China | Reform decisions from Third Plenary Session seek to modernize China's tax system

The Third Plenary Session of the 20th Central Committee of the Communist Party of China (CPC), held in Beijing from 15 July to 18 July 2024, reviewed and adopted the "Decision of the CPC Central Committee on Further Comprehensively Deepening Reform and Advancing Chinese-style Modernization" (hereinafter referred to as "the Decision").

The Decision puts forward more than 300 major measures to deepen reforms, with several key tasks clearly outlined for deepening the reform of the fiscal and taxation systems. This Tax Alert highlights some of the important reform trends related to these systems.

Implement taxation by law and standardize incentive policies

The Decision sets out the comprehensive implementation of the principle of taxation by law, standardizing tax incentive policies, and improving support mechanisms in key areas, highlighting the requirements for further improving tax law and optimizing the tax business environment. In recent years, China has actively promoted tax legislation, with 13 types of taxes having completed legislation. The taxes for which legislation has yet to be completed include value-added tax (VAT) and consumption tax, and their legislative process is expected to accelerate. The Decision also mentions improving the real estate tax system, which includes Land Appreciation Tax (LAT), Urban Land Use Tax (ULUT) and Property Tax, indicating that the legislation for related taxes will also steadily advance. In terms of standardizing tax incentive policies, the Decision emphasizes precisely focusing on national strategic areas to enhance the targeting and effectiveness of tax incentives. Tax system reform will further guide resource allocation, encourage innovation and entrepreneurship, create a favorable tax business environment and promote high-quality economic development.

Align with the development of new business forms and deepen tax system reform

The Decision has mentioned support and development for new business forms on multiple occasions, including "researching a tax system suitable for new business forms," "optimizing the market entry environment for new business forms and new fields, and promoting innovation in customs, taxation, foreign exchange, and other regulatory areas to create an institutional environment conducive to the development of new business forms and new models," as well as "innovatively developing digital trade and advancing the construction of comprehensive pilot zones for cross-border e-commerce." This reflects the government's high level of attention and supportive attitude toward the development of new business forms. It is expected that China's tax system can further integrate and consolidate relevant international experiences on the existing basis to play a greater role in better supporting and guiding the development of new business forms, while achieving fair tax burdens for both online and offline businesses.

Deeply integrate digital economy and real economy to cultivate advanced manufacturing industries

The Decision aims to integrate the real and digital economies, accelerate new industrialization, cultivate and strengthen advanced manufacturing clusters, and promote high-end, intelligent and green manufacturing development. It also seeks to establish a mechanism to maintain a reasonable proportion of investment in manufacturing and reduce overall costs and tax burdens.

Fiscal and tax policies supporting the development of the manufacturing industry are expected to be further enhanced to effectively reduce costs for manufacturing enterprises and boost their vitality.

In this context, manufacturers should seize opportunities brought by digitalization and "intelligentization" (i.e., the addition of artificial intelligence to a system) while navigating tax compliance requirements and mitigating potential risks.

Improve the green tax system to support low-carbon development

The Decision further specifies the direction of "improving the green tax system" reform, which includes comprehensively implementing the reform of water resource fee into Resource Tax. This indicates that the next step will be to accelerate the reform of relevant systems to better leverage the regulatory role of taxation in the conservation and intensive use of water resources. The reform also encompasses improving the environmental protection tax, refining the policy systems related to VAT, consumption tax and corporate income tax to promote green development, and advancing green and low-carbon development.

Deepen reform of individual income tax (IIT)

The Decision outlines the following requirements for IIT reform:

• Improve the system that combines comprehensive and categorized IIT

• Implement unified taxation of labor income

• Standardize the tax policies for business income, capital income and property income

• Increase the IIT deductions related to childbirth, child-rearing and education costs

Based on this direction, if the relevant new policies can, to a certain extent, address the issue of tax burden disparities among different types of labor-related income during the withholding process and keep the refund or additional payment amount during the annual IIT reconciliation within a more reasonable range, it will be welcomed by taxpayers.

