China VAT Export Rebate Cuts: Impact on Sourcing&Trade Imbalances

Three types of changes

The specific effects on different types of products are varied¹:

¡P VAT refunds no longer apply to certain products that consume high amounts of energy and resources or cause high levels of pollution in the production process, including 553 types of goods such as cement, chemical products, fertilizers, salt and leather.

¡P VAT refund rates are now lower for certain products that tend to cause trade friction, including 2,268 types of low value-added exports such as toys, steel products, textiles, paper and furniture. The new rate varies, with refunds for some products reduced to as low as 5%.

¡P Only an exemption from VAT on export sales, with no refund of VAT previously paid on inputs, now apply to 10 types of special products, including stamps, peanuts and oil paintings.

Background TO China's Export VAT Refund System

Circular 90's changes can only be understood in the context of China's exisitng VAT procedures for exported products. China has adopted three different types of VAT treatment for exported products:

(1) exemption and refund policy: whereby the export sales are exempted from output VAT and the input VAT of raw materials can be refunded;

(2) exemption only policy: whereby the export sales are exempted from output VAT, but the input VAT is not refundable or the input VAT is also exempted; and

(3) deemed domestic sales: whereby the export sales are treated the same as domestic sales that are subject to an output VAT.

The most common form of exemption and refund policy is the "Exempt, Credit and Refund" (ECR) system that applies to the exportation of most types of products by manufacturers. The ECR method generally entails non-recovery of input VAT, but no output VAT, as summarized below:

¡P Exemption. Export sales are exempt from output VAT.

¡P Credit. Input VAT on raw materials and supplies (used for products for both domestic sales and exportation) can be credited against the output VAT on domestic sales. However, a portion of input VAT is not creditable and, thus, is required to be transferred from input VAT into "inventory" or "cost of sales" from an accounting perspective; such input VAT transferred out will be charged to the Profit and Loss account and, thus, is called "irrecoverable input VAT."

¡P Refund. The excess amount of input VAT over the output VAT will be refunded until a threshold (VAT refundable) is met, and it will then be carried over for future credit or refund.

Irrecoverable input VAT = (export value of finished products