By Ryan Yan

The Value-Added Tax Law of the People's Republic of China (hereinafter referred to as the VAT Law) was passed by the 13th Meeting of the Standing Committee of the 14th National People's Congress on December 25, 2024, and will come into effect on January 1, 2026. Although the law consists of only 38 articles, it should not merely be viewed as a direct adoption of core provisions from the Provisional Regulations on VAT and the Implementation Measures for the Pilot Program of the Business Tax-to-VAT Reform (Finance and Tax [2016] No. 36). The VAT Law introduces a fundamentally different legislative philosophy and approach. The underlying logic and shifts in approach will inevitably have a profound impact on future updates and refinements of VAT-related laws.

I. A Pioneering Approach to Element-Based Legislation in the VAT Law

Element-based legislation, which lies between enumerative and generalized legislation, identifies taxable transactions by identifiable and connectable elements extracted from different scenarios. This method runs through almost every part of the VAT Law, avoiding over-reliance on specific transaction scenarios or abstract principles.

1.Spatial Elements

As a core foundational concept of the VAT law, taxable transactions are not identified through an intrinsic definition or a listing method in the legislation. Instead, it is characterized by spatial elements. According to Article 3, Paragraph 1 of the VAT Law,[ Article 3, Paragraph 1 of the Value-Added Tax Law of the People's Republic of China stipulates that “legal entities and individuals (including individual businesses) engaged in the sale of goods, services, intangible assets, and real property (hereinafter referred to as taxable transactions) within the territory of the People's Republic of China, as well as those importing goods, shall be taxpayers of value-added tax and shall pay value-added tax in accordance with the provisions of this law”.] taxable transactions are initially distinguished by geographic factors, such as domestic versus import transactions. These spatial elements then link four types of items: goods, services, intangible assets, and real estate, thus identifying taxable objects. Within domestic transactions, additional spatial identification factors are applied, including place of departure, place of destination, place of issuance, consumption place, and residence.Through the connection of the elements mentioned above, the content and boundaries of taxable transactions are clearly .

Article 3, Paragraph 1 of the Value-Added Tax Law of the People's Republic of China stipulates that “legal entities and individuals (including individual businesses) engaged in the sale of goods, services, intangible assets, and real property (hereinafter referred to as taxable transactions) within the territory of the People's Republic of China, as well as those importing goods, shall be taxpayers of value-added tax and shall pay value-added tax in accordance with the provisions of this law”.

Article 4 of the Value-Added Tax Law of the People's Republic of China stipulates that taxable transactions occurring within China refer to the following circumstances:

(1)Sales of goods: The place of departure or the location of the goods is within China;

(2) Sales or lease of immovable property, or transfer of natural resource usage rights: The location of the immovable property or natural resources is within China;

(3) Sales of financial products: The financial products are issued within China, or the seller is a legal entity or individual within China;

(4)Sales of services or intangible assets: The services or intangible assets are consumed within China, or the seller is a legal entity or individual within China.

presented. 

However, listing and summarizing methods are not completely excluded in the VAT Law. For example, in the case of "deemed taxable transactions," the VAT law lists specific scenarios such as "collective welfare" and "personal consumption."Similarly, for mixed or combined business situations, the VAT Law follows previous legislative practices by using general expressions.  

Although listing and summarizing methods are used in the VAT Law, it still differs from other tax laws in legislation. In recent tax legislation trends, the general approach is to first define principles, then norms, and finally provide a list.[ Article 8 of the Corporate Income Tax Law of the People's Republic of China (2018 Amendment): "The actual expenses incurred by an enterprise that are reasonable and related to the income earned, including costs, expenses, taxes, losses, and other expenditures, are allowed to be deducted when calculating the taxable income."] The principle-based provisions are located at the foundational or core concept level, and the structure expands sequentially from top to bottom. In contrast, the new VAT law places the element-based norms at the core, taking a central approach that connects the preceding and extends to the following.

