New VAT Method for Ag Processors

China's tax bureau has published draft regulations that award a new tax break to agricultural processors. It raises the rate used to deduct the "purchase VAT" on agricultural raw materials from 13% to 17%, in effect reducing the value added tax paid by agricultural manufacturers. The regulations apply to dairy and edible oil manufacturers as "pilot" industries (implying that the plan is to spread it to all agricultural processing industries).

Like many countries, China has a value-added tax (VAT) which assesses a tax on the amount of value added at each stage in the industry chain. Each manufacturer calculates the difference between the final value of his products and the value of raw materials, and pays 17% of the difference as tax. The calculation is complicated by the taxation of unprocessed agricultural products at a lower rate of 13%.

Under the "old" method, a dairy product manufacturer's VAT is calculated as:
VAT = 17%x(value of dairy products manufactured) - 13%x(value of raw milk used)

So, 1000 yuan in dairy products produced from milk purchased for 500 yuan would be assessed a tax of 170-65=105 yuan.
This assumes that a 13% VAT (65 yuan) was already paid on the raw milk (more on that later).

The new method will be:
VAT = 17%x(value of dairy products manufactured) - 17%x(value of raw milk used)
So the processor deducts a larger amount for the hypothetical tax already paid on raw milk or other raw materials, reducing his/her tax burden. In the example above, the new VAT would be 170-85=85 yuan, reducing the tax by 20 yuan.

Rearranging the equation for the "old" method with a little algebra:
VAT = 17%x(dairy products - raw milk) + (17%-13%)x(raw milk)
Under the old method, the processor pays 17% of the value he/she adds to the raw milk plus an extra 4% (17%-13%) on the value of the raw milk (50 yuan in the above example). In theory, under the old method the processor pays for the lower VAT rate for agricultural producers. The new method shifts the 4% burden to the government.

The official rhetoric says the main purpose of the new regulation is to reduce this excess tax "burden" on agricultural processors, thus encouraging more processing of agricultural products and making processors more competitive.

An article discussing the implications of the new VAT method for edible oil manufacturers shows that it's much more complicated than this.

First of all, little or no VAT is actually paid on domestic agricultural products. Companies, cooperatives, and farmers who sell agricultural products they produced themselves are exempt from VAT. That encompasses nearly all agricultural products. Agricultural processors get to deduct the "purchase VAT" whether even when no VAT was actually paid. They write out their own receipt and deduct the hypothetical VAT.

The article calls the "purchase VAT" a "virtual" deduction since the value of (domestically-produced) raw materials does not in fact include any VAT payments. One industry analyst interviewed for the article calls the VAT deduction a "hidden subsidy" for agricultural processors.

One of the purported reasons for the new method is to reduce "cost pressure" on agricultural processors. However, several Chinese edible oil processors quoted in the article say the new regulation will have little or no effect on them. The chairman of Longjiang Fuliangyou Co in Heilongjiang Province said, "It will have no effect on our factory, since our production is tax-free."

The new method is actually most beneficial to processors that use imported soybeans. The VAT system as a whole discriminates against imports, and the method mainly benefits companies using imported raw materials since they bear the biggest actual tax burden. One person quoted in the article calls edible oil the most-taxed industry. Imported soybeans are assessed a 13% VAT on their gross value including the 3% tariff (the tariff on imported edible oils is 9%).

A futures trader gave his opinion: "Since the VAT on imported soybeans is relatively large, the new method is directed at importers."

The article suggests that the new method is mainly intended to stop cheating and fraud in VAT payments. The actual computation of the VAT leaves a lot of room for fraud. The regulations list a whole range of exceptions and special accounting methods. Since VAT is usually not paid on agricultural raw materials, processors usually issue their own receipts that they use to document their input VAT deduction. Analysts quoted in the article say the new rules reduce the room for cheating.