Of the many initiatives included in the central government's 4trillion yuan (HK$4.54 trillion) economic stimulus package last November, the overhaul of value added tax (VAT) across all industries was perhaps the most significant. The key change under the reform moved VAT in China from a production-based system to a consumption-based system, which means that input VAT incurred on fixed assets (with certain exceptions) can now be used by many enterprises to offset against output VAT, resulting in lower VAT liabilities for some. A second alteration to the VAT regime saw a change in the thresholds so that commercial entities with turnover of more than 800,000 yuan and production entities with turnover above 500,000 yuan can pre-register as VAT taxpayers. The VAT credit on the purchase of fixed assets is only allowed for registered VAT general taxpayers. In addition, processing factories, companies that formerly had an exemption from VAT on the purchase of fixed assets have had that exemption removed and must now pay the input VAT without being able to get the credit. All changes and concessions apply to domestic and foreign-invested enterprises and were effective from January 1 this year. According to Annie Lau, director of corporate and China tax at Deloitte in Hong Kong, the VAT overhaul is a significant breakthrough in tax reform in China. 'It will help companies in those industries requiring higher capital investment, mainly the production and manufacturing industries. VAT reform is one way to encourage them to increase their investment in fixed assets and equipment so that they can improve both production levels and efficiency,' she said. Generally speaking, VAT is divided into production-based VAT and consumption-based VAT, according to the different treatments of input VAT recovery for fixed assets. Unlike consumption-based VAT, for example, production-based VAT does not allow the input VAT for purchased fixed assets to be deducted. China implemented the production-based VAT model when it carried out national VAT reform in 1994. But it has been piloting programmes for VAT transformation since 2004 when it allowed companies in eight industries in northeastern China to credit the input VAT for purchased fixed assets against the output VAT. The scope of VAT enlargement deductions was further expanded from 2007 to include 26 old industrial base cities of the central regions and five alliance cities in Inner Mongolia. Last year, to support the reconstruction following the Sichuan earthquake, the central government allowed 51 earthquake disaster counties and cities to recover VAT on fixed assets. According to Jean Li, tax partner, KPMG China, based in Beijing, for most taxpayers the reform is good news because they can now claim a VAT credit on the purchase of fixed assets. But there are some losers. 'The one obvious group is those engaged in encouraged projects and who are involved in export sales. Under the old regime they were exempted from input VAT upon the importation of equipment. But now the VAT exemption policy has been cancelled, they need to pay VAT on the importation of equipment. And because they're engaged in export sales - normally exempt from VAT - they don't have enough output tax to absorb all the input tax credits,' she said. Accordingly, the firms have been trying to clarify some of the points regarding the VAT reform with the State Administration of Taxation in Beijing to see whether it will provide help to those enterprises which are suffering under this new policy. 'The feedback so far is that they won't provide any particular help to save these processing factories,' Yvonne Law, tax partner, Deloitte China, said. 'The general policy for some time has been to encourage them to change to a wholly foreign-owned production enterprise rather than to keep them as processing factories. Once they change, they will qualify as a general taxpayer and get the input VAT credit.' According to central government figures, the VAT reform will cost 123 billion yuan over the course of this year. The detailed rules of the reform and regulations for the implementation of VAT, business tax and consumption tax are under consideration and more changes are expected to be announced throughout this year.