In June 2018, the Standing Committee of the National People’s Congress proposed major amendments to the PRC Individual Income Tax Law (IIT Law). These changes are expected to take effect in October 2018, with full implementation of the revised law planned for January 2019. The reforms are some of the most important and comprehensive since the passing of the original IIT law in 1980, and will certainly impact the payroll/finance operations of every company in China. Key amendments are the introduction of tax deductible expenses for Chinese employees and a reduction for expatriates; a reshuffle of the tax brackets to alleviate the IIT burden on low and middle-income earners; and changes to the residency rules for foreigners.
One important aspect of Chinese IIT laws that the amendments do not touch, is that employers remain responsible for withholding IIT. So the burden remains on companies to get it right.
1. Introduction of Tax Deductible Expenses
Arguably the most important amendment to the IIT Law is the long overdue implementation of deductible expenses. Expatriates have long been allowed to deduct certain expenses from IIT; under the revised law, all individuals (incl. expatriates) will be able to lower their monthly/yearly IIT payment by offsetting their income against “special additional deductions” including:
- Education expenses for children;
- Expenses for further self-education;
- Health care costs for serious illness;
- Housing loan interest; and
- Housing rent.
This means that individual employees must work closely with their employer’s finance / HR departments to ensure these special deductions are taken into account every month, which can greatly increase a company’s administrative burden. The amendments also expressly forbid employers from denying valid deductions produced by their employees.
It is also important to recognize that foreigners will be subject to the same rules. In effect this can mean a decrease of the deductibles and so an increase of the tax burden, e.g. with relation to laundry, meal allowances, and home flight tickets, which are items that currently are deductible for foreigners but may not be in the future.
Finally, the law allows for tax returns to individuals to be paid out after the March 31st annual tax reconciliation, which means that if too much IIT has been paid due to under-reporting of deductions, these can be reported later. It remains to be seen how this will work in practice.
2. IIT Rate Changes and Statutory Deduction Increase
The statutory deduction (i.e. the first part of the salary that is not subject to IIT) will increase to CNY 5,000 (from CNY 3,500 for Chinese employees, and CNY 4,800 for foreigners). More important, is the shuffling/lowering of income tax rates for employees with taxable income of up to CNY 35,000; the new tax brackets are as below.
|Current and Amended Tax Brackets for IIT on Monthly Taxable Income (after standard deduction and allowable deductions)|
|Current Bracket||Amended Bracket||IIT rate (%)|
|up to 1,500||up to 3,000||3|
As an example of the scope of these changes, a Chinese resident national with a taxable income of CNY 40,000 per month would have to pay CNY 8,195 in taxes; but under the amendments he will see his tax burden fall to CNY 6,090, and that is without even considering the new special deductions!
3. Changes to Residency Establishment Period
The amended IIT Law reduces the qualification of residency from 1 year to 183 days. This means that any foreign individual who has stayed in China for 183 days or longer in a calendar year will be considered a resident, with income sourced within or outside the country subject to IIT. It is unclear whether the current “5-year tax rule” (i.e. a foreigner’s global income is only taxed if (s)he has stayed in China for five years without interruption) will be repealed, though clarification in implementing regulations is expected later this year.
4. New Measures to Combat Tax Evasion
Further emphasis is placed on combating tax evasion under the amended IIT Law. Among the key changes are income recapture for China residents’ overseas company business activities and profit distribution. The amendments also give greater authority to tax officers to review any situation under which an individual seeks to reduce his IIT burden without justified business-related purpose. China residents, both foreign and domestic, should review their global income structure to avoid unnecessary and expensive individual income tax audits.
5. Closing Remarks
The 7th major revision to the PRC Individual Income Tax Law will begin to take effect later this year, and is arguably the largest amendment to the law yet, in terms of the scope and importance of the changes. Foreign companies will need to review their payroll and IIT declaration processes and communicate the changes with their expatriate and local employees to ensure a smooth transition. Chinese individuals will need to ensure their lease agreements, education agreements, and other supporting documents are up to date in order to enjoy the new tax benefits; while foreigners will need to prepared or compensated for any decreases in deductibles.