Draft VAT Implementation Regulations released

• The draft Value-Added Tax (VAT) Law Implementation Regulations, released for public comment on 11 August 2025, propose operational details for the China VAT Law taking effect on 1 January 2026.
• Significant proposed changes include restrictions on input VAT credits for long-term assets (including fixed assets, intangible assets and real estate) exceeding RMB5m and non-VAT transactions, as well as mandatory annual reconciliation requirements.
• The draft regulations propose new rules for cross-border transactions, clarifying when services are considered consumed in China, and introduce general anti-avoidance provisions to target arrangements lacking a reasonable commercial purpose.
• Affected entities should review the draft regulations and prepare for compliance by assessing their VAT practices, particularly regarding input VAT credits and the treatment of mixed-use assets.

On 11 August 2025, China's Ministry of Finance and the State Administration of Taxation jointly released the draft Value-Added Tax (VAT) Law Implementation Regulations (draft regulations), providing key operational details for the VAT Law coming into effect on 1 January 2026. Below are the key proposed changes relevant to foreign-invested enterprises and foreign companies operating in China.

Cross-border transactions and the place-of-consumption principle

The draft regulations clarify when services and intangibles are considered "consumed in China," a critical factor in determining VAT liability. Some key clarifications pertain to:

• Services consumed domestically:
  • Services sold by overseas entities/individuals to domestic entities/individuals, except those consumed on-the-spot overseas
  • Services directly related to domestic goods, real estate or natural resources
• Zero-rated cross-border services:
  • Existing categories, such as research and development services, software services and international transport remain zero-rated
  • Requirement for transferred technology to be "completely consumed overseas" to qualify for zero-rating
  • No definition provided for "completely consumed overseas," leaving room for future clarification

These changes aim to align China's VAT framework more closely with international practices, while highlighting the need for robust documentation to prove overseas consumption. Until further guidance is issued, companies may need to rely on existing practices and documentation standards.

Input tax credits for loan services are not recoverable

The VAT Law does not explicitly set out rules on whether the input tax credits on loan services is recoverable. In this regard, Article 20 of the draft regulation proposes the following provision: "Where a taxpayer purchases loan services, as well as investment and financing advisory fees, handling charges, consultancy fees, and other expenses paid to the lender that are directly related to such loan, the corresponding input VAT shall not be credited against output VAT."

This provision further clarifies that the scope of non-recoverable input VAT explicitly includes investment and financing advisory fees, handling charges, consultancy fees, and similar costs directly connected with the loan. This formulation is consistent with the existing provisions under Circular 36.

Restrictions on input tax credits for long-term assets

One of the most significant proposed changes is the restriction of input VAT credits for mixed-use long-term assets (i.e., long-term assets used for both general VAT-taxable projects and non-VAT-taxable projects, VAT-exempt projects, etc.).

Under the proposed framework:

• Assets valued at less than five million Renminbi (RMB5m) (approx. €596,776) would continue to enjoy full input VAT credit regardless of mixed usage.
• Assets exceeding RMB5m would enjoy full input VAT credit upon acquisition, but annual adjustments would apply based on actual usage over the asset's depreciation period for non-deductible portions.

This introduces a new "annual usage-based adjustment" requirement for long-term assets exceeding RMB5m, significantly increasing compliance complexity for companies with substantial long-term asset investments. Affected companies would need advanced asset management systems to track usage over extended periods and perform annual reconciliations.

Non-VAT transactions and input VAT credit

Article 22 of the draft regulations proposes that if a taxpayer purchases goods, services, intangible assets or immovable property for use in nontaxable transactions other than those specified in Article 6 of the VAT Law, the corresponding input VAT shall not be credited against output VAT.

Article 6 of the VAT Law clearly defines the following four categories of nontaxable circumstances, without including any catch-all provision:

1. Services that employees provide to their employing entities or employers in return for wages and salaries
2. The collection of administrative charges and government funds
3. Compensation received for expropriation or requisition in accordance with the law
4. Interest income derived from deposits

Compared with the existing VAT regulations, the draft regulations tighten the scope of input VAT credit, which may directly affect enterprises engaged in non-VAT transactions.