"Connecting the preceding" refers to linking the established and definitive principled clauses or general norms, such as the legislation practices for mixed and combined business situations mentioned previously. "Extending to the following" reflects a cautious approach, where issues that are not yet mature or are more forward-looking or exploratory are left intentionally undefined or left blank. For example, regarding the clause on "deemed taxable transactions," except for financial goods, it almost entirely avoids discussing service categories. This not only reflects a limitation of authority but also demonstrates a cautious attitude.

2.Monetary Elements

Monetary elements distinguish between taxable and non-taxable transactions based on compensation and non-compensation, as well as the amount of transaction value. Article 3, Article 5 and Article 6 of the VAT Law outline how paid transactions are used to identify taxable transactions, while certain unpaid transactions correspond to Article 5 of the Value-Added Tax Law of the People's Republic of China states that "Any of the following circumstances shall be deemed as taxable transactions and shall be subject to value-added tax (VAT) in accordance with the provisions of this Law:

(1)Legal entities and sole proprietorship use self-produced or entrusted processed goods for collective welfare or personal consumption;

(2)Legal entities and sole proprietorship transfer goods without charge;

(3)Legal entities and individuals transfer intangible assets, real estate, or financial products without charge."

Value-Added Tax Law of the People's Republic of China, Article 12: “If a taxpayer engages in more than one taxable transaction involving different tax rates or levy rates, the sales amount for each transaction should be separately accounted for according to the applicable tax rate or levy rate. If not separately accounted for, the higher tax rate shall apply.” Article 13: “If a taxpayer engages in a single taxable transaction involving two or more tax rates or levy rates, the tax rate or levy rate applicable to the main business of the taxable transaction shall apply.”

 Article 8 of the Corporate Income Tax Law of the People's Republic of China (2018 Amendment): "The actual expenses incurred by an enterprise that are reasonable and related to the income earned, including costs, expenses, taxes, losses, and other expenditures, are allowed to be deducted when calculating the taxable income."deemed taxable transactions.Article 20 states that for transactions with sales amounts that are significantly low or high without a legitimate reason, the tax authority may assess the sales amount in accordance with the Tax Collection and Administration Law of the People's Republic of China and relevant administrative regulations.

Compared with previous tax law, there is a deliberate avoidance of abstract or theoretical concepts in VAT Law. Identifying taxable transactions based on compensation can also be found in Article 10 of the Implementation Measures for the Pilot Program of Business Tax-to -VAT Reform (Finance and Tax [2016] No. 36), [ Article 10 of the Implementation Measures for the Pilot Program of Business Tax-to-VAT Reform (Finance and Tax [2016] No. 36): "Sales of services, intangible assets, or real estate refer to the provision of services for consideration, or the transfer of intangible assets or real estate for consideration, except in the case of the following non-business activities: ..."]but it is linked directly to business activities, which seems to be influenced by the definition of economic activity in Article 9 of the EU VAT Directive (2006/112/EC).[ Yang Xiaoqiang et al.: "On Business Activities in VAT Legislation," Taxation and Economic Research, 2023, Issue 4 (Total Issue No. 140).] The use of business activities as a criterion inevitably leads to a series of theoretical questions, such as whether there is continuity, whether there is a counterparty, or whether there is profit. In contrast, the business activity criterion is deliberately avoided by the VAT Law. Non-business activities are even listed alongside business activities. For example, in the enumeration of non-taxable items under Article 6 of the VAT Law, non-business activities like "administrative and institutional fees" are listed alongside activities that may involve business, such as "interest income from deposits." 

Similarly, in Article 44 of the Implementation Measures for the Pilot Program of  Article 3, Paragraph 2 of the Value-Added Tax Law of the People's Republic of China stipulates that "sales of goods, services, intangible assets, and real estate" refers to the transfer of ownership of goods or real estate for consideration, the provision of services for consideration, or the transfer of ownership or usage rights of intangible assets for consideration”.

