Call Your Accountant… VAT Rebate is Going Away!!

Thursday, September 20, 2007 4:00
Posted in category Uncategorized

China tax

For those of you who were readers of All Roads earlier in the year, you will know that I beat the majority of news services to the punch when reporting the reduction of the VAT rebate for 3000 goods.

Well… if our sources are correct (same sources as last time), then we are about to see the end of the VAT rebate system for all or part of the goods still enjoying these rebates.

Update: I am not expecting a 100% across the board removal of the VAT rebate regime. I would expect goods in the 5-8% rebate category as highest risk, and while China will probably follow HK and other countries with some ongoing VAT rebates, there are certainly going to be changes in the near future for many categories.

Now, I am not suggesting anyone start ramping up production to beat the clock, but I am suggesting that readers begin factoring in the fact that VAT is going away.

It may not be tomorrow, it may not be at the end of the year (current rumor), it may not be next summer (my original expectation), but it is going to happen…. and when it does, it may sting exporters for anywhere between 5 and 13%.

That’s right.. 5 – 13% of your profit may go away at the end of the year!

Spend some time and figure out the impact.

If you are in a strong market position, are already in China, are exporting, and believe your customers do not have any alternative then to buy your products… go ahead and increase your prices accordingly.

Otherwise, it is time to get your sales and operations team into the same conference room to find ways to save money (no.. that does not mean you can switch out water based paint for lead) and understand what options exist on the pricing side as well.

2006 and 2007 have been two of the most interesting years in terms of regulation and policy. there have been a lot of both that have been put out by Beijing to force more mature market conditions, and if this rumor is true, it could potentially have a huge impact on exporters.

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11 Responses to “Call Your Accountant… VAT Rebate is Going Away!!”

  1. China VAT Rebates….The end is near? » Third Party Logistics News - 3plwire says:

    September 20th, 2007 at 7:35 am

    […] system in China being abolished. If you are doing business in China you will definitely want to the read this article. Popularity: unranked [?] Archived in China | Trackback | del.icio.us | Related Posts: U.S. […]

  2. SwizStick says:

    September 20th, 2007 at 2:07 pm

    Hi Mr. Brubaker,

    SwizStick here from 3plwire.com. Do you know of any Western media outlets reporting on this situation? Or is it only being reported (or speculated?) locally in China? Just trying to get a wider perspective on the whole situation, as it certainly would be useful information for some of the people I work with.

  3. Rich says:

    September 20th, 2007 at 6:39 pm

    Hi Swizstick,

    There are no western outlets reporting on this, and I would not expect anyone to do so until there is an official statement. That is standard, and that is why I mentioned I beat them to the punch earlier this summer (I posted new VAT rebate tariff three weeks before they reported).

    As for whether or not this is just another rumor, there is some element of that. We heard this from 3-4 of our suppliers, and the timing could be off. In my mind, the removal of the VAT rebate is only a matter of time, and so the only speculation really is whether or not it happens at the end of this year (recent rumor), next summer (my first guess), or at some other time.

    If we are lucky, we will get an official announcement soon, but I would expect any announcement to come after the Oct 15 meetings in Beijing

    Say hi to Splatty, and feel free to email me if you have any further questions.

    R

  4. Riddler says:

    September 20th, 2007 at 8:48 pm

    Mr. Brubaker –

    I am curious why you feel that the elimination of the VAT rebate is only a matter of time. I note that in many other countries something similar effectively occurs where sales taxes/vat’s are imposted – governments seem to attempt to charge them only at the consumer level and not at the manufacturer level – and where goods are exported, they are not imposed at all (e.g. logic of switching from a manufacturer’s sales tax to a goods and services tax in Canada in the late 80s. I’m told something similar is the case for the EU as well). Or do you feel the rebate is to be eliminated simply due to pressures to reduce trade imbalances?

    Best regards.

  5. Rich says:

    September 20th, 2007 at 9:12 pm

    Hi Riddler,

    Sorry. I should have qualified this a bit…

    You are correct in that other countries still have a VAT system in place for some items, and that is what China is moving to. It will not remove VAT rebates for all categories.. it will be a selective process much like in July where certain categories will see the changes (I consider those in the 5-8% rebate range at greatest risk of complete removal).

    Using the updated July 1 regime, one can see that for high tech goods there was actually a move from 13% to 17%, but for other goods the rebate went away altogether

    In my mind, I would expect for goods linked to energy consuming industries to see further reductions and/or complete removal. Aluminum, Steel, etc…

    As to why these VAT rebates are being reduced, I think there are multiple factors at play.
    1) First and foremost, I think Beijing is trying to balance out the economy and reduce its reliance on low value add/ energy consuming exports.
    2) Removing VAT has the same effect (on exports) as a much larger RMB move. the benefit though is that VAT rebate reductions do not have an impact as far reaching as a RMB move, and therefore any negative macroeconomic impacts are mitigated
    3) Second, Beijing is probably trying to keep some of the taxes for themselves.

    Thanks for stopping in, and feel free to follow up again if you have more questions

  6. Jay Boyle says:

    September 20th, 2007 at 9:44 pm

    Rich is on the money!

