On 31 August 2018, the Standing Committee of the National People's Congress passed the Decision on the Amendment to the Individual Income Tax ("IIT") Law (the "Amendment"). Amongst other issues, the Amendment mainly provides for the introduction of the definitions of resident and non-resident taxpayers, the consolidation of four types of labour income, changes to the IIT threshold and the adoption of tax deductions. Some of the amendments, such as a new tax threshold and tax rates, came into effect on 1 October 2018, while the remaining provisions will take effect on 1 January 2019. We have set out a brief summary below.
Key Changes in the Amendment
a) Definitions of resident taxpayer and non-resident taxpayer
The Amendment stipulates that any individual who is domiciled in China, or who has no domicile in China but has stayed in China for 183 days or longer during a single tax year, will be considered to be a Chinese tax resident and shall be subject to IIT on any income derived both inside and outside China.
Expats who have no domicile in China and do not stay in China, or who have no domicile but have stayed within China for less than 183 days in a tax year, will be considered to be non-resident taxpayers, and will only be subject to IIT on income derived inside China.
b) Four types of labour incomes consolidated into one category (“Consolidated Income”) to impose unified new tax rates and threshold
The Amendment consolidates wage and salary income, labour remuneration, author's remuneration and royalties into one category to impose unified progressive tax rates. Currently, these four types of income are taxed separately at different rates. For example, labour remuneration is attributed a fixed 20% tax rate, whilst salary and wages income is subject to progressive tax rates of 3% to 45%. After the Amendment, all four types of income will be taxed on a consolidated basis and new progressive tax rates will be imposed. (See Annex IIT Rates Table).
In addition, the IIT calculation on Consolidated Income will be made annually instead of monthly, which means statutory taxable income will be the balance of the Consolidated Income for the year minus the tax threshold and all statutory deductions. However, the IIT should be pre-paid on a monthly basis and filed annually between 1 March 1 and 30 June in the following year. It is worth mentioning that the IIT threshold for Consolidated Income has been confirmed as RMB 60,000 per year (i.e. RMB 5,000 per month) according to the Amendment.
As mentioned in the first paragraph, the new progressive tax rate table and threshold came into force as of 1 October 2018.
c) Tax deductions
In addition to existing deductions for statutory social security premiums and housing fund contributions, the Amendment allows for a number of specific additional deductions to be made before tax. Expenses that may now be deducted include children's education, continuing education, medical expenses for serious diseases, elderly care, mortgage interest and house rent. ("Specialized Extra Deductions").
Impact on Foreign Expats in China
Compared with existing IIT Law, the Amendment will make it easier for foreign nationals without domicile in China to be recognized as tax residents and thus subject to taxation on their income sourced within and outside China. The tax exemption policy and tax-free allowances previously enjoyed by foreign nationals may also be affected. The details are as follows:
a) Staying in China for 183 days or more in each tax year will trigger resident taxpayer status
Under the existing IIT law, a foreign national without domicile in China is subject to IIT on his/her income sourced outside China only when he/she stays in China for one year or longer, which could be avoided by arranging absence from China (a “Tax Break”).
With the reduction of that threshold from one year to 183 days, however, the tax burden of foreign nationals who have stayed in China for between 183 days and one year could become heavier. It may therefore be prudent for those who have stayed in China for nearly 183 days to consider a Tax Break.
b) Whether the “Five-Years rule” will survive or not remains unclear
According to the current IIT legislation, a foreign national who has stayed in China for longer than one year but fewer than five consecutive full years may still be exempt from IIT on their foreign-sourced income, with the approval of the competent tax authority.
According to an officer of the Ministry of Finance and State Administration of Taxation at a recent press conference, this exemption is likely to be retained. On 20 October 2018, the Ministry of Finance and the State Administration of Taxation jointly issued the Implementation Rules on Individual Income Tax Law of People's Republic of China (Revision and Consultation Draft) (the "Revision Draft"), outlining the draft revisions and seeking public comments on the proposals. The consultation remains open for contributions until 4 November 2018. Article 4 of the Revision Draft suggests amending the existing Five-Years Rule to state that "a foreign national who has stayed in China for longer than 183 days but fewer than five consecutive full years, or who has stayed in China over five years but has any Tax Break of more than 30 consecutive days during this five years may still be exempt from IIT on their foreign-sourced income, if they complete the required filling formalities with the competent tax authority."
We await further information and will keep you updated.
c) Impact of Extra Tax Deductions
Various allowances paid by employers to foreign employees for expenses on housing, meals, home visits, children's education and language training are currently exempt from IIT.
As the Amendment will provide extra tax deductions for both tax residents and non-residents to cover expenses for children's education, continuing education, medical expenses for serious diseases, elderly care expenses, interest of mortgages or house rents etc., it is not yet clear whether the existing exemption policy will continue to apply to foreign expats or whether it will automatically become invalid due to its conflicts with the Amendment.
On 20 October 2018, the Ministry of Finance and the State Administration of Taxation jointly published the Interim Measures for Special Deduction of Individual Income Tax (Solicitation draft) (the "Special Deduction Draft"), and opened a public consultation on these provisions. The Special Deduction Draft suggests that if foreign individuals meet the eligibility conditions for Special Extra Deductions, they may choose between deductions either according to Special Extra Deductions rules, or under the existing deductions rules for foreign nationals. However, the two deduction frameworks cannot both be enjoyed at the same time.
The Special Deduction Draft remains open for public comments. This also means there may be unforeseen changes to the draft provisions, after the consultation has concluded. We will keep you updated on any significant news in relation to these deductions.
Impact on IIT on Annual Bonus
Current IIT legislation provides a preferential rule regarding the calculation of IIT on annual bonuses. Specifically, the annual bonus is divided by 12 to identify the corresponding tax rate which is used to calculate IIT. This special rule lowers the tax burden borne by employees for the annual bonus they receive.
The Amendment, however, introduces Consolidated Income calculated on a yearly basis, which means that annual bonus may be incorporated into employees' consolidated income and thus be taxed at the new progressive tax rates. Therefore, the tax burden will be heavier for taxpayers who receive large annual bonuses or rely on their annual bonus as a major income source, unless specific rules regarding IIT on annual bonus are introduced.