China eyes reforms to road fuel consumption tax

China is planning to start imposing consumption taxes on gasoline and diesel on a retail rather than ex-refinery basis, as part of a wider effort to crack down on tax evasion through fuel blending.

The government is installing tax monitoring systems at some major service stations in preparation for the tax reforms. It is unclear when the tax changes will be implemented nationwide, but a trial run is due to start in the southern province of Guangdong by the second half of this year.

Consumption taxes – set at 2,184 yuan/t ($39.60/bl) on gasoline and Yn1,461/t ($30/bl) on diesel – are currently levied by Beijing and collected by the central government's state tax bureau. The reforms will instead lead to revenue from the duties being shared between central and local tax bureaus, in an attempt to motivate local authorities to step up tax collection.

Tax evasion typically happens in the blending process, using products such as mixed aromatics (MA) for gasoline and light cycle oil (LCO) for diesel. These products are not invoiced as road fuels and so are exempt from the consumption tax.

This gives blenders a margin equivalent to the consumption tax and allows them to sell the blended road fuels at a much lower price than refinery grades, which are taxed at the refinery gate. Collecting taxes at the pump, rather than the refinery, will extend the tax coverage and end this practice, the government hopes.

Guangdong, where the reforms will be tested, is largest Chinese provincial importer of LCO, which traders say may come under the consumption tax regime as soon as May. But some market participants doubt the change will be imposed so soon because it would raise costs at major infrastructure projects across China, which use a lot of gasoil that has been blended with LCO.

LCO is currently exempt from consumption taxes because it can be used as a feedstock for petrochemical, which benefit from government import incentives.

China's LCO imports have being rising – with arrivals almost doubling to around 300,000 b/d last year - contributing to domestic diesel oversupply and hitting refinery margins. The planned changes to the way consumption tax is levied may be a more effective way of ending these distortions than directly taxing LCO, by giving LCO importers more time to switch to other products, market participants said.

If the reforms are successful, blenders may choose to buy more blendstocks from independent refiners in Shandong province rather than cheaper imported LCO, one Chinese oil product trader said.

LCO itself is more expensive than gasoil in the Chinese import market. The changes could send LCO prices back to levels that are competitive with diesel, or lead to LCO being used as a blendstock to produce very low-sulphur fuel oil (VLSFO) in the bonded bunker market, something that currently rarely happens, market participants said.