Article 5 of the Value-Added Tax Law of the People's Republic of China states that "Any of the following circumstances shall be deemed as taxable transactions and shall be subject to value-added tax (VAT) in accordance with the provisions of this Law:

(4)Legal entities and sole proprietorship use self-produced or entrusted processed goods for collective welfare or personal consumption;

(5)Legal entities and sole proprietorship transfer goods without charge;

(6)Legal entities and individuals transfer intangible assets, real estate, or financial products without charge."

Article 6 of the Value-Added Tax Law of the People's Republic of China: "Transactions under the following circumstances are not taxable transactions and shall not be subject to value-added tax:

(1)Services provided by employees to their employers or clients in return for wages or salaries;

(2)Collection of administrative fees, public institution charges, and government funds;

(3)Compensation received due to expropriation or requisition in accordance with laws;

(4)Income from deposit interest.

Article 10 of the Implementation Measures for the Pilot Program of Business Tax-to-VAT Reform (Finance and Tax [2016] No. 36): "Sales of services, intangible assets, or real estate refer to the provision of services for consideration, or the transfer of intangible assets or real estate for consideration, except in the case of the following non-business activities: ..."

Yang Xiaoqiang et al.: "On Business Activities in VAT Legislation," Taxation and Economic Research, 2023, Issue 4 (Total Issue No. 140).

Article 6 of the Value-Added Tax Law of the People's Republic of China: "Transactions under the following circumstances are not taxable transactions and shall not be subject to value-added tax:

(1)Services provided by employees to their employers or clients in return for wages or salaries;

(2)Collection of administrative fees, public institution charges, and government funds;

(3)Compensation received due to expropriation or requisition in accordance with laws;

(4)Income from deposit interest.

Business Tax-to-VAT Reform (Finance and Tax [2016] No. 36), although "significantly low or high prices" as a criterion is also raised, it is directly linked to "legitimate commercial purposes," pointing to anti-avoidance measures. The tax authorities are granted the power to determine the sales amount, leaving room for anti-avoidance adjustments. In contrast, in Article 20 of the VAT Law,[ Article 20 of the Value-Added Tax Law of the People's Republic of China: "For transactions with sales amounts that are significantly low or high without a legitimate reason, the tax authority may assess the sales amount in accordance with the Tax Collection and Administration Law of the People's Republic of China and relevant administrative regulations.”] "significantly low or high sales amounts" are linked to "no legitimate reason," which is aligned with Article 35 of the Tax Collection and Administration Law of the People's Republic of China. The expression "no legitimate reason" is more general, leaving room for future legislative adjustments or for the tax authorities' discretion. In addition, the handling method is more lenient, the authorization granted to tax authorities is assessing, instead of determining, the sales amounts, which implies no late fees or tax interest. Therefore, the VAT Law does not contain anti-avoidance provisions.

The deliberate avoidance of qualitative issues and principles reflects a significant shift in legislative thinking: focusing on key elements, giving priority to quantitative elements over qualitative ones, emphasizing on clearly identifiable and measurable factors over abstract or theoretical concepts.

II. Background and Rationale for Element-Based Legislation

The shift towards element-based legislation in the VAT Law addresses the complexity and inefficiencies that have arisen in the tax system. The integration of Western principles, such as the "reasonable commercial purpose" doctrine from common law and the "economic substance" principle from civil law, has resulted in conceptual confusion and inconsistent enforcement, especially as China’s rapid economic development does not always align with these principles. For example, if taxable activities arise from business operations, it leads to questions such as whether investment activities should be considered business activities. If not, it raises the issue of whether financial products constitute investment activities, and so on. If different tax enforcement agencies have varying interpretations, it will directly result in taxpayers being uncertain and unable to comply. The VAT Law seeks to avoid theoretical disputes by grounding its approach in tangible and recognizable elements, which enhances clarity and reduces ambiguity. This practical approach simplifies the tax system, making it more understandable and actionable for businesses and taxpayers.

