China’s VAT tax reforms are pushing small businesses to the brink

Small business owners say they’re being punished by the new tax regime that was supposed to help them

PUBLISHED : Friday, 30 September, 2016, 6:42pm
UPDATED : Friday, 30 September, 2016, 10:52pm

For China’s small companies, sometimes less is more.

Beijing’s much-hyped valued-added tax (VAT) reform, aimed at cutting the tax payments of smaller mainland firms, appears to have had the opposite effect on many entrepreneurs, who say they have become victims of the new system.

Paul Meng, owner of a Shanghai-based Japanese-food restaurant, felt the new tax regime had punished his embattled business instead of supporting it.

“I actually paid more taxes after the reform,” he said. “It made it more difficult for me to keep the restaurant alive.”

The tax reform, which the government began to roll out in March, was touted as a significant move to ease the tax burden of service firms at a time when China’s economic slowdown was hurting business morale nationwide.

I actually paid more taxes after the reform. It made it more difficult for me to keep the restaurant alive
Paul Meng, Shanghai restaurant owner

Meng said his restaurant business broke even last year as rising labour costs and higher rents offset a small increase in sales.

“After running it for two years, I can’t stop myself from ruing the wrong decision,” he said. “It seems unlikely that I can recover my two million yuan investment into the restaurant based on the lacklustre operations.”

The 42-year-old added: “The government’s boosting measures turned out to be much worse than expected. Instead of helping us, some of the policies made a lot of trouble.”

Before 2012, Beijing had imposed tax on service companies based on their sales revenues.

Shanghai’s information technology and logistics businesses were the guinea pigs for a trial of the new corporate tax regime under which the amount levied was calculated based on the value they added to their products and services.

The pilot scheme proved unsuccessful, as a survey found that two thirds of Shanghai-based companies ended up paying more tax under the new system.

The VAT reform was expanded nationwide this year with all services firms including securities brokerages and insurers subject to the new tax regime.

Under the VAT system, the value of invoices issued by suppliers of raw materials is measured against the value of the sales invoices issued by the service companies to their customers.

The different between the two is considered to be “value added.”

The State Administration of Taxation predicted that the tax reform could save companies in the services sector a combined 500 billion yuan in tax payments a year.

But Meng found that his suppliers of sea food and vegetables, most of whom are small vendors in a flea market, weren’t able to provide the VAT invoices. This increased his tax payments.

Zhao Yang, chief economist with Nomura, said that the VAT reform could initially result in a higher tax burden owing to ineffective enforcement.

“It appears to have had no immediate positive impact on businesses,” he said. “Taking a long view, it will benefit the development of privately-owned companies.”

Ironically, the Ministry of Finance, in a report to the National People’s Congress in late August, said that the amount of business tax – tax levied on sales of goods and services – collected in the first six months of this year jumped more than tenfold from a year ago.

The ministry said in a statement that the soaring figure was the result of the change in the way corporate tax is calculated after the VAT reform.

Before, all sales tax was collected by local governments, while under the VAT system half of the tax revenue is required to be transferred to the state government.

“Whatever the reason is behind the incredible year-on-year jump, it is certain that the tax authorities collected more tax payments from businesses,” said Meng. “We hope the government can live up to its promise of cutting tax payments.”

Thousands of China’s small businesses are now at a do-or-die moment as they battle to survive the economic slowdown and a massive loss of orders from foreign clients.

Beijing’s policy direction of encouraging entrepreneurship to sustain the growth of the world’s second-largest economy has turned out to be an empty promise to businesspeople like Meng.

For them, it’s time to hunker down, not to bet on the future.

“Long-term benefit is a far-cry,” said Hu Yong, the boss of a privately-owned screw maker. “Small businesses are playing a game of survival now.”

Ma Guangyuan, a renowned independent economist, said lacklustre investment by private businesses had created a “horrible scene” that could eventually devastate the long-term development of China’s economy.

“The leadership is paying close attention to the data of private investment,” he said. “Private investment is of vital importance to the national economy.”

Private-sector investment growth posted a sharp fall this year amid a worsening business environment, with entrepreneurs struggling to keep their companies afloat.

The growth rate fell to 2.1 per cent, the slowest since 2012 when the mainland starting publishing the data.

In stark contrast, state-sector investment maintained a lofty growth rate of more than 20 per cent.

Private-sector investment grew 10.1 per cent last year, down from 18.1 per cent in 2014.

In the mainland, the majority of privately-owned companies are either so-called mom-and-pop shops - small, independent, often family-owned and operating out of one location - or small-scale manufacturing firms.

Many of them rent the properties from which they run their businesses. The red-hot real estate market has forced entrepreneurs to pay higher rents to landlords.

“A rise in rent cost could easily eat into all of our profits,” said Xia Yunfeng, another restaurant owner. “The tax cut was seen as the last straw for us, but it actually didn’t happen.”

With the shadow of a slowing economy hanging over them, a huge number of entrepreneurs are increasingly considering quitting their businesses.

You Guozhong, who operates a vendor selling bean curd in Shanghai, said he could understand why some small business owners are calling it a day.

“I can earn several thousand yuan if I serve as a security guard for a residential complex, equivalent to the money earned from the business,” he said. “It’s too expensive to be a boss of any business.”

China’s privately-owned businesses provide 80 per cent of jobs nationwide.

A large number of closures and bankruptcies could ignite social disunity as thousands of laid-off workers take to the streets to protest against their employers or the governments’ inertia.

Meng said he would have to keep up the hard work, since he would lose his two million yuan investment if he were to close down the restaurant now.

“I have no choice,” he said. “The investment into the restaurant has bonded me with the Chinese economy. I wish the economy could turn around sometime in future.”