FILE PHOTO: A China yuan note is seen in this illustration photo May 31, 2017. REUTERS/Thomas White/Illustration/File Photo

SHANGHAI (Reuters) -China has reinstated value-added tax (VAT) on interest income from new bonds issued by government and financial institutions starting Friday, ending a long-standing tax break to ease growing fiscal pressure.

The Ministry of Finance announced last week that the VAT exemption would no longer apply to interest income from government bonds, local government bonds, and financial firm-issued debt issued on or after Aug. 8, 2025.

Interest income from bonds issued before that date - including subsequent tranches - will remain exempt until maturity, the ministry said.

"With China's fiscal deficit hovering near historic highs and interest payments on government bonds continuing to rise annually, we believe it is natural for policymakers to consider ways to moderately boost revenue and curb spending to prevent further fiscal strain," said analysts at investment bank CICC.

This would help lift fiscal revenue by an estimated 32 billion yuan ($4.46 billion) in 2025, rising to 65 billion yuan in 2026 and 99 billion yuan in 2027, based on a 6% VAT rate, according to Caitong Securities.

In another sign that China is accelerating its tax revenue streams, some onshore taxpayers have recently received notices from local tax authorities instructing them to declare overseas income and pay applicable taxes, including earnings from foreign stock investments, the central bank-backed Financial News reported this week.

The CICC analysts expected the policy focus to shift toward monetary easing in the second half.

"If monetary easing materialises, the few basis points of impact from recent tax policy changes would likely be offset by falling yields, and could even contribute to further declines in government bond rates this year," they said.

China's long-dated government bond yields dropped following the policy release last Friday, as investors shifted demand toward outstanding bonds that remain exempt from such tax.

China exempted interest income from government and local government bonds from business tax in the early stages of bond market development to foster growth. After 2016, the exemption of business tax was replaced with value-added tax (VAT), maintaining tax-free status for interest income derived from sovereign and municipal bonds.

China's bond market has expanded steadily and the previous VAT exemption on bond interest income had achieved its intended objectives, and that it was now appropriate to adjust and refine the policy in line with current market conditions, the official Xinhua said last Friday.

Foreign investors will continue to benefit from corporate income and VAT tax exemptions on interest income from onshore bond investments until the end of the year, according to an official announcement in 2021.

($1 = 7.1823 Chinese yuan renminbi)

(Reporting by Shanghai Newsroom; Editing by Raju Gopalakrishnan)