Value-added tax (VAT) is the most important type of turnover tax. Its key function is to maintain neutrality and indirectness (or transferability), which requires the tax burden to Article 44 of the Measures for the Implementation of the Pilot Program for the Business Tax-to-VAT Reform [C (2016) No. 36]: "If a taxpayer engages in taxable behaviors at prices that are significantly lower or higher than market rates, and the transaction does not have a reasonable business purpose, or if the behaviors listed in Article 14 of these measures occur without sales revenue, the competent tax authority has the right to determine the sales revenue in the following order: …Reasonable business purpose" refers to actions primarily aimed at obtaining tax benefits, including arrangements designed to reduce, exempt, or delay the payment of value-added tax, or to increase the refund of value-added tax.”

Article 20 of the Value-Added Tax Law of the People's Republic of China: "For transactions with sales amounts that are significantly low or high without a legitimate reason, the tax authority may assess the sales amount in accordance with the Tax Collection and Administration Law of the People's Republic of China and relevant administrative regulations.”be effectively and quickly shifted from the resource and product stages to the consumption stage. 

However, the single VAT rate system which commonly used in Western countries encounters significant resistance in China’s specific tax law practices, which reflecting the issue of inefficiencies in tax system. China's national conditions, including its industrial structure and sectoral distribution, which makes it difficult to implement a single tax rate across all industries. Not only does this fail to reconcile with the historical tax system, but it also risks making certain industries unsustainable due to excessive tax burdens. For example, if the banking sector, which previously faced a 5% business tax rate, were to shift to a 17% VAT rate, it would be particularly harmful to banks already struggling with bad debts. Additionally, as a developing country, China places paramount importance on development, which necessitates the preservation of tax incentives. This leads to an excessive number of tax rate levels, akin to a river with numerous dams of varying heights, creating layers of blockages and congestion. This results in the loss of the VAT's intended characteristic of smooth tax shifting.

The root of the issue lies in the previous legislative path, which started by classifying industries and then determining tax rates. This approach has resulted in the failure to eliminate these pain points in the current VAT law. Reflecting on past legislative practices, lawmakers have been prompted to reconsider whether the essence of a turnover tax lies in the flow of capital or in the tax contribution of different industries and transactions. This is why the author argues that measurement factors should outweigh qualitative factors. On the surface, this issue appears to be about whether to prioritize measurement factors or qualitative factors, but fundamentally, it is about whether the development space of market entities or the financial interests of the state should take precedence. The VAT law gives a clear answer, as evidenced by the repeated emphasis on development in Articles 1 and 2 of the VAT Law.

III. Implications of Element-Based Legislation for the Future

Building on the above analysis, the defining characteristic of the VAT Law can be summarized as "quantification first, acceleration of flow." This approach will influence future VAT regulations and their application.

1.VAT Law Principles

The VAT Law prioritizes the flow of funds, aiming to accelerate the transfer of tax burdens and ensuring that taxes move efficiently to the final consumer. This operational focus takes precedence over abstract theoretical debates. For example, the law avoids adopting the "destination principle" or "consumption principle" commonly debated in VAT theory and instead uses spatial elements, such as the place of departure and place of issuance, to determine taxability. Regarding mixed or combined operations, the law does not attempt to distinguish between one or two taxable transactions but rather addresses the issue with somewhat blunt measurement methods, applying tax rates based on the primary business or the higher rate. As for out-of-pocket expenses, the concept is almost entirely ignored, and instead, it is referred to as 'the price related to taxable transactions,' focusing solely on the price rather than its nature.

Measurement standards are precise and easily identifiable, whereas qualitative standards are generalized and vague, which can lead to ambiguity or even disputes, ultimately hindering smooth flow. By prioritizing quantitative criteria, the VAT Law simplifies the tax system, promoting smoother tax burden transfer and ensuring taxes flow efficiently to consumption. Therefore, the absence of principle provisions in the VAT Law should not be viewed as a legislative approach of initial transition followed by improvement, but rather as a deliberate decision to prevent taxpayers from being trapped in a legislative maze. If the legislative approach of the VAT Law can be consistently adhered to, it is foreseeable that future VAT regulations will not include principled provisions but will instead rely on identifiable and operational measurement elements and are more likely to be supplemented by enumerative legislation.

