Developers set to benefit under China’s VAT pilot scheme

China’s property companies will pay value-added tax instead of business tax starting May 1 under new taxation reform introduced by the central government, with analysts estimating potentially significant tax savings for developers and a boost to the commercial sector as more office buildings will be purchased.

The long awaited VAT pilot programme, seen as an important part of China’s fiscal and taxation reform, has been expanded to all industries including real estate and the construction sector.

To replace the current business tax of 5 per cent, developers will be levied an 11 per cent VAT effective May 1, with the land cost being deductible, according to a new notice from the country’s financial and taxation authorities.

With land price deductible, an 11 per cent VAT based on a 30 per cent gross profit – the industry average level – means a 3.3 per cent actual tax rate. When compared with the previous 5 per cent business tax on sales developers can save an average 1.7 per cent in tax on their property sales, Huatai Securities wrote in a note last week.

The savings could be significant. Take China Vanke, the country’s biggest home developer, as an example. It recorded property sales of more than 180 billion yuan (HK$214.7 billion) in 2015, so a 1.7 per cent saving equals 3 billion yuan.

Developer margins have narrowed in recent years due to surging land costs, making VAT much more preferable to developers over a flat business tax.

Swiss bank UBS expects VAT reform could improve Chinese developers’ operating margins by an average of 2 per cent in 2016 over 2015 levels.

Compared to residential developers, analysts said developers with a higher proportion of assets in commercial properties could benefit even more under the new tax system. These include firms such as China Resources Land and Soho China.

“When enterprises buy office buildings their costs will be reduced because adding new real estate is deductible under VAT. That would stimulate enterprises to purchase office buildings to improve working conditions, and this can also help clear the stock of office buildings,” said Zhang Hongwei, research director at real estate consultancy Tospur.

In a note published on Monday Citic analysts wrote: “Purchasing real estate helps preserve or grow asset value in the current context. Therefore, we believe more businesses will opt to buy office properties (rather than rent them) and even upgrade their offices appropriately.”

Commercial property in China is facing oversupply. By the end of 2015, office building space and commercial building space for sale each increased 25 per cent year on year, respectively. The new measures highlight how serious the government effort is to destock commercial properties.

For personal homebuyers, the government will also apply VAT instead of the business tax in the case of residential properties sold less than two years after their purchase, dated from May 1. Sales of properties held for at least two years will be exempt from VAT，while sales of large properties in the four biggest cities will still be taxed regardless of how long they are held.

David Hong, head of research at China Real Estate Information Corp, said the new tax system wouldn’t affect most homebuyers’ investment decisions. Rather, it would only have an impact on those doing frequent trading in the market.