Paying taxes in China

 This article follows one from January entitled Is Paying Taxes Easy? that introduced the World Bank’s methodology of computing and comparing the paying taxes indicators among 190 economies. In this article, we will look into how China performs in Paying Taxes. 

China is taking actions to optimize its tax environment 

Improving the doing-business environment has been an important initiative in China, evidence for which can be found in the annual Government Work Report, various circulars, and news announcements issued by the central and local governments. For instance, the State Council released the “Regulations on Improving the Doing-business Environment” in October 2019, underscoring the protection of market players, market environment, government services, etc. needed to create a stable, fair, transparent and predictable doing-business environment in China.

As one of the key elements in improving the doing-business environment, optimizing the tax environment is undoubtedly among the top priorities of the nation. Recent efforts are dedicated to three areas, tax reduction and fee cut, upgrading tax legislation from tax regulations, and improving taxpayer services. China’s achievements and plans in these areas as well as other fiscal and tax reforms are reflected in the Paying Taxes indicators (see table below).

Paying Taxes indicators

Total tax and contribution rate: a decreasing trend 

Total tax and contribution rate (TTCR) measures the amount of taxes and mandatory contributions borne by a typical company in the World Bank Group’s Paying Taxes report. The lower the TTCR, the lesser the tax burden.

For China, a developing economy with a population of 1.4 billion, managing its TTCR is a challenging task. It involves not only multiple government organizations (i.e. tax and social securities authorities, at both the central and local levels) but also a careful balance between simplification of tax regimes and the impact on government revenues and expenditures. For the Paying Taxes report, this is more complex due to the World Bank Group’s expansion of its measurements to include two cities (Beijing and Shanghai). As the different social security contribution rates and different treatments of certain taxes between Beijing and Shanghai add to the complications.

Yet, even while facing these challenges, China has come a long way in reducing its TTCR. When comparing Paying Taxes 2006 (which measures 2004) against Paying Taxes 2020 (which measures 2018), there has been a substantial decrease in the TTCR from 82.8 percent to 59.2 percent. Undeniably, the series of tax reforms launched have greatly relieved tax burdens for corporate taxpayers. These include: reducing the statutory corporate income tax (CIT) rate from 33 percent to 25 percent in the 2008 reform; introducing the lower CIT rate for small and thin-profit enterprises from 2018 and further relaxing the threshold in 2019; eliminating double taxation in the turnover tax regime by expanding the scope of input value-added tax (VAT) recovery to capital purchases effective from 2009; and combining business tax and VAT through the “B2V reform” starting in 2012.

These reforms are having a significant impact. In 2018 alone, China cut taxes in the total amount of RMB 1.3 trillion. In 2019, over RMB 2.3 trillion in taxes and fees were further reduced out of the total tax revenue RMB 15.8 trillion. The amount and the speed in implementing tax reduction measures across China is impressive, and has been recognized in the TTCR in recent years’ Paying Taxes reports.

But obviously tax reductions alone cannot bring down China’s TTCR. A major component of the TTCR in China is employers’ contributions to social security and the Housing Provident Fund (around 46.2 percent of the TTCR in Paying Taxes 2020). The government has committed to reduce this part of the labour costs for enterprises of all sizes, especially small- and medium-sized. From 2019, the employer’s pension contribution rate has been standardized at 16 percent of employees’ annual salary, lower than that previously collected by most cities of around 20 percent.

Number of payments

The number of payments is a relatively straight-forward indicator. It reflects the total number of payments made by the case study company in one year. According to the Paying Taxes methodology, joint payments can be counted as one time where two or more taxes and mandatory contributions are filed and paid in the same tax filing form. Electronic filing is also counted as one time in a year for each type of tax. This counting methodology is designed to encourage economies to simplify and digitize tax filings.

In Paying Taxes 2006, with a tax system involving multiple types of direct and indirect taxes, the number of payments for China was 37. With the gradual adoption of online filings and electronic payment methods, China managed to reduce the number of payments to nine since Paying Taxes 2010. This was reduced in Paying Taxes 2019 by one after the completion of the B2V reform in 2016 that abolished business tax. In Paying Taxes 2020, the country-wide successful implementation of online filings has helped China achieve a record low number of seven payments, and the country ranked at 16th among 190 economies for this sub-indicator. 

