On 1 January 2026, China implemented its first Value-Added Tax Law and supporting implementation regulations, marking a significant shift in the country’s largest tax category. This legislative upgrade consolidates existing policies while introducing changes that will impact how businesses operate, particularly those engaged in cross-border transactions.

For foreign-invested enterprises and multinational companies, understanding these changes is essential to maintaining compliance and optimising tax strategies in China’s evolving regulatory landscape.

Reshaped rules for cross-border transactions

One of the most significant changes under the new VAT framework is how China treats cross-border services, intangible assets and financial products. The law now places greater emphasis on where these are consumed rather than simply where they originate.

Determining the place of consumption for services and intangibles

The implementation regulations introduce more detailed tests for determining whether services or intangible assets are subject to Chinese VAT. A key development is that services or intangibles supplied by overseas entities that are “directly related” to goods, real estate or natural resources located within China are now deemed consumed domestically and therefore subject to VAT.

This expansion could potentially subject more transactions to VAT liability, even when the purchaser is an overseas entity. However, the absence of a clear definition for “directly related” creates uncertainty that businesses should be prepared to navigate.

Revised VAT triggers on complex financial products

For financial products, the new law establishes that VAT applies if the product is “issued within China” or if the “seller is a domestic entity or individual”. This differs from previous rules and may create challenges for complex over-the-counter derivatives where identifying the “seller” is difficult. Further clarification on the meaning of “issued within China” is awaited.

Simplified deemed sales, but tighter input VAT deduction rules

While the new laws simplify the scope of deemed taxable transactions, it concurrently tightens the rules for inputting VAT credit.

Reduced deemed sales scenarios

The VAT law significantly decreases the listed scenarios for deemed sales to three core types. Common situations such as consignment sales or transferring goods to another branch are no longer explicitly listed. Professional interpretations suggest this does not necessarily mean such transactions are exempt; if they meet the definition of a “consideration-based” transaction, they should be treated accordingly.

Clarifications to the input VAT deduction rules and new restrictions

Loan services

Input VAT on interest and directly related costs for loan services is temporarily non-deductible, though authorities are tasked with reviewing this policy.

Non-taxable transactions

A key change is that input VAT incurred on purchases used for non-taxable business activities (outside those explicitly listed as non-taxable) that generate economic benefits is non-deductible. This likely prevents businesses from claiming input VAT on costs related to generating income such as dividends.

Catering and employee benefits

The non-deduction rule is now limited to services “directly used for consumption”; a narrower phrasing than before, though its precise meaning requires clarification.

Mixed sales and taxpayer status under the new substance over form rules

The new regulations introduce judgement-based principles for mixed sales and stricter criteria for small-scale taxpayer status.

The “principal-accessory” test

For transactions involving supplies subject to different VAT rates, the rate applicable to the “principal business” applies. Determining what constitutes a “single transaction” now depends on whether the component businesses have an “obvious principal-accessory relationship”, where the accessory is a necessary supplement to the principal. This substance-based test is subjective and may lead to disputes.

Stricter small-scale taxpayer criteria

The implementation regulations state that only “non-enterprise units that do not frequently engage in taxable transactions and whose main business is not within the scope of taxable transactions” may choose to be small-scale taxpayers. This means enterprises must register as general taxpayers once their annual taxable sales exceed the threshold, with no option to revert.

Other key operational points and new obligations

Annual reconciliation for input VAT apportionment

For non-allocable input VAT related to both taxable and exempt or simplified-method activities, businesses must now perform a mandatory annual true-up adjustment in the following January. This adds a new layer to year-end tax planning and accounting processes.

Refined rules for long-term asset input VAT

New rules based on the original value of “long-term assets” (fixed assets, intangibles, real estate) have been introduced, with specific annual apportionment requirements for assets over RMB 5 million used for both deductible and non-deductible purposes.

New VAT anti-avoidance clause

Authorities are empowered to make adjustments for arrangements lacking reasonable commercial purposes that result in improper tax benefits, emphasising the need for substance in tax planning.

Actionable recommendations for businesses

The new VAT law presents both challenges and opportunities for businesses operating in China. To navigate this transition successfully, we recommend the following steps:

• Conduct a comprehensive impact assessment: Review all business lines against the new rules to quantify potential tax and cash flow changes. Pay particular attention to cross-border transactions, mixed sales arrangements and input VAT deduction practices.
• Optimise business processes and contracts: Consider revising business models and contractual terms, with particular focus on clarifying “place of consumption” responsibilities in cross-border contracts.
• Strengthen internal controls and systems: Update tax control processes and adapt financial or ERP systems to accommodate new requirements such as the annual input VAT reconciliation and long-term asset apportionment rules.
• Monitor forthcoming guidance: Stay informed on clarifications for terms such as “directly related” and detailed rules for long-term asset input VAT calculation.
• Engage with professional advisers: Work with the tax authorities familiar with the new law to address areas of uncertainty during the transition period and ensure ongoing compliance.

Navigating ongoing uncertainty

Although the VAT law and its implementation regulations have taken effect, numerous uncertainties and areas of ambiguity remain that require further clarification. As China’s tax authorities release additional guidance and interpretations, businesses should stay proactive in understanding how these changes affect their specific operations.

The implementation of the new VAT law represents not just a compliance challenge but an opportunity for businesses to review and optimise their tax governance frameworks. With careful planning and expert guidance, companies can navigate this transition while maintaining stability in their China operations.

If you are interested in getting more details about the preferential policies of VAT or would like to consult on taxation for individual or company, please feel free to contact LehmanBrown via email: enquiries@lehmanbrown.com.