Tax reform for individual income tax (IIT) in China has continued to progress with the publication of the final implementation regulations in December 2018. In the first of two articles, we look at the changes addressing domestic taxpayers in China and the corresponding implications for employers. The second of our articles addresses the preferential taxation of certain income and benefits as well as international assignees.
The implementation regulations published on 22 December 2018 provide domestic Chinese taxpayers with increased detail on the proposed forthcoming regulations impacting tax residency, tax reliefs and clarification on when an individual is required to file an annual tax return (ie a tax reconciliation). For domestic Chinese employees, long-term foreign residents of China and international businesses with a presence in China, reviewing and understanding the impact of the proposed rules will be important given the short timeframe before the regulations come into effect.
With potential changes that include new tax reliefs, businesses should review whether assignee and employee tax costs can be mitigated in the future, while understanding and preparing for the compliance considerations associated with these.
Clarification of tax reform in China
The announcement of the final implementation rules of the PRC IIT reform and the Practice Guidance of Additional Special Deduction further refine and clarify the changes and amendments of individual income tax reform that were published earlier in 2018. The key pronouncements in the final regulations are as following:
Five-year rule is replaced by six-year rule
For an individual who is not domiciled in China and who has been present in China for no more than six consecutive years (a year is counted where an individual is in China for more than 183 days), non-China-sourced income which is not borne by a Chinese enterprise, public institution, and other applicable economic organisations is not subject to China tax.
To maintain such tax treatment, an individual can undertake travel outside mainland China for a period of more than 30 consecutive days in a calendar year to ‘break’ the six-year rule on or before the sixth year. Individuals present in China for more than six years are taxable on their worldwide income.
Comparing the draft rules and regulations, the existing five-year rule has been replaced by a new six-year rule. For individuals who are non-China domiciles and who may meet the five-year residence rule in 2018, may now be able to break this in 2019 and be regarded as having not spent six consecutive years in China. The Individual taxpayers who are impacted by the change and may benefit from more limited taxation in China should note that absence from China that crosses two calendar years will not qualify for breaking the six-year rule.
Guidance on additional special deductions
The new tax law allows tax residents to take additional special deductions that can reduce taxable income. These deductions now include children’s education, post-school education, serious illness medical expenses, mortgage loan interest, rental payment deduction and support for the elderly relatives. The final implementation rules further clarify the specific standard and applicable scope of these special deductions (detailed content as below table listed).
|Additional special deduction items||Deduction standard||Deduction method||Withholding timing|
|Child education||RMB 1,000/month/ child||Standard deduction||Monthly withholding or annual reconciliation|
|Post-school education||RMB 4,800/year during the academic education (maximum 48 months)||Standard deduction||Monthly withholding or annual reconciliation|
RMB 3,600 for the year get the qualification for:
|Standard deduction||Annual reconciliation in the year of obtaining the relevant certificates|
|Serious illness medical expense||Limit to RMB80,000/year||Base on the actual medical expenses which is higher than RMB15,000 (with maximum limit)||Annual reconciliation|
|Mortgage interest||A fixed deduction of RMB1,000/month (maximum 240 months)||Standard deduction||Monthly withholding or annual reconciliation|
|Rental expenses||RMBRMB800/month, 1,100/month or 1,500/month according to locating city||Standard deduction||Monthly withholding or annual reconciliation|
|Support for elderly relatives||Only child: RMB2,000/year)||Standard deduction||Monthly withholding or annual reconciliation|
|Not only child: RMB1,000/month should be allocated to siblings as well|
Some items, subject to an annual cap have been changed to a monthly cap and for some there are limitations on the deduction period.
The above deductions can also be the responsibility of an employer to process through payroll. An employee will be able to provide deduction information to an employer for inclusion in payroll as a monthly deduction. This correspondingly has the potential to greatly increase payroll compliance burdens where deduction information and supporting documentation is provided monthly. Alternatively, employees can retain information and apply a for deduction in their annual tax return (tax reconciliation).
It is important to note that the previous draft rules about the above benefit-in kind allowed for the tax efficient treatment to also apply to international assignees and expatriates (ie non-Chinese persons) working in China. These are not included in the final version of the tax law and this applies only to domestic Chinese employees. Separate regulations have been published in respect of the existing tax efficient benefits for international assignees which are discussed further in our second article.
Individuals who are regarded as tax residents will now be required to complete an annual tax return (reconciliation). This will apply for those persons who derive income from two or more sources, if they earn ‘comprehensive’ income other than just employment income (for example, service fee, author fee or royalty fee. Similarly, if deductions are being claimed resulting in an overpayment of tax, or if tax withheld is lower than the tax payable a reconciliation will be required.
Deletion of transfer of property regulations
In the final version of implementation rule, the regulations regarding actions deemed as a transfer of property have been removed. The previous draft implementation rules provided clarity on the tax implications of asset exchanges, property donations, debt repayment, sponsorship, investment and other transactions. These may have been deemed to be transfers of property unless otherwise stipulated by the administration department of finance and taxation under the state council. Where deemed a transfer, assets could be taxed as property transfer income.
As outlined below however, a basic concept regarding avoidance of tax has been retained in the new tax laws. It is expected that the China tax authority will issue separate regulations in this area in the future.
Anti-tax avoidance regulation
The previous draft regulations defined ‘anti-tax avoidance’ for the first time, including certain transactions that include:
- related parties
- independence trade principle
- control clauses
- where the actual tax burden is obviously low
- being without reasonable business purpose.
These terms have not been included in the final implementation rules published in December 2018. Basic concept regarding avoid of tax is in IIT new laws.
Regulation of withholding reporting and self-reporting
Based on further definition and verification about the withholding obligation of the withholding agent and the annual reconciliation obligation of the taxpayer in the final implementation rules, the State Administration of Taxation announced the ‘Bulletin on publishing the administrative measures of the PRC individual income tax experiment’ and the ‘Bulletin about the PRC individual income tax self-reporting questions’ to further emphasise and verify the withholding responsibility as well as self-reporting responsibility, process and requirements of the withholding and taxpayer respectively.
The six-year rule applicable to non-domicile taxpayer - The previous five-year rule applicable for an individual who is not domiciled in China is updated to an extended six-year rule. This extension is aimed at providing non-domiciled individuals a longer period to avoid worldwide taxation in China and shows an effort by the China government to retain foreign talent in China.
Non-taxable benefit-in-kind items applicable for foreign individuals - The regulations regarding a foreign individual’s ability to take advantage of non-taxable benefits-in-kind items has been deleted from the final draft. Companies and employees should however review further changes that may impact these regulations.
Deletion of specific anti-tax avoidance regulation in implementation rule - Initial drafts of the new individual income tax law included an anti-tax avoidance regulation and draft terms. The final version of the implementation rule does not include these rules. It is expected that in future, the China tax authority will issue separate regulations to stipulate tax collection and administration in this area.