The 2018/19 holiday season was a busy period for the Chinese tax authorities. Their publication of finalised regulations addressing tax reform for individual income tax will not give businesses and employees with Chinese connections long to review, understand and implement required changes.
The new regulations became effective from 1 January 2019 so international businesses with mainland China operations will need to understand the immediate and future impact of the changes on their workforce.
Summarising Chinese individual income tax changes
Overall the regulations both give and take away benefits to individual taxpayers. A preferential tax treatment that lowers the tax burden on incentive compensation such as bonuses and equity income, continues and has been expanded. Taxpayers can also benefit from the introduction of new deductions available against taxable income. By contrast, preferential treatment will be phased out replaced in a few years, with taxpayers facing potentially much higher income tax burdens in the future.
Changes for employers
Administrative challenges are expected for employers both in managing payroll deductions and elections. They will see the phasing out of preferential tax treatment and the resulting future increases in employee taxation of incentive compensation will likely see market pressure to mitigate it. Employees will be looking to see how their employers respond; a new front in an already competitive talent battle.
Changes for international assignees and expats
The current preferential tax treatment of benefits, from accommodation to children’s schooling costs and language tuition will begin moving to be fully taxable in the future. Assignment tax costs for employers are set to increase and expat benefit packages will become costlier on a net basis. For businesses with tax equalised assignees working in China, tax changes in China will see for some, significant increases in the tax cost of the assignments.
Unpacking the changes from an international perspective
There are five developments in the new regulations that international business and non-Chinese individuals working in China should address to understand the impact.
- Tax residency for non-domiciled individuals – Income tax is limited to Chinese-sourced income only for individuals who are not domiciled in China. For long-term residents, they can benefit from not being subject to tax on their worldwide income if they spend 30 consecutive days outside mainland China in a tax year. The period of absence was previously required in a five year period and this has now been extended to six years.
This provides some relief for expats working in China and particularly those individuals potentially affected in 2018 who now have a further year to meet the criteria. Long term expats living in China will benefit from the additional clarification, extension and not being taxed on worldwide income.
For businesses with non-domiciled expat employees in China, if they are sent on assignment or extended business trips to foreign countries, they may not be able to benefit from tax relief under the double tax treaty as they do not meet the residency requirements to qualify. Businesses should review their situation in order not have unexpected international tax consequences.
- Preferential tax treatment of bonuses and equity income – Taxpayers have been able to apply annual Chinese tax rates once a year to a bonus and equity income event. This has meant taxpayers were potentially subject to a considerably lower taxation on this income rather than if it were taxed alongside regular income. While this benefit has been extended, it will cease after 2022, meaning potentially higher rates of tax on such income.
Employees should review how the coming changes will impact them, potentially where tax rates could rise from 10% to 45%. For individuals who are also taxable in a foreign country, such as US citizens in the US, their overall effective tax rate may increase.
Employers should consider how to address future changes that impact bonus and equity payments. Future payments may be worth less on a net basis to employees. Some of this burden may be taken by the employer rather than transferring it all to employees. These changes may see competitors vie for talent with increased compensation packages.
- Preferential tax treatment of international assignee benefits – International assignees benefit from no or limited tax on certain employer-provided benefits including housing, children’s schooling fees and living costs where a registered tax policy is in place. These benefits will no longer be available with such tax relief after 2022. This potentially results in significant increases in tax cost for international assignees. For locally employed expats, the cost of providing such benefits will also increase requiring employers to consider how to address such changes.
Where benefits are provided on a gross basis, employees will be subject to China tax, meaning potentially high tax burdens arising on non-cash income like accommodation. International individuals may find their overall effective tax rate increases too.
Tax efficient delivery of benefits will be phased out meaning employers should review and update compensation packages for local employees to identify who will bear any future taxes. For tax equalised employees in China, businesses will see tax costs increased as they absorb the additional tax on benefits. Employers will want to review the potential cost impact to budget ahead of time.
- Changes to deductible expenses – A new list of deductible expenses, with a more relaxed substantiation rules have been confirmed. These are available to both international and domestic employees (the former must choose between the above and these once per year). It does however potentially make payroll administration more complex. Employees may choose to deduct costs, and payroll will need to review whether the costs are deductible and if they fit within the maximum amount announced.
International assignees may continue to benefit from the exemptions in an international employee policy, so it’s not required to change approach if this is in place. However, assignees may find they can deduct costs previously not available to them.
Employees can potentially benefit from considerable reductions to taxable income through the new deductions. On a month-to-month basis, the ability to have deductions factored into payroll withholding will mean benefiting from a real time reduction in taxes. Expats should review the overall impact of the deductions.
As employees can request deductions to be taken through payroll, international businesses with local operations should work closely with human resource and payroll teams to understand and plan for the potential administrative burdens. Where elections are being made, businesses may want to support employees understand the changes and the process for claiming deductions.
- Annual tax returns and tax refunds – An important change to note is the criteria for which an individual may file a tax return. Deductible expenses may be taken via a tax return going forward and so an individual who has suffered withholding would be able to claim a tax refund.
For employees who claim a foreign tax credits on a non-Chinese tax return, any balancing tax payments or refunds on a Chinese tax return could impact their overseas taxes. Individuals should assess potential changes and whether a residual foreign tax liability could arise if Chinese taxes reduce.
We hope that the information outlined in this insight will help you navigate the changing rules; whether you are an employer with a workforce in China or employee working in China. If you would like to discuss in further detail, please get in touch with your local member firm or one of global mobility services team.