Consumption Tax in China

Overview of China's tax structure

Since the economic reforms of 1978, China has undergone significant transformations in its tax system, evolving from a centralized tax structure to a more market-oriented framework. These reforms have played a crucial role in modernizing the country’s fiscal policy, fostering economic growth, and improving tax administration. One of the key developments in this process was the introduction of various forms of indirect taxation, which have become essential components of China's revenue system.

Contributing Advisor

Hannah Feng

Partner

As part of its indirect tax system, China imposes both a value-added tax (VAT) and a consumption tax, with the latter playing a unique role in regulating economic activities and ensuring equitable taxation. Following the full implementation of VAT reform, consumption tax has become one of the two primary indirect taxes in China. Unlike VAT, which is levied broadly on goods and services at different stages of the supply chain, consumption tax specifically targets select products deemed either luxury items or those with potential social or environmental impacts. This tax is applied to individuals and organizations involved in manufacturing, importing, processing, or selling taxable goods.

Consumption tax is a significant source of government revenue, contributing substantially to China’s fiscal budget. In 2015 alone, the tax generated RMB 890.7 billion, reflecting its importance in national economic planning. Beyond revenue generation, it serves as a regulatory tool to influence consumer behavior and industrial development. By imposing higher tax rates on goods such as tobacco, alcohol, and luxury vehicles, the government discourages excessive consumption of certain products while promoting social welfare objectives. Moreover, consumption tax forms part of the base upon which VAT is levied, further integrating it into the broader tax framework.

Originally introduced through the Interim Regulations on Consumption Tax in 1994, the current system has undergone amendments, notably in 2008, to enhance its effectiveness. These regulations, promulgated by the Ministry of Finance (MOF) and the State Administration of Taxation (SAT), ensure a structured approach to taxation, aligning with China's economic policies and global best practices.

Major laws governing taxation in China

What is consumption tax in China?

China's consumption tax (CT) is an indirect levy targeting specific goods and services, designed to both regulate consumption patterns and serve as a revenue source. The governing framework consists of the Interim Regulations on Consumption Tax and its Implementation Guidelines, which underwent updates/promulgation in 2008. The tax applies to five main product categories:

• Items whose excessive consumption negatively impacts health, social order, or environmental conditions, such as tobacco products, alcoholic beverages, and pyrotechnics.
• Premium and discretionary goods, encompassing fine jewelry and cosmetic products.
• Energy-intensive and high-end items, including passenger vehicles and motorcycles.
• Non-renewable and irreplaceable resources.

Who needs to pay consumption tax?

Under China's tax framework, consumption tax obligations apply to several categories of taxpayers who engage with taxable goods at different points in the commercial chain. These taxpayers include:

Manufacturers of taxable products

This category encompasses companies and individuals who produce goods that fall under consumption tax regulations within China. For example, a domestic cigarette factory that manufactures tobacco products would be required to calculate and remit consumption tax based on their production volume or sales value, depending on the specific tax calculation method for tobacco products.

Importers of taxable products

When taxable goods enter China from foreign countries, the entities responsible for importing these items must pay consumption tax. This applies regardless of whether the importer is a trading company, distributor, or the end-user of the products. For instance, a company importing luxury watches would need to declare and pay consumption tax at the customs clearance stage.

Consignment processors of taxable products

This refers to businesses that process raw materials or semi-finished goods owned by other parties into finished taxable products. In these arrangements, even though the processor doesn't own the materials, they are still responsible for the consumption tax liability. For example, if a company provides raw materials to a distillery to produce alcoholic beverages, the distillery (as the processor) would typically bear the consumption tax obligation.

Sellers of taxable products

In certain circumstances, the retail or wholesale seller of taxable goods may become the taxpayer. This usually applies in specific situations where the manufacturing or import stage taxation wasn't applied, or for particular categories of goods where the tax point is set at the sales stage rather than production or import. For instance, retailers of certain luxury goods might need to calculate and remit consumption tax based on their sales revenue.

Key Features of China's Consumption Tax

• Tax rates vary significantly based on the type of goods.
• Higher rates apply to luxury items and products with adverse environmental or social impacts (e.g., premium tobacco, high-end cosmetics, select alcoholic beverages).
• The consumption tax is primarily collected at the manufacturing or importation stage.
• This proactive collection method streamlines administration and minimizes opportunities for tax evasion.
• While the consumption tax generates substantial revenue, its contribution is smaller compared to the dominant Value-Added Tax (VAT) system.
• It serves as a targeted fiscal tool to regulate specific consumption patterns without overshadowing VAT.
• Introduced in 1994 and amended notably in 2008, the system reflects continuous refinements to align with evolving economic and environmental priorities.
• These adjustments ensure that the tax remains an effective instrument for both revenue generation and promoting sustainable consumption practices.

