China’s VAT Overhaul Saves McDonald’s $66 Million

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By Mark Melnicoe

Since China completed a shift last spring to a value-added tax system for its entire economy, foreign and domestic companies alike have scrambled to adjust to the historic change—global restaurant chain McDonald’s has made a saving of 450 million yuan ($66 million) as a result.

McDonald’s says it remained profitable in the world’s No. 2 economy last year largely because of its ability to adapt to the change.

It paid 450 million yuan ($66 million) less in tax than it would have under the old business tax system from the May 1 start of the VAT overhaul through Dec. 31, 2016, a Feb. 13 notice from China’s State Administration of Taxation indicates. The SAT said the company’s tax burden fell from 4.9 percent to 0.6 percent.

That percentage referred to the turnover tax on revenue, said Regina Hui, vice president of communications for McDonald’s China.

“The VAT reform implemented by the government provides favorable conditions, while companies also need to be proactive. By seizing the opportunity, McDonald’s China realized a smooth tax transition and significantly reduced the tax burden,” Hui told Bloomberg BNA in a Feb. 22 e-mail.

McDonald’s, which has more than 2,400 outlets in China, is battling trends that include increased competition and changing consumer tastes around the world. It doesn’t break out revenue and profit figures by country but said in a third-quarter filing with the Securities and Exchange Commission last year that profits in its “high growth” sector were “driven by improved restaurant profitability in China, which benefited from recent VAT reform.”

McDonalds, with more than 36,000 restaurants in 117 countries, is the world’s largest restaurant company. Its estimated revenue last year totaled $24.6 billion, a 3 percent drop from 2015.

Quality Scandal Now Behind It

In its last full annual report, for 2015, it reported solid performance in China, as it rebounded from a debacle in the summer of 2014 when one of its main beef suppliers turned out to have been selling it old, expired meat it mixed with good meat.

“Results in China, Japan and certain other markets were negatively impacted due to lost sales and profitability, including expenses associated with rebuilding customer trust,” the annual report stated.

Last year’s strong performance in China was more attributable to the firm’s tax situation.

Strong Supplier Relationships Called Critical

Hui suggested that McDonald’s longtime presence in the country and its relationships with suppliers was a key component in its success.

“During the 27 years of operation in China, McDonald’s helped local suppliers build a robust accounting system and good compliance with the tax laws,” Hui said.

When China completed its move to an all-VAT system by bringing financial services, consumer services—including restaurants—real estate and construction under the umbrella, a crucial element for companies became the ability to deduct the VAT they themselves pay for goods and services.

That, in turn, created pressure on suppliers to impose the VAT so they could provide invoices, which buyers need to take the tax deduction. Under the old business tax regime, the tax often wasn’t charged, a breach of compliance that meant a loss of revenue for the government.

Full Deduction for Invoiced VAT

That’s where McDonald’s relationships with its suppliers proved to be an advantage.

“As a result, McDonald’s quickly realized 100 percent deduction of the raw material input tax, which significantly reduced cost and improved profit,” Hui told Bloomberg BNA.

“I think the comment made by McDonald’s is consistent with our observation of taxpayers in the VAT reform,” Liqun Gao, a partner and indirect tax leader for eastern China at Deloitte in Shanghai, told Bloomberg BNA in a Feb. 23 e-mail. “It seems that McDonald’s did a good job in getting ready for the reform.”

Gao said lining up qualified suppliers is critical “in order to make sure input VAT credit can be obtained on as much purchase as possible” to reduce the tax burden.

A Boon for Most Companies

Figures from China’s Ministry of Finance show that the VAT overhaul is paying off for most companies. From May to October, taxes continued to drop in construction, real estate, finance and consumer services, which saw an increase of 530,000 taxpayers, the ministry said in a report last November.

While ignoring media reports that some, mostly smaller, companies were paying much more tax, it reported the new tax scheme helped enterprises save 96.5 billion yuan ($14 billion) that otherwise would have been paid as tax during the first six months of the change to a VAT system.

“The steady progress of the reform invigorated the market, reduced burdens for enterprises and helped create employment opportunities,” Premier Li Keqiang said after presiding over a State Council meeting Nov. 29.

Move to Franchise System Coming

McDonald’s made a big move last month, when it agreed to sell 80 percent of its China and Hong Kong operations to CITIC Capital—which manages capital for international investors—and Chinese state-owned CITIC Ltd., and to the Carlyle Group, an American private equity firm, for $2.08 billion. Once the deal finishes, CITIC and CITIC Capital will own a 51 percent controlling stake and Carlyle will own 28 percent, according to a news release from the three companies. McDonald’s will retain 20 percent.

Most of the restaurants in China will go to a franchise system, which is a typical arrangement for McDonald’s and other fast-food chains. In fact, 80 percent of McDonald’s restaurants around the world are operated as franchises.

Hui said the move to franchises wouldn’t affect the company’s tax status in China, including the VAT savings.

To contact the reporter on this story: Mark Melnicoe in Shanghai, at correspondents@bna.com

To contact the editor responsible for this story: Penny Sukhraj in London at psukhraj@bna.com

For More Information

The notice from China's State Administration of Taxation,in Chinese, is at http://www.gov.cn/xinwen/2017-02/13/content_5167609.htm

Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.

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