In a comprehensive reform of its tax system, China has now implemented a value-added tax (VAT) regime for all industries, including the real estate, construction, finance and consumer industries. Under the new regime, the Ministry of Finance and State Administration of Taxation will apply an 11 percent VAT to all real estate assets acquired after May 1.
The much-awaited pilot program of the central government, aimed at reducing tax burden and multiple taxation norms for businesses, replaces the 5 percent business tax that until now was being levied on the sector. The roll-out has created some uncertainty over how the tax burden is to be shared between the buyers and sellers of property.
“We will have to adjust for lower rents in our cash flows if the tenancy agreements cannot be renegotiated to fully reflect the 11 percent, as a result of which our internal valuation of the asset will reduce, ceteris paribus. However, if the buyer of the property bought it before May 1, he has an option to select using the 5 percent simplified VAT tax method. As such, there will have to be a process of negotiation on how the tax burden will be shared,” explained Elvin Lim, managing director at Starcrest Capital Partners.
Colliers International said in a research note published earlier this month that the higher tax might in fact prompt landlords to increase rents.
“Landlords of high-quality properties in prime locations with high occupancy rates will be in a particularly strong position to transfer this cost to tenants. On a more general level, this will be an issue in negotiating new leases and renegotiating existing leases in the long term,” noted the property consultancy.
However, other industry observers said the move will eventually help in improving a developer’s margins and encouraging the sale of more properties. The property services firm CBRE said there will be a destocking of excess inventory in the commercial real estate sector because owners who categorize their property as a fixed asset will now be allowed to claim input VAT credit.
Additionally, under the new VAT regulations, land purchase costs are allowed to be deducted from sales revenues, which will be a relief to the cash-strapped developer community and is expected to improve their operating margins.