Tax Exemptions for Public Funds Face Uncertainty

The Shanghai-based mid-sized brokerage banking analyst told Jiemian News: "Reinstating VAT on government bond interest will significantly impact new allocation demand. If public funds retain tax exemptions, some demand may shift to them."

Regulations exempt public funds from income tax and VAT on government bond holdings. Previously, commercial banks' proprietary funds already used public funds to invest in credit bonds.

For banks, direct credit bond investments face >30% tax (25% corporate tax + 6% VAT), while channeling through public funds—despite management fees—yields higher post-tax returns, incentivizing both sides (banks seek tax savings, funds earn fees).

This even spawned "customized fund" models: Banks commission bond funds to invest in specified corporate bonds, with the fund hosted at the same bank—effectively using funds as conduits.

If public funds retain exemptions for government bonds, banks may follow suit. But scale would be limited: 1) Government bond issuance is massive; 2) Banks need direct holdings to secure local deposit relationships.

Critically, post-adjustment, public funds' VAT rate on government bonds rises to 3%—just 3pp lower than banks' proprietary investments (with income tax still exempt). After fees, banks' net gain from using funds narrows to ~2pp.

Moreover, public fund exemptions may also change. "Public funds drove bond trading last year. Central bank hints suggest their tax perks could be scrapped to level the regulatory field and reduce conduit roles," said the Beijing私募基金fixed-income director.

However, Huaxi Securities noted public fund tax exemptions stem from two policies tied to equity investment perks, possibly standing independently. As the new rules omit specific institutional changes, exemptions may persist short-term.

For fiscal authorities, while higher bond coupon rates will increase interest payments, VAT revenue from reinstated taxation could outweigh this, slightly easing fiscal pressure. H1 2025 tax revenue fell 1.2% YoY to ¥9.29tn, with VAT (¥3.6tn, +2.8%) remaining the largest component.