how VAT may be applied to the construction and real estate sectors in China, especially given the lack of uniformity of VAT policies internationally. China may choose to follow VAT systems in countries like Canada, Australia and New Zealand, which tax the first sale of residential premises or the EU model, which largely exempts residential real estate, or do its own thing. Experience so far suggests that whatever system is adopted, it is expected to have unique Chinese characteristics:


  • China currently imposes BT on both sales and leases of new and second-hand properties. Statistics published in The China Tax Yearbook 2011 show that BT revenue collected from construction and real estate combined represents approximately 51 percent of total BT revenue in China.
  • Any policies which result in either the sale or letting of real estate, whether new or second-hand, being exempt from VAT would potentially represent an erosion of the current BT tax base. This may stimulate demand and prices which the Government is currently seeking to contain.
  • Under China's legal system, all land is owned by the State. However, the State grants land use rights for fixed terms, ranging between 40 years and 70 years. Such land use rights may be transferred, leased or mortgaged.

While very little detail has been released, there are several possible ways in which the Government may treat construction and real estate under VAT. See table below.


Current position under BT Possible treatment under VAT
Initial grant of land use rights
As the grant is from the Government

As the grant is from the Government
Construction services
3 percent x (gross revenue less subcontractors costs)

11 percent VAT
First sale from developer to the public
5 percent x gross revenue
?
Uncertain but likely to be subject to VAT
Second-hand sales by public
5 percent x (sale price less purchase price)
?
Uncertain – China could be the first OECD country to impose VAT on resales

The inter-relationship between the construction and real estate sectors is fundamental to determining the impact of the VAT reforms. In transitioning to VAT, policy makers will need to consider:


  • The threshold for general VAT taxpayer status – this is currently RMB5 million (approx. USD800,000) under the VAT pilot program. Whether this threshold will apply to real estate remains to be seen.
  • Transitional rules regarding the treatment of existing or partially competed developments. Tax authorities in China may look to Australia's margin scheme, given the similarities it bears to how resales are currently taxed in China under BT.
  • Most countries only apply VAT to the real estate activities of businesses or entrepreneurs. No similar limitation currently applies in China. Potentially, the tax base could therefore be much wider.

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Lachlan Wolfers

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Global Indirect Tax Brief: February 2013

GITB: February 2013
Updates on key tax issues and challenges in indirect tax being faced by taxpayers in countries around the world.