China’s VAT Law Goes into Effect in 2026: Key Changes and Guidelines for Tax and Accounting Professionals

by Mei Zhang, Yuehan Ren, Tianjun Ma, Guangzi Bi, Xuanye Wang, and Siyuan Qiu

On 25 December 2024, China’s legislature passed the Value-Added Tax Law of the People's Republic of China ("VAT Law"), which will come into effect on 1 January 2026 and replace the Interim Value-Added Tax Regulations of the People's Republic of China ("Interim Regulations"), which have been in force for 31 years. VAT is the largest tax category in China, and the VAT Law marks a new chapter in China’s tax system.

First, some history. In 1994, China established the VAT system based on the Interim Regulations and the Implementing Rules for the Interim Regulations of the People's Republic of China on Value-added Tax ("Implementation Rules"), as well as the Circular on Comprehensively Promoting the Pilot Program of the Collection of Value-added Tax in Lieu of Business Tax (Cai Shui [2016] Circular 36, "Circular 36"). Over the course of more than thirty years, the VAT system has undergone numerous significant reforms and improvements. The recent changes to the VAT system have been in the works since 2019. The State Council is also expected to release implementing regulations (“Implementing Regulations”) as guidance for the VAT Law, though the release date is not set.

In this article, DaHui’s tax team will interpret the main changes in the VAT Law and then examine five key issues to focus on in the implementation of the law.

I. Six Key Changes in the VAT Law, Compared to the Previous System

1. Standardizing the Scope of Taxable Transactions and Removing Taxable Labor Services

The VAT Law standardizes the scope of taxable transactions into four main categories: the sale of goods, services, intangible assets, and real estate.

By standardizing the scope of taxable transactions and removing “labor services,” the VAT Law simplifies the tax categories. At the same time, by unifying labor and services under taxable services, the VAT Law can prevent the common and troublesome issue of businesses mistakenly issuing incorrect fapiao (i.e., Chinese VAT invoices) due to confusion between labor services and other services.

2. Simplifying the Deemed Sales Provisions and Removing the Catch-all Clause

Article 5 of the VAT Law significantly reduces the scope of deemed taxable transactions (i.e., sales), which is now limited to:

a) The use of self-produced or commissioned processed goods by entities and individual businesses for collective welfare or personal consumption;

b) The gratuitous transfer of goods by entities and individual businesses; and

c) The gratuitous transfer of intangible assets, real estate, and financial products by entities and individual businesses.

Compared to the enumerated deemed sales clause in the Implementation Rules and Circular 36, a key change in the VAT Law's Article 5 is that services provided for free by entities or individual businesses to other entities or individual businesses are no longer deemed taxable transactions.

In practice, from the perspective of tax administration, it was difficult for tax authorities to effectively monitor and audit non-taxable free services due to the intangible nature of services, and from the perspective of taxpayers, most services did not have corresponding deductible-input VAT, which often led to a disproportionate VAT burden on taxpayers. The VAT Law can alleviate both these issues by simplifying the scope of deemed taxable transactions and removing the catch-all clause.

3. Adjusting the Scope of Non-Deductible VAT Input Tax and Clarifying the Necessity of Obtaining Deduction Certificates

Article 22 of the VAT Law removes the restriction on “loan services purchased” from the list of non-deductible items in the sixth subparagraph of Article 27 of the Appendix 1 of Circular 36. However, Article 22 retains the catch-all provision in Article 10 of the Interim Regulations, which allows the State Council to specify other input taxes that are non-deductible. Article 16 of the VAT Law stipulates that Taxpayers must deduct the input tax from the output tax using VAT deduction vouchers as prescribed by laws, administrative regulations, or provisions of the State Council.

With the above changes, Article 22 of the VAT Law reduces the scope of non-deductible VAT input tax. If the State Council does not subsequently publish regulations that input tax related to “loan services” is non-deductible, the VAT Law’s implementation will ease the VAT burden on inter-enterprises loan services, which are common in practice. Additionally, Article 16 of the VAT Law clarifies for the first time at the legal level the necessity of obtaining VAT deduction certificates for deductions. However, the VAT Law does not make clear provisions for the specific implementation, and we will still need to wait for the release of relevant regulations.

4.Unifying the Simplified Calculation Method Tax Rate and Clarifying the 3% Tax Rate Tier

Article 11 of the VAT Law stipulates that if the simplified taxation method is used for VAT calculation and payment, VAT will be levied at a rate of 3%. The VAT Law also removes the catch-all clauses from Article 12 of the Interim Regulations and Article 16 of Appendix 1 of Circular 36.

Given that the VAT Law does not provide further provisions on the 5% simplified tax rate for the above items, it remains unclear whether the 5% tax rate will be adjusted to 3% in the future, or whether it will be completely phased out of the existing VAT rate tiers. Further clarification in subsequent regulations will be needed to address this matter and guide implementation.

