China’s New VAT Law: A Major Milestone in Tax Reform

On December 25, 2024, China’s National People’s Congress Standing Committee passed a landmark piece of legislation—the Value-Added Tax (VAT) Law. Set to take effect on January 1, 2026, this new law will replace the existing Interim VAT Regulations that have governed China’s tax system for nearly three decades. It marks a significant step toward modernizing China’s tax framework, providing greater clarity and consistency for businesses, and supporting the country’s continued economic transformation.

A Unified Framework for a Modern Tax System

The new VAT Law consolidates a wide range of existing tax rules into a single, comprehensive framework. By doing so, it strengthens the legal foundation of VAT, which remains one of the most important sources of revenue for both central and local governments. Currently, VAT accounts for about 38% of China’s total tax revenue, reflecting its central role in the economy.

With the new law, China’s lawmakers aim to improve the efficiency, fairness, and predictability of the tax system, while providing businesses with clearer guidelines for compliance. In addition, this reform aligns VAT practices with international tax standards, reinforcing China’s global standing in the world economy.

Key Provisions of the New VAT Law

Broadening the Scope of Taxable Transactions

While the scope of taxable activities remains largely unchanged, the new VAT Law refines and clarifies which transactions are subject to tax. VAT will continue to apply to the sale of goods, services, intangible assets, real estate, and imports within China. A notable update, however, is the application of the destination principle to services and intangible assets. Under this principle, VAT will be levied on transactions where consumption occurs within China, regardless of whether the seller is based domestically or abroad. This marks an important step in ensuring that cross-border transactions are taxed in line with international practices.

Exemptions and Non-Taxable Transactions

Certain activities continue to be exempt from VAT under the new law, including:

Wages or salary payments from employer to employee.

Administrative fees and government funds.

Compensation for lawful expropriation.

Interest income from deposits.

Furthermore, the sale of certain financial products remains outside the scope of VAT, providing relief to specific industries such as banking and finance. These exemptions ensure that VAT is applied in a way that minimizes tax burdens on non-commercial transactions and public sector activities.

Tax Rates and Simplified Taxation

The VAT rates under the new law remain in line with existing practice:

13% for general goods and imports.

9% for transportation, utilities, and telecommunications.

6% for certain modern services such as healthcare and education.

Additionally, the law simplifies the taxation of small businesses by introducing a 3% levy rate under the simplified tax regime, down from the previous 5%. This change aims to streamline the compliance process for smaller businesses and reduce their administrative costs.

Refunds for Excess Input VAT

One of the key features of the new VAT Law is the expansion of the input VAT refund mechanism, which was previously piloted in certain regions. Businesses that accumulate more VAT on their purchases than they owe on their sales will be eligible to claim refunds. This provides an important cash flow benefit to companies, particularly those involved in capital-intensive industries. It also ensures that the VAT system remains neutral, avoiding cascading taxes on business operations.

Taxpayer Rights and Administrative Transparency

The new VAT Law strengthens protections for taxpayers by introducing clearer rules around tax filing periods, invoicing, and tax authority obligations. Among the most important changes is the adoption of the Golden Tax Phase IV system, which enhances tax reporting and compliance through advanced digital technologies. This move is expected to increase tax transparency and reduce administrative costs for businesses, while also improving the ability of tax authorities to detect fraud.

Deemed Sales and Special Rules

Under the new VAT Law, certain transactions are treated as “deemed sales,” including:

The use of self-produced goods for non-business purposes.

The transfer of goods, intangible assets, or real estate for free or below market value.

Notably, the law now excludes free services from VAT, addressing a concern that businesses were previously burdened with tax obligations on non-commercial activities. This change will simplify compliance for many organizations.

Mixed Sales Transactions

For businesses engaging in mixed transactions (i.e., providing both taxable and non-taxable goods or services), the new VAT Law establishes clearer guidelines for determining the appropriate VAT rate. The applicable tax rate will be based on the dominant nature of the transaction, helping businesses allocate VAT appropriately and reduce the risk of non-compliance.

Tax Incentives for Targeted Industries

The new law continues to offer VAT exemptions and reduced rates for industries critical to China’s economic development. For example, certain agricultural products, scientific research materials, and public welfare activities are exempt from VAT. In addition, the State Council retains the authority to introduce further exemptions or preferential policies for specific sectors to support economic priorities such as green energy, innovation, and rural development.

The Legislative Context and Future Implications

The passage of the VAT Law marks the culmination of China’s ongoing tax reforms, which began in 1994 with the introduction of VAT as a central element of the tax system. Over the years, the interim regulations were adjusted to accommodate the needs of a growing and increasingly complex economy. The new VAT Law is part of a broader effort to modernize the entire tax system and improve efficiency and transparency in tax administration.

The law also comes as China seeks to enhance its role in the global economy. By aligning its tax system with international standards, China aims to attract foreign investment, ensure fair competition, and streamline the tax reporting processes for multinational corporations operating in the country.

What This Means for Businesses

The new VAT Law will take effect on January 1, 2026, giving businesses time to adjust to the new requirements. Companies are encouraged to:

Review their tax practices: Businesses should assess their current VAT strategies, including pricing structures, invoicing, and record-keeping, to ensure they comply with the new law.

Consult tax professionals: With complex provisions related to exemptions, refunds, and mixed transactions, consulting tax experts will help businesses navigate the intricacies of the new law.

Invest in training and systems: As the VAT Law emphasizes digital reporting, businesses should invest in modern accounting software and ensure their finance teams are adequately trained on the new regulations.

Conclusion

China’s new VAT Law is a significant development in the country’s fiscal policy, offering a clearer, more consistent framework for businesses and improving the overall tax environment. By addressing issues such as cross-border taxation, simplifying compliance for smaller businesses, and enhancing taxpayer protections, the new law provides businesses with the tools to thrive in an increasingly globalized economy. As China continues its economic transformation, the new VAT Law is poised to be an essential part of its long-term strategy for sustainable growth.