Tax reform for individual income tax in China is progressing with the publication of implementation regulations on 20 October 2018. The implementation regulations provide 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 tax reconciliation).
For assignees, long-term foreign residents of China and organisations with internationally mobile employees, reviewing and understanding the impact of the proposed rules will be important. With potential changes that include new tax reliefs, businesses should review whether assignee tax costs can be mitigated in the future, while recognising the compliance considerations associated with these. The consultation period for these changes ends in mid-November 2018.
Refining and clarifying the changes and amendments
After the Standing Committee of the National People's Congress approved the ‘Decision on Amending the Individual Income Tax Law (IIT) of the People's Republic of China’ on 31 August 2018, the State Administration of Taxation officially announced the ‘Regulations on the Implementation of the Individual Income Tax Law of the People's Republic of China (draft for soliciting public comments)’ and the Provisional Measures for Additional Special Deduction of Individual Income Tax (for soliciting public comments) on 20 October 2018 to seek public comments for a period of two weeks. It also means the specific implementation rules for reform will soon come to an end.
The announcement of the draft implementation rules of the PRC IIT reform and the draft deduction provision this time further refine and clarify the changes and amendments of the PRC IIT reform. The main contents are as following:
China tax residency
The new tax law clarifies the test for determining whether an individual should be regarded as tax resident, or not resident, in China.
For an individual who is not domiciled in China and who has been present in mainland China for less than five consecutive years, or who has stayed five consecutive years but has a single absence from mainland China for more than 30 days, the individual will be subject to tax only on income that is China-sourced. Non-China-sourced income which is not borne by a Chinese enterprise, public institution or other economic organisation (after the completion of relevant registration with in-charge tax authority) is not subject to China tax.
A tax resident who stays in China for more than five consecutive years and has not undertaken a single period of travel outside mainland China for more than 30 days within five years will be subject to China tax on their worldwide income. This applies from the sixth year of residency and once they have been present in China for more than 183 days in a calendar year.
Guidance on special deductions
The new tax law allows a tax resident to take introductory special deductions that can reduce taxable income. These deductions now include children’s education, post-high school education (including master degree and professional education), serious illness medical expenses, mortgage loan interest, rental payment deduction and support for the elderly relatives.
The maximum deductible annual amount for a resident is RMB55,200 (before inclusion of illness medical expenses for the elderly). The introduction of the deductible limit standard and the requirement set up for the taxpayer to submit information provide greater operational clarity for employers and individuals.
The draft implementation regulations note that expenses may be reviewed by relevant authorities to assess compliance. For employers, the tax withholding agent will undertake an important compliance role in reviewing the applicability and deductibility of expenses in line with the new rules. It will therefore be particularly important for employers to make sure they understand and implement the new regulations effectively from 2019. Additionally a taxpayer may also deduct expenses through their annual tax return (reconciliation filing) without providing information to the withholding agent for processing through payroll.
The tax reform rules shared further clarify the amounts and scope of these special deductions:
|Additional special deduction items||Maximum Deduction||Scope||Withholding timing|
|Child education||RMB 12,000 per annum, per child||
|Monthly withholding or annual reconciliation|
|Post-school education||RMB 4,800 per annum||Academic education||Monthly withholding or annual reconciliation|
|RMB 3,600 per annum||
Skill qualification post-school education
Professional and technical qualification post-school education
|The year of obtaining the relevant certificates|
|Serious illness medical expense||Limit to RMB 60,000 per annum||The part of the medical expenses exceeds RMB 15,000 recorded in the social medical insurance management information system||Annual reconciliation|
|Mortgage interest||A fixed deduction of RMB 12,000 per annum for either husband or wife upon agreement||The loan interest for the first house||Monthly withholding or annual reconciliation|
|Rental expenses||RMB 9600, 12000 or 14,400 according to locating city||Taxpayer or taxpayer’s spouse has no housing in the taxpayer’s main working city||Monthly withholding or annual reconciliation|
|Support for elderly relatives||Only child: RMB 24,000 per annum||The expenses of taxpayers support for parents and other legal supporters aging 60 and over.||Monthly withholding or annual reconciliation|
|Not only child: RMB24,000 per annum should be allocated to siblings as well|
Special deductions must be deducted from a tax resident’s taxable income in the tax year the costs relate to. Deductions cannot be carried forward to the following tax year if the taxpayer is unable to completely deduct the costs in the current year.
For international assignees and expats (ie non-Chinese foreign individuals) working in China, deductions can be taken for children’s education costs, post-school education costs, mortgage interest and rental expenses where they also meet the relevant conditions. Alternatively, international employees in China may choose to continue to benefit from existing provisions that allow for certain employer-provided benefits and expense reimbursement to be regarded as non-taxable. Businesses with international assignees to China should review the impact of the new legislation to identify the most effective approach to managing tax cost in China.
Improve the tax calculation method and foreign tax credit rules
The implementation rules clarify the method of calculating domestic and overseas comprehensive income and operational income. The rules state that taxable income from comprehensive income and operational income sources from within and outside of the China shall be combined and calculated respectively. The credit limit of personal overseas income shall also be calculated by different countries (regions) but not items.
Annual reconciliation of comprehensive income
The draft regulations clarify the specific conditions in which an annual reconciliation filing is required through an individual tax return, summarised as follows:
|Annual tax return (reconciliation filing)||
Annual reconciliation filing requirements
|A tax resident has comprehensive income from two or more sources, and the balance of annual comprehensive income less special deductions exceeds RMB 60,000.|
|A tax resident has employment income, income as an author, or royalties. The balance of annual comprehensive income less the special deductions exceeds RMB 60,000.|
|Tax that is prepaid through withholding is lower than the actual tax payable amount in the tax year.|
|Where it is unclear if an individual is a resident or non-resident, tax should be withheld in line with tax treatment for anon-resident. If the taxpayer determines they should be regarded as a resident an annual reconciliation return is required.|
|Individuals who need to apply for a tax refund should file an annual reconciliation and state the tax refund due. The taxpayer should also provide Chinese bank account details for the refund deposit.|
Anti-tax avoidance definition
The draft regulations define ‘anti-tax avoidance’ for the first time, including:
- related parties
- independence trade principle
- control clauses
- if the actual tax burden is very low
- without reasonable business purpose.
The draft implementing rules refine provisions on anti-tax avoidance and provide welcome clarity on concepts and how anti-avoidance provisions operate. The draft regulations indicate that the Chinese tax authorities will continue to invest in the administration and review of tax compliance for high-net-worth individuals.
Regulation of actions deemed as a transfer of property
In order to be consistent with the current policy, the draft implementation rules provide clarification on the tax implications of asset exchanges, property donations, debt repayment, sponsorship, investment and other transactions. These may be 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 of assets may be taxed as property transfer income.