Many readers of my recent blog post entitled “Another change to the VAT system in China. A minor impact for most buyers and a massive impact for some buyers. An abstract topic that none the less is relevant to every buyer of goods from China” asked that I explain some background on the VAT system.
Per request, here is a reprint of a short article I wrote a few years back when working at the sourcing agency I founded (called PassageMaker Sourcing Solutions) which is every bit as relevant today as it was when it first was published. In exchange for me stating
“PassageMaker (www.PSSchina.com) is in a unique position to help client avoid VAT headaches as, according to our knowledge, we were one of the first US-owned Contract Assembly/ Inspection facilities to be granted full import-export rights and authorized to process VAT rebates by the Chinese government in Shenzhen.”
they are letting me publish the article below.
What is VAT and why should I worry about it?
VAT is one of the most confusing and often overlooked issues when purchasing from China.
At the risk of oversimplifying, in theory a 17% tax is paid at each step as the given product flows down the supply chain toward the end users. Take the example of a plastic comb. Raw plastic is purchased for injection molding, then the molded comb is sold to a beauty product distributor who in turn sells to a trading company for eventual export. When the comb is exported, there may be a VAT rebate of 0-17% (depending on the product classification) against the 17% taxes paid. Without going into the complex tax formulas, let’s say the VAT rebate for plastic combs is 10%. So 17-10=7% amount the stays in the government coffers while 10% goes back to the exporting company.
Overlooking the impact of VAT on your sourcing project can lead to major complications:
- If you don’t know the VAT rebate amount, then you don’t really know your vendor’s true pricing. This can complicate negotiations and vendor comparisons. The vendor may be pocketing the VAT rebate without explaining to the buyer. To further complicate the situation, VAT and product classification can be negotiated with the local customs bureau. So basically, a vendor may tell you they are only getting a certain % back, when in reality it may be much more.
- Unlike PassageMaker, many vendor’s lack import-export rights and proper VAT processing facilities. They are forced to use 3rd party trading companies which inflate the price and complicate the relationship.
- If the order is small, vendors may find ways to avoid the VAT issue (can’t get a rebate if it wasn’t paid in the first place!) and offer a “non VAT price”. While a “no tax price” may be attractive at first, things get can get ugly when:
- you buy direct from the factory in China, but find out later you can’t export out of the country because of a lack of tax documentation.
- the volume of business grows to a point that the supplier can’t avoid putting the tax payment on their books. Just when you are expecting a price discount for a large order, out of the blue you get smacked with an increase for a tax that now all of the sudden has to be paid.
Also, if readers are in need of VAT support I have two suggestions.
1. http://psschina.com/about/virtual-tour/auxiliary-services/value-added-tax-planning explains how to outsource the exportation and VAT rebate processing to a 3rd party if you are unsure your current set up is optimized.
2. CSIC sponsor www.Fiducia-China.com are experts at business formation should you desire to set up an entity in China in order to apply for VAT rebate on your own.
Wishing you successful China Sourcing!
Author, “The Essential Reference Guide to China Sourcing” (chinasourcinginfo.org/book/)