Additionally, the Decision proposes "standardizing the tax policies for business income, capital income, and property income," which means that further clarification of related regulations and the implementation of detailed collection and management measures will be needed. This includes clarifying the specific definitions and scope of the related incomes, tax calculation methods, collection and management processes and supporting measures.

Reform the consumption tax

The Decision proposes "shifting the collection stage of the consumption tax to a later stage and steadily assigning it to local governments," establishing the direction for consumption tax reform. This involves moving the collection stage to a later point and transitioning the consumption tax from a central tax to a shared/local tax. This is expected to help alleviate local fiscal pressures and further utilize the consumption tax's regulatory function on specific consumption behaviors. However, shifting the collection stage may face challenges, such as a significant increase in the variety and number of taxable items, which are relatively dispersed, potentially complicating tax collection and management.

The phase IV of the Golden Tax Project¹ focuses on smart taxation, driven by tax-related big data, aiming to build a multidimensional, real-time collection, connection, and aggregation of comprehensive data, laying the technical foundation for shifting the consumption tax collection stage. Additionally, shifting the collection stage generally implies an increase in the tax base. Therefore, the industry is also concerned with whether the shift in the collection stage for taxable items will be implemented in batches, whether the tax rates for relevant items will be reduced accordingly, and the extent of such reductions.

Connect the VAT chain and establish a long-term mechanism for input VAT refund

China's VAT system includes a simplified tax calculation method and various preferential policies, such as tax exemptions, immediate collection and refund, and refund upon collection, which may affect the integrity of the VAT chain. The decision to streamline the VAT chain is beneficial for improving the VAT system.

Additionally, since 1 April 2019, China has piloted a VAT incremental input tax refund system for eligible taxpayers, and subsequently extended the refund system to eligible small and micro enterprises and certain industries. The second draft of the VAT law incorporates the achievements of recent VAT refund reforms, allowing the taxpayers to choose to carry forward the excessive input tax credit or apply for a refund. It is anticipated that the VAT law will incorporate the input tax refund system into the legislation, promoting this measure to all industries at an appropriate time.

Deepen the reform of tax collection and administration

The Decision also puts forward the requirement to "deepen the reform of tax collection and administration." Currently, as the draft amendment to the Law on the Administration of Tax Collection has been included in the list of laws to be submitted to the Standing Committee of the National People's Congress for deliberation. The public looks forward to the revision of the Tax Collection and Administration Law which will address new changes and trends in the field of tax administration, clearing obstacles and providing support for deepening tax administration reform at the law level. There is broad expectation that this revision will consider the addition of provisions related to advance rulings, establishing a national framework and basic rules.

The current Tax Collection and Administration Law does not clearly define the authority and boundaries for tax authorities to use information systems in tax administration. This ambiguity in the boundaries of rights and responsibilities may affect the certainty expectations of both tax authorities and taxpayers and is not conducive to the effective protection of taxpayer rights. If this revision can explore the addition of related provisions to legally clarify the scope and boundaries of tax authorities' use of Golden Tax System, it would be more beneficial in balancing tax administration efficiency and taxpayer rights.

Other common expectations regarding this revision include the coordination between the Tax Collection and Administration Law and other laws such as the Criminal Law, and whether it can reflect the principle of protecting taxpayers' legitimate expectations.

Conclusion

In addition, the Decision outlines tax reforms such as simplifying local surcharges and building a common national market. It also reaffirms China's commitment to "opening up," proposing to expand openness in service trade, lowering entry barriers and fostering a fair, competitive market. The Decision aims to encourage foreign investment by expanding the catalog of favored industries and reducing the negative list for market access.

China's recent reforms present significant opportunities for businesses. Companies should proactively adapt to these changes by carefully evaluating the new policies, enhancing their risk management capabilities and strengthening their competitive advantages. Companies doing business in China should consult with their tax advisors to help navigate the new landscape.