Issues that are temporarily difficult to identify or technically challenging to regulate, such as the issue of providing services without charge, are left blank in the VAT Law, leaving all the space for market participants. Only by doing so can resources flow efficiently and rapidly to the consumption end, thus promoting social development. As society develops, tax sources will be more abundant, compensating for some of the earlier tax losses. In contrast, catch-all provisions are not advisable, as judicial practice should focus more on how to apply the element-based provisions rather than creating principles. If the VAT law is to incorporate principled regulations, such provisions should be introduced only after the country has undergone significant development over a prolonged period and is fully equipped to do so, rather than being a matter to be addressed in the near future. 

2.Implementation Regulations

Unlike previous tax laws, such as the Corporate Income Tax Law or Individual Income Tax Law, and Vehicle and Vessel Tax Law, the VAT Law does not explicitly authorize the State Council to formulate implementation regulations at the end of its provisions. This is particularly significant given that the scope of authorization granted to the State Council is limited to very specific matters, such as deduction items, taxation methods, and agent declaration and payment obligations. Moreover, the VAT Law explicitly refers to the State Council’s regulations on “the method for levying VAT on personal items brought into or mailed into the country” and “the detailed rules for export tax refunds (or exemptions)” as measure. Therefore, the author believes that there will not be an Implementation Regulation of the VAT Law in the future. Furthermore, the VAT Law grants the State Council the authority to define standards for small-scale taxpayers, determine the scope of zero-rate applicability, set thresholds for tax exemption, and create specific preferential policies. These are all closely tied to industrial policies and economic development, which require timely adjustments, making legislative action in the form of implementation regulations unsuitable.

3.Tax Incentives

If all the provisions of value-added tax were limited solely to the VAT Law itself, it would undoubtedly establish a long-term stable market expectation. The elements that hinder the flow of tax burden will be adjusted within the scope of authority granted by the State Council in the future. For instance, it is foreseeable that interest paid by enterprises on loans will inevitably be deductible. If such deductions are not allowed, then, in the case of rediscounting businesses, since the State Taxation Administration would find it difficult to formulate tax incentives for discount-related matters, the lack of tax incentives would lead to the cessation of such businesses.

Tax incentives policy is one of the elements distorting tax neutrality or impacting the speed of tax burden circulation. Even small-scale taxpayers, in essence, are a form of tax incentives. The large-scale issue of issuing false invoices is also closely linked to the excessive number of tax incentives. In response, the current VAT law addresses this issue. 

Looking ahead, the author believes that some tax incentives will likely be eliminated, while others, in line with social development, will be introduced but strictly within the scope defined by the current VAT Law. However, since tax incentives are issued by the State Council, their legislative scope and speed will lag behind those of the State Taxation Administration, it is unlikely that excessive tax incentive policies will be introduced.

IV. Conclusion

The VAT Law is a tax law with Chinese characteristics. It does not adopt the case law system of common law countries, which has a listing effect, nor does it rely on the so-called legal principles of the civil law system. Instead, it takes a more pragmatic road by summarizing the experience generated by China's practice. The long process of VAT reform and the myriad issues encountered along the way have generated rich practical cases, which provide the foundation for the accuracy of identifiable and measurable elements. Where elements can be identified, there is no need for enumeration; where they can be clearly defined, there is no need to express them through principles. The appropriateness of these elements directly determines the quality of the legislation. 

China’s tax law practice is both developmental and open, and thus, it does not apply rigid principles. While principles contribute to the integrity of a system, enforcing legal uniformity at the expense of vibrant tax law practice would undermine the dynamic nature of the system. This is why the VAT law places particular emphasis on developmental expressions. Over the years, instead of blindly following foreign tax laws, China has actively participated in international rule-making, proposed its own views and adhere to the logic of China’s own approach. It is hoped that this element-based legislative approach will not be limited to VAT alone, but will also expand to other tax laws and even to other legal systems. This would give market participants greater room to operate, which would undoubtedly be beneficial for China’s economic and social development.