Keep up with COP28: Key updates from this years event
Tax reform for individual income tax in China has continued to progress with the publication of the final implementation regulations in December 2018. In the second of two articles, we look at the changes addressing tax treatment of international employees in China, changes to preferential tax treatment of bonuses, equity compensation and certain benefits, and the corresponding implications for employers.
Read individual income tax in China - Part 1
With the latest implementation regulations for individual tax reform announced at the end of 2018, China’s Finance Ministry and State Administration of Taxation have jointly published guidance on tax collection and management policies to make sure of a smooth transition to the new tax regime. Bulletin No. 164, published on 27 December 2018, details key changes in regulations for international employees working in China and considerations for the employing companies. Many employers and employees are familiar with preferential tax treatment of certain income items and the changes proposed from 1 January 2019 and again from 2022 can be summarised as follows:
| Policy time regulation | Income type |
| Preferential tax treatment will be cancelled after 2022 |
|
| A separate policy will be published with effect after 2022 |
|
| New treatment implemented from 1 January 2019 |
|
Withholding agents as well as taxpayers should closely review the impact of Bulletin No. 164. Similarly employees should review existing salary and benefit policies to clarify the impact of the new individual income tax regulations on the business and its employees.
Currently, employers may tax an annual bonus paid to a tax resident either by including it in ‘comprehensive income’ (ie total taxable annual employment income) or by applying a preferential tax calculation. The preferential tax calculation can be applied only once annually per employee and applies annual tax rates to the bonus, often resulting in a lower tax liability as the applicable tax rate is lower than on combined, comprehensive income.
Effective from 1 January 2022, the preferential tax treatment on bonuses will no longer apply and an annual bonus paid to a tax resident individual in China must be combined into the current year's comprehensive income to calculate and pay the individual income tax. For many employees, this will result in increased taxes on annual bonuses relative to prior years.
Taking an example, Mr. Zhao, earns RMB 150,000 in 2019 (exclusive of all non-taxable pre-tax deductions and additional special deduction items). In December 2019, he also receives an annual bonus of RMB 40,000. Assuming he has no other employer and other income besides the above income, the tax due is as follows.
| Scenarios | Tax due on comprehensive income | Tax due on annual bonus | Annual tax liability |
|
Scenario 1. Preferential tax treatment |
150,000×20%－16,920＝13,080 | 40,000×10%－210＝3,790 | 16,870 |
|
Scenario 2. Bonus combined into comprehensive income |
150,000×20%－16,920＝13,080 | (150,000＋40,000×20%－16,920) －13,080 ＝8,000 | 21,080 |
| Tax difference | 0 | 4,210 | 4,210 |
It should be noted that there are certain instances where including a bonus in comprehensive income may be beneficial. Employers should review and plan for the distribution of annual bonuses to allow employees to benefit from effective overall taxation in the period until 2022 when the preferential treatment will no longer apply.
The Chinese tax authorities put in place similar preferential tax treatment for equity incentive income in Cai Shui 2005 No. 35. These regulations for the preferential tax treatment of equity incentive income were due to expire on from 1 January 2019.
Bulletin No. 164 states that tax residents who receive qualifying equity incentive income such as stock options, stock appreciation rights, restricted stock units and other equity incentives (equity income), shall continue to benefit from preferential tax treatment until 31 December 2021. From 1 January 2022, tax shall be calculated by including the taxable equity income into comprehensive income.
Taking an example, an individual, Mrs. Li was employed by a domestic listed company and participated in the company's stock option plan. In October 2019, Mrs. Li he exercises options and receives taxable income of RMB60,000. According to Bulletin No.164, Mrs. Li can benefit from preferential tax treatment for her stock option income.
It should be noted that if a tax resident receives equity incentive income two or more times in a tax year, tax shall be calculated by combining the total income and applying the approach above.
Where an individual is paid a one off severance payment as a result of the termination of a labour relationship (this may be in the form of economic compensation, subsistence allowance and other allowances granted by the employer), the payment may not be subject to income tax. This applies if the payment is less than three times the average annual salary of the local city in the prior year. This information is published annually for employers by local authorities, typically in April.
If there is a portion that exceeds the average salary threshold, that amount is taxable. It may not be included in comprehensive income for determining the applicable tax rate. Rather preferential tax treatment may apply and income tax calculated by applying the comprehensive income tax rates separately to this income.
As an example, Miss Sun worked for a company located in Shanghai that terminated her employment contract in October 2019. The employer agreed to pay Miss Sun a severance payment of RMB300,000. Assuming the annual average salary in Shanghai in the prior year was is RMB85,000, Miss Sun is taxable on RMB45,000 only (RMB300,000 – RMB85,000 x3) at applicable full year tax rates.
The new individual income tax regulations published in 2018 outlined a number of new deductions that taxpayers may take to reduce taxable income. These deductions include children’s education, post-school education, serious illness medical expenses, mortgage loan interest, rental payment deduction and support for the elderly relatives. Foreign residents in China have historically been able to benefit from beneficial tax treatment of assignment-related benefits.
From 1 January 2019 to 31 December 2021, foreign China tax residents may choose between taking the new deductions against taxable income or the preferential tax treatment of employer-provided benefits such as a housing allowance, language training costs, children's education costs and other allowances.
| Tax-free allowances for foreign individuals | Special additional deductions | Time of policy application |
| Children education fee | Children education |
|
| Housing allowance | Housing rent or housing loan interest | |
| Language training fee | Post-school education | |
| Home leave allowance | Medical expense for serious illness |
|
| Relocation fee | Support for the elderly relatives | |
| Meal /laundry fee | ----- |
Note that once an employee has chosen an approach for the year, it cannot be changed during that year. For employees whose employment arrangements in China may change and may for example move onto a local contract without common assignment benefits, this should be taken into consideration when planning such arrangements.
The new regulations combine the previous policies on the taxation of commission income for insurance salespersons and securities brokers with the new individual income tax law. All previous regulations have now been abolished. Bulletin No. 164 outlines how taxable income is determined as the amount of income excluding VAT, minus a 20% cost fee and the cost of acquisition, as a further 25% of the amount of income. The cumulative withholding calculation method is applied to calculate income tax.
Commission income earned by securities brokers and salespersons is regarded as remuneration for personal services. Taxable income is calculated after deducting a 20% cost fee and excluding VAT. The net income after deductions is included in comprehensive income and on which income tax is calculated. The cost of business development taken as a deduction for insurance salespersons and securities brokers is calculated at 25% of the amount of income.
When withholding agents pay commission incomes to insurance salespersons and securities brokers, they shall calculate the withholding tax according to the accumulated withholding method detailed in Taxation Announcement No. 61 2018.
If an employer sells a house to employee at a price lower than the fair market purchase price or the construction cost, the difference to the employee's expenditure will continue to be taxed at the preferential annual tax rates. Bulletin No. 164 defines the taxable amount shall not be included in comprehensive income.
Bulletin No. 164 includes additional guidance on the taxation of annuities to retirees and annual performance salary deferred cashing income and term award obtained by the leader of the central enterprise.
We hope you found this summary useful. If you would like to discuss any of the areas raised in this article please contact David Luo, Sherry Chen or Tony Xu from the Grant Thornton China tax team.