Advertisement
Advertisement
The property ndustry has long been a major generator of tax revenue in China. Photo: Reuters

China's plan to extend VAT to property leaves players bracing for impact

With VAT for the property industry edging closer, many are expecting a rocky transition

As China will soon push for a reformed value-added tax (VAT) to replace the existing business tax in the real estate industry, last-minute debate is heating up on some of the core issues.

Developers are nervous about whether the change will mean an increase in their tax burden as it is now hard to pass on extra costs to clients and their profit margins are already facing compression. Home buyers want to know if prices will eventually increase. Other investors are keen to know whether any tax cut provided by Beijing during the transitional period will have a substantial impact on China's ability to service its mounting debts and support its efforts to boost the economy.

"Having been involved in these tax reforms in a number of countries, the hardest areas to apply VAT are to real estate and to financial services," said Lachlan Wolfers, a tax partner at KPMG.

That is why Beijing is leaving the two, together with construction and services such as catering and hospitality, in the last batch of VAT reform that was started in 2012.

Because real estate involves everyone via various channels such as offices and factories or lease and purchases, decisions on detailed rules and tax rates are so hard that even Finance Minister Lou Jiwei could not give a timetable when asked by reporters during the national parliament meeting in March. "We are launching it this year. But it's hard and I dare not tell you when exactly," he said.

Wolfers told the that the earliest date for an official announcement is probably Wednesday when the State Council has its weekly meeting, which will then take effect on October 1 at the earliest or January 1 next year at the latest.

He added that 10,000 to 15,000 words of detailed implementation rules, to be revealed a few days after the announcement, have already been written.

The State Council's repost on May 18 of a reform agenda this year by the National Development and Reform Commission fuelled hope that VAT in the last four industries will be delayed further, maybe till early next year.

The NDRC said China would try to widen the VAT reform out to the construction, real estate, financial and life services industries this year, which was taken as a softening of tone from when China announced the plan, aiming at the end of this year as the deadline as part of its 12th five-year plan outlining the major economic agendas for the years between 2011 and 2015.

A top mainland developer told investors early this month that a delay in the launch was a good sign that policymakers were treading a more careful line.

"The key is to look at the financial impact on different developers," said Carol Wu, head of research at DBS Vickers (Hong Kong). She said the tax rate - 11 per cent or 6 per cent - is crucial, as well as whether expensive land costs can be deducted.

The impact on property prices is going to depend a lot on what transitional measures are introduced to deal with existing real estate holders
 Lachlan Wolfers, KPMG

Wolfers, who has been in close talks with mainland tax authorities, said: "What I'm hearing is that the VAT rate for real estate and construction will be 11 per cent, but the officials may be looking to introduce what we call grandfathering or transitional measures to deal with the problem."

"One of the proposals, which I think is really a sensible one, is that if you have an existing project, when the VAT commences, you will be allowed to apply a 5 per cent simplified VAT rate. You'll be paying broadly the same amount of tax as you were paying business tax."

China has introduced similar measures to help soothe transitional pains in other industries, such as transport, postal and telecommunications, which cost the nation 191.8 billion yuan (HK$242.7 billion) last year alone. That came against the backdrop of an economy losing steam to its slowest pace in more than two decades, which also drove down growth in the country's fiscal revenue to 8.6 per cent, down from 10.1 per cent in 2013 and 12.8 per cent in 2012.

The real estate industry has long been a major tax revenue generator. Data from the Finance Ministry showed taxes related to the property sector accounted for more than 35 per cent of the increase in the nation's tax revenues in 2009 when the global financial crisis took a toll on the world's No2 economy.

If the VAT reform does not exempt the residential segment, which makes up about 70 per cent of China's real estate market, it will then be the most affected. Other segments include office, retail, industrial and hotels.

As an indication, Australian new home prices went up by less than 10 per cent after the goods and services tax rate was implemented in July 2000. The country exempted the residential sector from the new tax.

"The cost will be higher (for mainland home buyers)," said Anthony Tam, managing director of Mazars Tax Services, adding that whether residential is exempted or not, developers will embed part of the tax increase in their asking prices.

Wolfers said: "The impact on property prices is going to depend a lot on what transitional measures are introduced to deal with existing real estate holders."

He added that there will be no exemption for the residential sector in China.

While most property analysts are expecting the government to allow developers to deduct land cost when paying VAT on the sales of their projects, Wolfers said this would be unlikely as local governments, which sell parcels to developers, are not VAT payers. That will leave developers subject to both VAT and land appreciation tax, which rose 18.8 per cent last year to 391.4 billion yuan despite a real estate market downturn.

"For those cities where land value is high relative to the overall cost, the impact is potentially a higher tax burden," Wolfers said.

That will probably make most developers rethink their current strategies of flocking to first-tier cities such as Beijing, Shanghai, Shenzhen and Guangzhou, where land costs are the most expensive nationwide.

In some cases, land costs can be higher than the asking prices of projects on sale in the neighbourhood, forcing developers to build luxury homes. But they then need to survive a low sales pace, putting a premium on the firm's control of financing and marketing capabilities.

Some developers said if land acquisition VAT is paid as a one-off instead of gradually in line with the construction progress, it will increase their operating costs.

Tam told the that China should allow developers to deduct the current values of their land parcels in order to avoid double taxation alongside the land appreciation tax.

He added that the government also needs to help developers gap the mismatch of cash flow due to time differences between input and output.

For example, property companies pay VAT when they buy building materials and hire contractors to start construction. These payments will get refunded only when the project is sold or leased. The time gap will be at least a few months, if not a few years, as is the case with hotels or shopping malls. That will be a considerable burden to developers, Tam said.

Even if developers are able to pre-sell projects before construction starts, the inflow of sales revenues and the outflow of VAT payment would still fall in different years, he added.

While acknowledging these challenges, Wolfers said a lot of the worries in the market are due to fear of the unknown as VAT and business tax are not directly comparable. Business tax is based on overall revenues while VAT is applied only on the amount of value increased at each stage of production or distribution of a good or service.

"From the perspective of the policymakers, it works well once it's introduced; but the hardest thing is to deal with the initial introduction," Wolfers said. "I went through that in Australia back in 2000 and this occupied a lot of time for the government officials. China is no different."

This article appeared in the South China Morning Post print edition as: Fear of the unknown
Post