    Some additional thoughts as to what is driving the change and how China uses its VAT.

    1. China uses VAT as a defacto RMB revaluation tool. This enables the policy makers to cool down certain sectors of the economy without having to revalue the RMB. This is more desirable then an exchange rate adjustment from the Chinese POV as Imports remain the same price and local industry is protected.

    2. This tax effectively taxes foreigners. China is experiencing the largest income disparity in its recent history and under Hu Jintao’s watch he has pledged to invest in programs to reduce this disparity. This tax (as long as workers keep their jobs) will have no negative effect on China’s masses.

    3. . Under WTO companies have the right to have a class action suit that would impose countervailing duties. There are currently anti-dumping law suits in the works in the US and in Europe that argues the VAT rebate as an unfair trade subsidy because the price of the export good is lower then the price of the same good domestically. By removing the VAT the China reduces the likelihood of this becoming and issue.

    The real unknown is how will this effect the economies of the major importers the USA and the EU. How much of these costs will be passed through? The US just cut interest rates and commodity prices are rising. Any pass through will have a multiplier effect on the inflation rate as duties are levied on a percentage basis. It is not as simple as saying we will just buy product X from South America or Product Y from Vietnam. There are switching costs involved. This is especially true for multinationals that own their production facilities in China. Plants can not just be moved or rebuilt overnight.

    Jay

  7. Rich says:

    September 20th, 2007 at 10:15 pm

    Jay.

    Thanks for chiming in. Your point that there are costs to moving are well taken. I was recently eating some Hunan ribs with some logistics executives at Dishuidong discussing the logistics of this argument, and essentially we came to the conclusion that even if you could move everything to Vietnam/ India overnight, the ports could not handle the traffic. The countries are simply not set up infrastructurally to have high levels of import/ export.

    One question in my mind is, could American manufacturers who once moved to China for lower costs no be faced with the scenario that the U.S. is now cheaper. And if so… is it possible to return there to manufacture? Or are too many industries (textiles for example) simply beyond the point of no return?

    If that is the case, then I think your point of pass through and inflation become a lot more interesting.

    China has allowed the U.S. (I cannot speak to the E.U.) to defy economic gavity. Where raw material costs have been rising for the last 10 years, products at the retail level have not. Once China begins raising its prices, the average Joe in America is sure to feel the pinch.

  8. Jay Boyle says:

    September 21st, 2007 at 12:54 am

    Hi Rich,

    As someone that spends the majority of my time in China looking at different companies’ costs I may be able to shed some light on to why there has not been too much pass through over the years.

    If you look at a typical product costs the raw materials cover about 60% to 70%, labor is less then 5 and the remainder is overheads. Despite what labor unions will have you believe it is very low overheads, overcapacity and productivity improvements in China that has contributed to this downward price pressure.

    I don’t think textiles should ever go back to the US. It just makes no sense at all to be trying to invest in or protect and industry that is on the bottom of the food chain. The textile industry should move to the most efficient highest quality producer.

    Every time the US, the EU or China protects an industry it creates larger problems somewhere else. Look at what corn production and subsidized ethanol is doing to the price of land in the Midwest or to the price of other commodities. Look at the price of pork in China or rice in Japan.

    Jay

  9. SwizStick says:

    September 21st, 2007 at 1:36 pm

    This is an awesome discussion and worthwhile reading. Thanks to everyone for their input and thoughts. This is certainly an important subject within my own company as well. I doubt my company, or anyone else with substantial presence in China, would be able to (or want to) transfer affected production to Vietnam, India or anywhere else for the simple reasons that Rich and Jay have mentioned. There are indeed substantial switching costs. However, I am curious to watch and see how companies will react to this both in the short term and long term. Will there be pressure from U.S. and EU customers to maintain the same pricing, despite the reduction or elimination of the tax rebate? Or will Chinese exporters try to implement a price increase? Will order quantities and volume overall be lower in the short term? And will some companies long term strategy be to get out of China for some of these items?

    We’ll have to wait and see, but it will be interesting to watch.

  10. Rich says:

    September 21st, 2007 at 11:30 pm

    Swizstick,

    I think the answers will come soon enough to a WalMart near you. I know I pick on them a lot, but they have a massive operation in China build on low margins, and I am not sure their suppliers will tow the line on these. If you are a factory with margins under 10%, an 8% reduction (really 13% since last year) is catastrophic.

    Short term China based, I would imagine they come to some kind of agreements on splitting… but I would expect the WalMarts of the world are already beginning to look at other options.

    My interest is to see how much of this makes its way back to the US consumer. I have one customer that has been holding prices for more than 2 years even though his costs have increased, and I am sure at some point he will make the decision to make the bump… and it is times like these that bumps are more easily accepted.

  11. Rich says:

    September 25th, 2007 at 11:18 pm

    Update: Rumors are that the entire regime will be eliminated. The only exemption s will be in the categories related to high technology goods (i.e. currently at 17%).

    Again, initially I expected some kind of reduction next summer, but the rumor mill is saying that this will come at the end of this year.

    Nothing is set in stone, and if I were a betting man I would say that if the rumor mill is right (again), then we will see something more official following the Oct 15 meetings in Beijing.