Change of responsibility for annual reconciliation of nonrecoverable input VAT under mixed use

Article 23 of the draft regulations sets out the method for calculating non-recoverable input VAT under mixed-use circumstances and requires enterprises to perform an annual reconciliation. Specifically, Article 23 provides that if a general VAT taxpayer purchases goods (excluding fixed assets) or services for projects taxed under the simplified method or VAT-exempt projects, and the non-recoverable input VAT cannot be clearly allocated, the amount of non-recoverable input VAT for the current period shall be calculated according to the following formula:

Non-recoverable input VAT for the current period =Total un-allocable input VAT for the current period × (Sales under the simplified method + Sales of VAT-exempt projects) ÷ Total sales for the current period

Taxpayers must apply this formula on a period-by-period basis and conduct an adjustment based on annual aggregated data during the tax filing period of January of the following year.

Although the formula for calculating non-recoverable input VAT is consistent with the current regulations, there is a notable change in the party responsible for the annual reconciliation. Under the current rules, reconciliation responsibility lies with the tax authority and, in practice, only a limited number of enterprises conduct annual reconciliations on their own.

Under the forthcoming rules, enterprises will bear the responsibility for proactively carrying out the reconciliation in their VAT filings. These enterprises should consider actions such as:

• Establish a VAT reconciliation mechanism and prepare annual working papers for adjusting non-recoverable input VAT.
• Strive to clearly allocate input VAT usage in daily management and establish a full lifecycle management system for cost and expense input VAT — that is, introduce usage confirmation identifiers at the procurement initiation stage, and ensure consistent usage confirmation practices at the booking and input VAT credit stages to help prevent large adjustments during the reconciliation stage.
• For input VAT that genuinely cannot be allocated (e.g., rent, office supplies), maintain proper management and statistical tracking to ensure consistency between tax reconciliation filings and financial accounting treatment.

Mixed sales

The VAT Law describes the taxation of "mixed sales" as follows: "Where a taxpayer carries out a taxable transaction involving two or more tax rates or collection rates, the tax rate or collection rate applicable to the principal business of the taxable transaction shall apply."

Article 10 of the draft regulations further proposes that a taxable transaction applying the tax rate or collection rate of the principal business must simultaneously meet the following conditions:

1. A single taxable transaction includes two or more business activities subject to different tax rates or collection rates.
2. The activities have a clear principal-ancillary relationship. The principal business occupies a dominant position and reflects the substance and purpose of the transaction; the ancillary business is a necessary supplement to the principal business and arises only on the premise that the principal business occurs.

The provisions clarify the principles for determining what constitutes "a single taxable transaction." In practice, tax authorities and taxpayers will need to engage in substantive discussions on the commercial reality of transactions to avoid confusion.

Deemed taxable transactions

The scope of deemed taxable transactions would be narrowed. Several scenarios currently treated as deemed taxable — such as inter-branch transfers and services provided without consideration — would no longer be included. However, transactions lacking a reasonable commercial purpose could still be scrutinized under the proposed general anti-avoidance provisions.

Tax incentive policy changes

The draft regulations propose several adjustments to existing VAT exemption provisions. Notably, beauty and cosmetic medical institutions would be excluded from the VAT exemption for medical services.

General anti-avoidance provisions

For the first time, general anti-avoidance rules are proposed at the VAT level. These would target arrangements lacking a "reasonable commercial purpose" that reduce or exempt VAT obligations or increase/accelerate tax refunds. This would give tax authorities broader discretion to challenge aggressive tax planning and raise the bar for corporate tax compliance, requiring demonstrable business substance beyond tax benefits.

Implications

The draft regulations are open for public comment until 10 September 2025. Affected entities should contact their tax advisors with questions about these proposed changes and assistance in evaluating their potential impact on operations, in addition to watching for further developments as more guidance becomes available.