Time to comply: digitalization has made a big difference ​

Unlike the number of tax payments, time to comply is perhaps more difficult and subjective to measure. It measures the time for the case study company taken to prepare, file and pay three type of taxes, namely CIT, VAT and labour taxes. In Paying Taxes 2020, China’s time to comply was assessed at 138 hours – 94 hours of preparation, 37 hours of filing and seven hours of making payments.

China’s compliance hours has improved drastically through the years. From Paying Taxes 2006 to Paying Taxes 2020, the total hours decreased from 832 to 138, though reducing compliance burden has never been easy. The inherent complexity in the design of the system requires more controls to ensure its effectiveness, for example, the use of VAT paper invoices to curb VAT fraud, corporates’ withholding obligations for individual income tax, social security contributions and the Housing Provident Fund due to the difficulty in collecting them direct from individuals, etc. The wide geographic spread of corporate and individual taxpayers makes it harder to balance the effectiveness of tax enforcement and the burden of compliance. To the Chinese tax authorities, this sub-indicator is perhaps a subtle measurement of their efficiency.

Digitalization, and tax officials’ cultural shift from tax enforcement to taxpayer service, are vital in slashing the compliance hours.

For tax collection and administration via digital means, Chinese tax authorities have done a lot: the Golden Tax III system was launched to connect VAT invoice management and VAT filings; artificial intelligence is increasingly deployed by tax bureaus, including handling tax queries, online tax trainings, etc. Furthermore, automatic data conversion from financial software to the tax filing system has also been introduced to create a “one-click filing” system for taxpayers. Today, almost all tax matters could be handled via online channels, and even on mobile apps. Tax authorities also promote new tax laws and regulations on popular social media, such as WeChat and Weibo, to connect with the younger generations. The use of digital means in disrupting the traditional tax administration has led to a big decrease in China’s tax compliance hours.

On taxpayer service, mindset change also happened from within. Actions including eliminating tax related approvals, encouraging self-assessment in lieu of tax audits, upgrading taxpayer consultation hotlines, and the most recent organizational reform to integrate the state tax authorities and local tax authorities into one, all have helped to promote an image of easy tax-paying.

Post-filing index: input VAT refund is the hope? 

The Post-Filing Index is a supplement to the aforementioned three indicators. Introduced in Paying Taxes 2017, the indicator measures the efficiency of processes that take place after a tax return has been filed when there could be additional interactions between taxpayers and tax authorities to agree on the final tax liabilities. The index seems to encourage economies to improve their post-filing administration processes.

China scored 50 out of 100 in the Post-Filing Index in Paying Taxes 2020, which measured both CIT correction and VAT post-filing refund processes. On the CIT correction indicator – measuring the time required to complete a CIT correction post-filing and the likelihood of triggering a tax audit should the case study company perform a CIT correction – China scored the full 50 marks. With respect to VAT post-filing, Paying Taxes measures two aspects: (1) the availability for the case study company to claim a refund for excessive input VAT credit (VAT refund); and (2) time taken to apply for and obtain the refund. China scored zero.

China used to only allow carry-forward of excessive input VAT credit to the next filing period, and a refund mechanism was not available until 2018 when a pilot refund policy was introduced for 19 sectors. This was rolled out to all industries in early 2019. As this reform came into effect only in August 2018, it was not possible for taxpayers to get a robust understanding of how long the VAT refund processes would take, and as such China scored zero in Paying Taxes 2020.

Beyond Paying Taxes 2020 

The diagram below illustrates the trend of Paying Taxes in China from 2004 to 2018 (calendar year).

China’s overall score in Paying Taxes 2020 was 70.1, which results in its ranking of 105. The government’s commitment to reform its tax system is witnessed in the steady improvement of its overall ranking since Paying Taxes 2008 (ranked 168).

With the expansion of VAT refund policy in 2019 to all industries, we may be expecting a higher score in the Post-Filing Index for Paying Taxes 2021 and beyond. As a matter of fact, according to public sources, in 2019, RMB 9.44 billion of excessive input VAT credit has been refunded to 852 Beijing-based enterprises and RMB 10.7 billion to 1,737 Shanghai-based enterprises.

Starting from Paying Taxes 2021, the World Bank Group has made some changes to the Paying Taxes methodology, which will result in a significant impact on the case study company parameter. More importantly, it may also change the dynamics of the overall rankings, especially for China.

This article was contributed by Rex Chan, Paying Taxes Team Leader at PwC China