As of the end of 2024, China elevated 14 out of 18 tax categories from administrative regulations to formal laws, marking a milestone in aligning domestic practices with international standards. Central to this transformation is the Value-Added Tax (VAT) Law, which represents China's largest tax category and reflects years of legislative refinement to meet evolving economic, cultural and technological needs.
The new VAT Law, effective from 1 January 2026, consolidates decades of VAT practice into a streamlined framework of 38 articles in six chapters, covering critical areas such as tax rates, taxable amounts, collection methods and preferential policies.
This article analyses the main updates to the VAT Law and their effects on foreign invested enterprises (FIEs), assisting senior executives, accounting and tax professionals in examining their businesses' internal processes and adapting tax planning, daily workflows, and operational risk management.
1. Certainty in VAT rates: stability amid transition
The new VAT Law retains the three-tier tax rates, i.e. 13%, 9%, and 6% while simplifying collection methods for specific sectors. Notably, transactions previously taxed at 5%, such as labour dispatch services, HR outsourcing, real estate sales, property leasing, and land-use rights transfers, may now fall under a unified 3% simplified rate, a key change in the updated VAT framework.
This adjustment reduces tax burdens for taxpayers in particular industries. Foreign businesses in real estate, logistics, or outsourcing are suggested to prioritise rate reclassification assessments to optimise cash flow and mitigate risks of commercial disputes. For example, companies should review contracts with stakeholders to reallocate potential tax savings, update billing systems to align with revised rate classifications and monitor transitional guidelines for specific sectors.
2. Redefined VAT treatment rules: providing clarity for cross-sector transactions
The new VAT law clarifies definitions of “mixed sales” and “sideline business” to reduce ambiguity for cross-sector transactions. The updated framework shifts focus to the primary business activity driving the transaction to determine the applicable VAT rate.
Under the new China VAT Law:
- Mixed Sales is defined as a single taxable transaction with two or more tax rates. Transactions with multiple tax rates are taxed according to the primary business activity’s applicable rate – a departure from the previous requirement that such sales must combine goods and services within the same transaction.
- Sideline Business is defined as two or more taxable transactions with different tax rates. Entities must still separately account for sales at different rates. Non-compliance triggers the highest rate.
This streamlined approach reduces compliance complexity by aligning taxation with the economic substance of the transaction, enabling businesses to classify their primary activities over rigid goods-versus-service distinctions. Foreign companies with diversified operations – such as retailers engaging in leasing – should strengthen internal accounting systems to ensure accurate activity classification and mitigate overpayment risks.
3. Enhanced flexibility for companies in waiving VAT preferential treatments
Historically, taxpayers are allowed to voluntarily forfeit preferential treatments (e.g. exemptions, reduced rates), but subject to a uniform 36-month lockout period regardless of taxpayer classification (general or small-scale). Article 27 of the new VAT Law retains the 36-month restriction but limits its scope to the specific preferential treatment waived, meaning forfeiting one benefit does not preclude eligibility for other incentives.
The explicit exclusion of small-scale taxpayers underscores the government’s commitment to sustaining support for micro and small enterprises (MSEs), reflecting a policy shift toward tailored, growth-oriented measures for this critical sector. This adjustment aligns with China’s broader objective of institutionalising MSE-friendly frameworks while maintaining fiscal discipline.
4. Narrowed scope of “deemed sales” in new VAT Law: simplifying intra-entity transfers
The new VAT Law removes the prior classification of cross-regional goods transfers between branches or jurisdictions as deemed taxable transactions. Under the new framework, intra-company transfers – such as inventory movements between headquarters and branches – will no longer incur VAT.
This reform particularly benefits foreign enterprises in trading and wholesale business sectors, which frequently redistribute goods across locations. Historically, many businesses deferred output VAT payments on unsold inventory, but the elimination of deemed sales now simplifies compliance by exempting such transfers.
For manufacturers, the change raises considerations around reconciling input VAT credits (claimed at productions sites) with output VAT liabilities (accrued at sales branes). Companies must now reassess VAT carryover processes, transactional records, and alignment with accounting or income tax practices to avoid discrepancies.
Additionally, asset transfers tied to investments, profit distributions, or similar activities are explicitly excluded from deemed sales treatment, as these inherently fall under taxable transactions. However, further clarification around free-of-charge services is expected to be addressed in forthcoming implementing regulations.
5. Potential impact of Input VAT deductibility on loans
Under current regulations, businesses are unable to deduct input VAT credits related to loan services. However, if upcoming implementing rules do not introduce further restrictions, VAT incurred on interest payments from loans or financing activities could become deductible – potentially reducing corporate borrowing cost. This shift would directly impact financial mechanisms, such as group cash pooling, margin trading, bill discounting, sale-leaseback financing, on-lending, and other "principal-guaranteed" financial instruments or asset management plans. While this policy adjustment may stimulate financial market engagement, details – including eligibility criteria and procedural requirements – await formal clarification from authorities.
6. Standardised input VAT credit refunds: balancing efficiency and compliance
The China VAT Law explicitly grants taxpayers including foreign enterprises the right to choose between refunds or carry-forward of excess input VAT credits, aligning with international tax practices. While China has actively promoted input VAT refund policies over the past three years to ease pandemic-related cash flow pressures, implementation remains inconsistent. Tax authorities often impose multi-layered reviews on refund applications, demanding detailed justifications for input VAT sources, which leads to processing delays.
However, fraudulent practices – such as inflating input VAT credits, underreporting output VAT by concealing revenue, fabricating qualifications, and submitting false declarations – highlight the need for stricter oversight. Moving forward, implementing rules are expected to establish unified standards, streamlining procedures, improving compliance, and reducing the risk of abuse.
Conclusion
China’s new VAT Law strikes a balance between continuity and innovation, emphasizing legal clarity, digital governance, and cross-border alignment. Foreign invested companies are recommended to update tax management systems to accommodate redefined categories, revisit contracts and pricing models to reflect rate changes, and engage advisors to navigate transitional uncertainties. By proactively adapting to these shifts, businesses can convert regulatory complexities into competitive strengths, ensuring resilience in China's fast-evolving market landscape.
Next steps
With five dedicated offices in China, Hawksford specialises in providing comprehensive tax and accounting solutions for foreign enterprises in China. We guide you through complex filing requirements, offer tax planning strategies that are tailored to your China business and aligned with your global operations. We also ensure that you fulfil your ongoing corporate tax and accounting obligations accurately and on time. Connect with our China accounting and tax experts for assistance in your Chinese business operations.
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