Goods subject to consumption tax

China’s consumption tax specifically targets categories of goods that can have a significant impact on both the economy and society. Luxury items, such as fine jewelry and high-end cosmetics, fall under this category. The higher tax burden on these products serves to temper demand for non-essential luxuries, aligning with broader economic and social objectives.

Moreover, the consumption tax is applied to products with recognized environmental or health impacts. Items like tobacco, alcohol, and gasoline are taxed at elevated rates to discourage overconsumption, reduce pollution, and promote public health. This selective taxing strategy helps guide consumer choices, encouraging a shift towards products and practices that are less harmful to the environment and individual well-being.

How to calculate consumption tax in China?

Consumption tax is calculated using the ad valorem method, the quantity-based method, or the compound tax method, which combines both the ad valorem method and the quantity-based method.

Ad valorem method:

CONSUMPTION TAX PAYABLE = TAXABLE SALES AMOUNT X TAX RATE

Quantity-based method:

CONSUMPTION TAX PAYABLE = TAXABLE SALES QUANTITY X TAX AMOUNT PER UNIT

Compound method:

CONSUMPTION TAX PAYABLE = TAXABLE SALES AMOUNT X TAX RATE + TAXABLE SALES QUANTITY X TAX AMOUNT PER UNIT

Comparison with other indirect taxes

Rebate and incentives

When goods are exported from China, they enjoy special treatment under China's consumption tax system:

• Goods that are exported from China are not subject to consumption tax.
• If goods were first imported into China (where consumption tax was paid), and then later exported, the consumption tax that was originally paid upon import can be refunded.
• When goods qualify for Value-Added Tax (VAT) exemption, they automatically receive consumption tax exemption as well.
• For companies selling goods domestically, it's important to understand that consumption tax previously paid on inputs or materials cannot be refunded or credited against consumption tax due on finished products.

China has developed a sophisticated system of consumption tax incentives that serve multiple policy objectives:

• The tax structure is designed to encourage companies to invest in research and development, particularly in sectors considered strategic for China's economic development.
• The tax system rewards energy-efficient production and products, helping China meet its energy intensity reduction targets.
• Certain industries receive preferential treatment to accelerate their growth and technological advancement.
• Companies producing energy-efficient and environmentally friendly batteries can qualify for consumption tax exemptions.

Administration and compliance

When a company processes taxable goods on behalf of others, it takes on important tax responsibilities within China's taxation framework. The processing company does not just facilitate production - it becomes legally obligated to serve as a tax collection intermediary. This company must withhold the appropriate consumption tax and then remit this amount to the tax authorities.

What's particularly important to understand is that the tax calculation is based specifically on the value of the raw materials used in the processing. This differs from some other tax systems where the final product value might be the basis. The focus on raw material value creates a more predictable tax basis earlier in the production process.

China's tax system offers remarkable flexibility in how often companies can file and pay consumption tax.

• Daily payment: For the most frequent remitters
• Three-day payment: A near-continuous payment cycle
• Five-day payment: Approximately weekly remittance
• Ten-day payment: Roughly three times monthly
• Fifteen-day payment: Bi-monthly remittance
• Monthly payment: Standard monthly accounting cycle
• Quarterly payment: For businesses with lower tax volumes

This graduated system allows the tax collection frequency to be appropriately matched to the scale and nature of different businesses. Think of it as a throttle that can be adjusted based on cash flow, administrative capacity, and tax liability volume.

Payment schedule determination

The tax payment schedule is not arbitrary or entirely at the company's discretion. Instead, the authorized tax authorities evaluate each taxpayer's specific circumstances, with particular attention to their typical tax liability amount.

This assessment considers factors like:

• The volume of taxable processing activity
• The consistency of the company's operations
• The total tax amounts typically generated
• The company's compliance history
• Administrative efficiency for both parties

This personalized approach ensures that high-volume processors with significant tax liabilities remit funds more frequently, while smaller operations face less administrative burden.

Transaction-based alternative

For companies that experience irregular processing schedules or unpredictable business patterns, the standard time-based payment schedules might not be appropriate. China's system accommodates this by offering a transaction-based alternative.

If a taxpayer demonstrates they cannot reasonably comply with a fixed deadline structure, they may request permission to pay consumption tax on a per-transaction basis.