2021 marks three years since the reform of individual income tax (IIT) in China and is also the final year of the transitional period for certain tax efficient policies that have benefitted employers and employees for many years. This includes the preferential tax treatment of annual bonuses and tax exemptions for certain 'benefits-in-kind' for foreign employees.
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At the time of tax reform in 2018, no guidance was shared on whether these preferential policies will continue after the transitional period. The potential increased individual income tax burden and the uncertainty has attracted the attention of both employers and employees.

In addition to changes in national regulations, regional developments are providing tax efficiencies tied to economic stimulus activities. Hainan Province, the Greater Bay Area and other regions/areas have implemented a series of special IIT incentives for international employees and financial incentives for companies for the acquisition and retention of talent.

These developments are occurring at a time when the China tax authority has enhanced its capability to analyse ‘big data’, and in turn, is targeting companies and even industries for tax audits where taxation is not compliantly managed.

Changes in preferential tax treatment for annual bonuses

From 1 January 2022 annual bonus payments made to a China tax resident shall be taxed alongside ‘comprehensive income’. Accordingly, the ability to efficiently tax bonus payments by applying annual tax bands and rates will cease to apply after tax year 2021.

Importantly, annual bonuses paid to non-residents of China still benefit from preferential tax treatment and this policy can be applied on an ongoing basis until there is a further regulation update. For companies with internationally mobile employees, it will be important to identify the implications for year-end bonus payments, incentive payments falling into the new tax year. Similarly companies with internationally mobile employees into or out of China should review the potential tax residency of forthcoming employee relocation to determine whether the continuing preferential treatment could be applied.

Non-taxable treatment of certain benefit for foreign individuals

Since tax year 2018, foreign employees have been able to choose tax efficiencies when they become China tax resident. This has been either the special additional deductions available to other Chinese residents, or tax exemption on certain expat 'benefits-in-kind' such as accommodation costs, language training expenses, and children education. For many international companies, these has provided a significant benefit in reducing tax costs for mobile employees. The expat benefit policy is valid only until the end of tax year 2021.

From 1 January 2022, foreign employees will no longer be able to benefit from the preferential policy providing tax exemptions for housing allowances, language training costs and children’s education fees. The more limited benefits available to other China tax residents will continue to apply, however where the company settles China tax due, perhaps under a tax equalisation policy, these expat benefits will incur a more significant tax cost from tax year 2022.

Income tax incentives and local financial incentives

With the announcement of the 'Notice on the Individual Income Tax Policy for High-end and Shortage Talents in Hainan Free Trade Port' (Cai Shui [2020] No. 32), the preferential personal tax policy for Hainan Free Trade Port has been officially implemented.

For highly qualified and scarce talent as defined in the regulations (including foreigners, Hong Kong, Macao, Taiwan and Chinese nationals) working in Hainan Free Trade Port, their comprehensive income, including salary, labour remuneration, author remuneration and royalties, as well as business income derived from the Hainan Free Trade Port, the amount of income tax paid in excess of a rate of 15% shall be refunded. This applies from tax year 2021 and accordingly the authorities are in the process of refunding through the 2020 annual tax reconciliation.

In addition to Hainan, there is also a similar policy for cities in the Greater Bay Area to attract and retain qualified high-end foreign talents. According to the policy, individuals who meet the relevant conditions may apply for financial subsidies for their comprehensive income, business operational income and subsidised income received from selected talent projects or talent projects that are higher than 15% of their taxable income.

Given China IIT applies at rates up to 45%, this represents a potentially significant tax saving for both employees and employers responsible for paying tax on behalf of their internationally mobile employees. International companies should review activities in China to determine whether they may qualify for these benefits through new or forthcoming business activity.

Insights from Grant Thornton

The termination of the annual bonus policy will affect employees at different levels. From the enterprise's perspective, it is recommended to review the compensation structure of different employees and anticipate their tax implications. It will be important that companies communicate with their employees to outline the potential impact and seek options for tax optimisation.

Companies should ensure that the existing non-taxable benefits arrangements for expatriate individuals are in compliance and that the corresponding documents are properly categorised and retained if required for tax inspections of employee benefits, such as year-end personal reconciliation and post-period management of the company. Companies should review policy trends and make adjustments in line with changes in the company's overall compensation system, while actively seeking options for tax optimisation.

It is recommended that companies understand and compare the different tax incentives and talent support policies in different areas, consider the business needs of companies, and identify tax planning opportunities. Optimising the tax efficiency of both companies and individuals. Companies should monitor the application process and material requirements in different regions, and make timely applications for the current year within the processing time period given by local authorities during the policy validity period.

In addition, companies are advised to update and refine their internal salary policies and employee application processes in conjunction with the relevant talent recognition criteria, personal tax financial subsidy calculation methods, issuance procedures, social security and visa issues, in order to cope with the regular application demands in the future.

A series of existing preferential policies are being gradually phased out as part of the continuing tax reform in China. At the same time, talent retention and attraction policies have been introduced at both national and regional levels. Aligned to wider business decisions and tax optimisation arrangements, employers should review the availability of new incentives and determine eligibility and benefit as part of their human capital strategy.

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 or Sherry Chen from the Grant Thornton China tax team.