China’s Real Estate Industry May Be Switching to a VAT

According to reports in the official China Securities Post, the Ministry of Finance is heading towards a major change in the way that it taxes the real estate industry, as the country’s government seems determined to reform the way that it derives revenue from the property sector.

The proposed changes involve substituting a VAT regime for the current business tax for real estate enterprises. The VAT approach has already been in place in most other sectors now for a few years, particularly in the country’s first-tier cities.
The proposed VAT rate for the industry would be 11 percent, which would mean the property sector is being taxed at the same rate as the construction industry. Although a Ministry of Finance spokesman clarified that these rates are not yet finalised. Ernst & Young has predicted that the tax would be implemented during the second half of 2015.

Taxing Profits Instead of Revenue

While the new tax regime could potentially have benefits to the real estate sector, thanks to a slightly lower effective tax rate, actual savings could be limited by how the government implements the new scheme.

On the benefit side, the 11 percent VAT, after deductions for inputs is believed to lower the effective tax rate from the current 5 percent of turnover to 3.3 percent, and some observers believe that the land appreciation tax, or LAT (which became a topic of much controversy last year) could be on the way out. However, the potential removal of the LAT is not yet confirmed.

Although the VAT is designed to tax profit, rather than revenue as in the case of the current 5 percent business tax, in a note to clients investment bank JP Morgan speculated that,

similar to LAT, a developer’s total cost is not known until a project is concluded, hence we believe the government would still charge prepayment on VAT, and it would be difficult for them to refund any difference between VAT prepaid and tax due on the final total cost of the project. So the actual benefits to cash flow may be small.”

While the overall benefits or risks of the new approach to taxing the real estate sector have yet to be determined, with the government’s recent moves to implement property registration and push forward with taxes on home ownership, it appears that China’s central authorities have begun to take a much keener interest in the way they collects revenue from the real estate sector.