5. Adding the “Sales Amount Significantly Too High” Clause and Expanding the Tax Authority’s Adjustment Rights

Compared to Article 7 of the Interim Regulations, Articles 19 and 20 of the VAT Law stipulate that in the case of deemed taxable transactions, when the sales amount is in a non-monetary form, taxpayers must determine the sales amount based on the market price. If the sales amount is unreasonably high or low, the tax authority may assess and adjust the sales amount.

This change can prevent taxpayers from obtaining improper tax benefits in related-party transactions by raising or lowering sales amounts, and also helps avoid the potential issue of tax authorities adjusting the sales amount based on unfair values and causing unreasonable tax burdens on taxpayers.

6. Legalizing the Input Tax Credit Refund System and Providing a Clear Legal Basis

Article 21 of the VAT Law stipulates that if the input tax for the current period exceeds the output tax for the current period, taxpayers may, in accordance with State Council regulations, choose to carry forward the excess amount for deduction in the next period or apply for a refund. This is the first time that the input tax credit refund system has been elevated to the legal level, allowing taxpayers to choose between continuing to deduct or applying for a refund according to the State Council’s regulations.

Since 2019, China has gradually established the incremental input VAT credit refund system. The legislation of the refund system in Article 21 has been made statutory, giving taxpayers the option of deducting or applying for refund in the next period, making full use of the incremental tax credit and reducing the burden on taxpayers. At the same time, it can also effectively solve problems that exist in practice, such as companies being unable to apply for refunds for their retained input tax credits (i.e., only being able to transfer them out) due to a variety of complicating factors such as long approval processes.

II. Five Key Issues to Focus on in the Upcoming Implementation Regulations

1. How to Define the “Primary Business” in Mixed Sales Transactions?

Article 13 of the VAT Law follows the general principle of mixed sales transactions being governed by the taxpayer’s primary business, but there is no longer a distinction between entities and individual businesses that sell goods and sell services. If a taxable transaction involves two or more different tax rates or levies, it is considered a mixed sales transaction, and VAT is calculated based on the primary business of the transaction. While the VAT Law does not provide a clear definition of how to determine the “primary business”, the upcoming Implementing Regulations might clarify this issue.

2. Will the Scope of Cross-Border Sales of Services and Intangible Assets Subject to Zero-rated VAT Remain Unchanged?

Article 10 of the VAT Law stipulates that for entities and individuals within China engaging in cross-border sales of services or intangible assets within the scope defined by the State Council, the tax rate will be zero. However, the VAT Law does not provide further clarification on the scope of such sales or assets.

Article 1 of Appendix 4 of Circular 36 stipulates ten categories of services, including international transportation services, space transportation services, and R&D services provided to foreign entities for consumption exclusively outside China, as well as other services specified by the authorities that are subject to the zero-rated VAT. In practice, it is difficult for enterprises to determine whether the services and intangible assets are used exclusively outside China and are unrelated to any goods and real property within the territory covered by Article 7 of Appendix 4 of Circular 36.

3. Will the Scope of Deductible VAT Input Tax Be Expanded, and How to Implement the Deduction by Obtaining the Deduction Certificate?

The VAT Law removes the restriction on deducting the input VAT on interest expenses for purchased loan services but retains a catch-all clause for other circumstances as determined by the State Council. Therefore, it is important to pay close attention to whether the Implementation Regulations include input VAT on loan interest expenses in the list of non-deductible items.

Additionally, the VAT Law, for the first time, explicitly clarifies the need to obtain VAT deduction certificates to claim deductions, thereby improving the VAT credit chain. However, it remains uncertain whether further guidelines will be issued to standardize practical operations.

4. How Will the Process for Applying for a Refund of Input VAT Credit Be Implemented?

The VAT Law explicitly provides taxpayers with the option to either carry forward the unutilized input VAT to the next period for deduction or apply for a refund of the input VAT, which gives taxpayers the flexibility to choose. However, in practice, due to variances in the internal refund approval processes of local tax authorities and the financial situations of different regions, it remains uncertain whether the refund process for input VAT credits will be standardized at the national level or if it will continue to be determined by local tax authorities.

5. What are the Specific Contents of the Special VAT Preferential Policies?

To support micro and small enterprises, support key industries, encourage innovation, entrepreneurship, and employment, the VAT Law reserves policy space for the State Council to formulate special VAT preferential policies in response to the needs of national economic and social development. The VAT Law also mandates that the State Council must assess and adjust these policies as needed. The specific contents of these special VAT preferential policies, including the extent of support, the industries covered, and the applicable conditions, is something worth watching.

Conclusion

The VAT Law is scheduled to be officially implemented on 1 January 2026, which means taxpayers have a little under a year to understand and prepare for the new tax law provisions. This is a major shift in China’s tax system, and over the next year, upcoming legal documents on the VAT Law are expected to gradually clarify or answer questions about specific issues. We recommend that taxpayers continue to pay attention to the latest developments in laws and regulations and develop and implement appropriate response strategies accordingly. DaHui’s tax team will continue to closely watch the latest regulations and supporting documents and share our understandings and interpretations with you.

For the full text of the VAT Law, please refer to: http://www.npc.gov.cn/npc/c2/c30834/202412/t20241225_442038.html