As the government's latest effort to cool the residential property market, the State Administration of Taxation ("SAT") of China issued a circular in May to strengthen the settlement of land appreciation tax ("LAT") — Notice on Issues Concerning Settlement of Land Appreciation Tax (Guo Shui Han  No. 220 ("Circular 220")).
In the past two years, China’s housing prices in major cities have surged, driven up by hefty interest rate cuts, aggressive credit extension and favorable home purchasing policies, many of which were introduced in 2008 to combat the global financial crisis. However, given the overheated property market and the political significance of providing affordable housing, the Chinese government is now determined to curb the rising residential housing prices. Circular 220 clarified a number of issues that may arise in the process of LAT settlement. Such clarification may help the local authorities in the LAT collection process.
Circular 220 will not be the last effort by the government to calm the housing market. It was previously reported that the imposition of a property ownership tax (???) was under discussion by the National People’s Congress ("NPC"). Local governments were also considering introducing their own measures. For example, it was reported that Shanghai may collect property tax (???) from property owners holding at least two properties, deeming the second and any additional properties as used for commercial purposes. Under the current property tax regime, a self-used property owned by an individual is exempted from property tax even if the owner has multiple properties. On May 31, the State Council announced that it would move forward to reform the mainland's property tax regime. It means that China will likely shift from introducing property ownership tax to expanding the scope of property tax at the national government level. This shift may be prompted by the fact that the State Council wanted to bypass the lengthy legislation process for enacting a property ownership tax and chose to re-interpret the existing property tax. Further development in this area is anticipated.
LAT was introduced in 1993 and is levied on the gain realised from the transfer of land, buildings and associated structures. The rate ranges from 30% to 60%, depending on the percentage of the gain realised as compared with deductible costs and expenses. Enforcement of LAT was weak until late 2006, when the SAT ordered local tax bureaus to reinforce the collection measures to rein in the sky rocketing property prices, but the actual enforcement has not been satisfactory. Circular 220 provides a number of detailed rules on revenue recognition, expense deductions and a few other related issues.
Pursuant to Circular 220, revenue recognition should be based on the sales amount in the relevant invoice; if no invoice is issued, revenue recognition should be based on the sales amount in the relevant contract. If the actual sales area is different from the area indicated in the contract and the purchase price has been adjusted accordingly prior to settlement of the LAT, revenue should be based on the adjusted purchase price.
Circular 220 also specifies detailed rules on deductible costs and expenses:
- Quality guarantee deposits: quality guarantee deposits withheld from a construction contractor can be deducted as development costs if the contractor has already issued an invoice to the developer for the deposits.
- Interest expense: a developer that does not borrow from banks or other parties and uses its own fund for the development of a project may be entitled to a deemed interest deduction. The deemed interest deduction is calculated as a percentage of the sum of land purchase price and development costs. The exact percentage is to be specified by the relevant provincial government but cannot be higher than 10%. If such developer's actual development expenses are lower than the deemed amount, it will effectively enjoy a deemed interest deduction.
- Penalties on idle land cannot be deducted as development costs or expenses.
According to Circular 220, late payment interest will not be levied if the taxpayer has appropriately made the provisional LAT payment and made the final settlement within the period specified by the tax authorities.
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