The current difficulties faced in the Chinese VAT system

4.1 From a general perspective

The problems of course, are not limited to the following two aspects I am going to present, but I think the following two are the most urgent ones requiring resolution. The first, as I mentioned previously, is the low grade of legislation. The current main legislation on VAT is the Provisional Regulations, which are administrative regulations formulated by the State Council. And the contents of the Regulations are rather simple, for example, the most important one, “Interim Regulation of the People’s Republic of China on Value Added Tax”, has only 27 articles in total, while numerous detailed rules for its implementation are dispersed in the Provisions or Notifications issued by the Ministry of Finance or the State Administration of Taxation. This situation, from one aspect, is not in accordance with the legality of tax303_{, from the other aspect, it makes the function of the VAT system in practice} rather intricate.

Second, there is the variety of tax rates. The tax rates arrangement in the current VAT system is rather complicated, with five rates for the general VAT taxpayer: 17%, 13%, 11%304_{, 6%}305 _{and zero rate; three rates for small enterprises or specific areas}306_{: 6%,}

303 _{Speaking of this, I have to say, we must have a clear recognition of the stage we are in for the}

current whole taxation system in China. We are still in a period to stress the principle of legal

prescription in taxation field, which means, it has not be achieved yet. And this is an objective fact or a basic background, which could not be ignored during the whole VAT reform. The discussion of my thesis should be also based on such a fundamental fact. For this matter, I will give my own view in Chapter 4.

304 _{The rate of 11% is a newly created tax rate in the ongoing reform, which is only applied to}

transportation.

305 _{The rate of 6% here is also a newly created tax rate in the ongoing reform, which is only applied to}

4%, 3%. Some of the rates have been added in the reform, as previously stated, and this transitional arrangement has resulted in new problems for the VAT system. However, this is a situation that could not be changed immediately, in fact, in the European VAT system, during its process of integration, the unification of VAT rates among the Member States is also an intractable problem. And even today, no satisfactory solution has been found. The reasons behind the difficulty might be very different for China and Europe, for the latter, one typical obstacle is state sovereignty of the Member States. China, although it has no worry about the matter of state sovereignty, has its own conundrums—how to expand the scope of VAT without aggravating the tax burden for the involved taxpayer307_{, and in addition, along with} the sectors newly included in the scope of VAT, the appropriate tax rate arrangement should be re-investigated. Therefore, to change the situation of the rather complicated tax rate arrangement totally demands the investigation of the practical data from the reform.

4.2 Specific problems for VAT deduction

In addition to the universal problems, such as the interruption of the deduction chain of some special mechanisms, here I present two specific problems in the Chinese VAT deduction system.

First, the deduction of input VAT depends too much on the formal requirement—a VAT invoice. For the consideration of the limited number of professional practitioners and the heavy workload of the tax audit, the formal basis for the deductible chain in VAT—VAT invoice—, is the main element or in other words, a decisive factor in the exercise of the right of deduction, which provides much space for tax fraud. Speaking of this, to combat the tax fraud related to the VAT invoice, a crime of “falsely making out special invoices for value-added tax” is regulated in Chinese Criminal Law, and

306 _{Prior to reform, the small enterprises applied 6% or 4% according to the different areas. While, in}

the reform, the previously rates were united by 3%, and the 6% and 4% are applied to the general VAT tax payer in the specific areas which they choose to apply a simple collection method.

307 _{To reduce the tax burden of taxpayers, especially taxpayers in the field of services is a main object}

for the new circle of tax reform, and at the same time, reduction of tax burden is good for the reform per se.

the gravest punishment for the crime could be sentenced to fixed-term imprisonment of not less than 10 years or life imprisonment.

No immediate refund is permitted in case of excess input tax for a certain tax period. The excess input tax can only be carried forward to the subsequent tax periods with no possibility of refund, even under the extreme condition of the termination of a company. This treatment is for the convenience of the tax authority and the interest of the state, while to some extent, it is unfair for the tax payer, especially for some special sectors, the extra amount of input VAT might be a significant share of the enterprise’s cash flow.

Chapter 4 Future direction for Chinese VAT and its deduction—from the