The Fifth Session on the Standing Committee of the 13th National People's Congress voted and adopted the Amendments to the PRC Individual Income Tax Law (Amended IIT Law) on August 31, 2018. This, the seventh amendment to the existing Individual Income Tax Law (IIT Law) since it was promulgated in 1993, is widely regarded as the most influential amendment to the IIT Law so far. It also represents a new beginning for IIT Law reform in China.
In this update, we highlight the major modifications to the existing IIT Law and their impacts on China's tax practices.
WHAT'S NEW?
1. New PRC tax residence rule
The Amended IIT Law adopts a new 183-days test to determine PRC tax residency. The test replaces the current one-full-year test under the existing PRC IIT Law.
A "PRC tax resident" is subject to PRC IIT on income derived from inside and outside of China (ie, worldwide income) and is defined to include an individual:
- having a domicile in China or
- without a domicile in China, but having resided in China for 183 days or more cumulatively within a tax year.
A "PRC non-tax resident" is subject to PRC IIT on income derived from China and is defined to include an individual:
- without a domicile, nor residing in China or
- without a domicile in China, but having resided in China for less than 183 days within a tax year.
The Amended IIT Law is silent as to whether there will be any specific exemption granted for foreign individuals who do not reside permanently in China. For instance, under the existing IIT Law, if a foreign individual with a domicile in China resides more than one full year in China, he or she will not be subject to PRC IIT on his or her worldwide income (but only on salaries and wages sourced from China) until he or she has resided in China for five consecutive full years. Since the implementation rules of the Amended IIT Law have not yet been issued, it remains to be seen whether any specific tax exemption will be available for foreign individuals − in particular whether the aforesaid five-year rule will continue to apply. Nevertheless, even if the five-year rule (which exempts foreign individuals from being subject to IIT on worldwide income) continues, it is likely that foreign individuals will need to leave China for 183 days in the fifth year to ensure a tax year break; if so, these individuals may need to return to their home countries or need to apply for work visas to work in other jurisdictions for 183 days or six months.
We also envisage that this new PRC tax residence rule will have a significant impact on foreign expatriates and frequent travelers working in China, as well as Chinese high-net-worth individuals (HNWI) with foreign passports. A thorough review of the PRC tax position of these individuals will be recommended.
2. Re-categorization of taxable income
The Amended IIT Law re-categorizes different types of income which are subject to IIT at different rates as follows:
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Allowable deductions |
Tax reporting |
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Please note that PRC non-tax residents will only be subject to PRC IIT on their respective salaries and wages, income from remuneration for personal services and manuscripts and income of royalties derived from China at the rates from 3% to 45% on a monthly basis. Such PRC non-tax residents are not required to conduct annual tax reconciliation filings with the competent tax authorities, which PRC tax residents are required to do in respect of their annual comprehensive income at the end of March of the following year.
3. Tax deductible expenses
Under the Amended IIT Law, please note that:
- The standard deduction amount has been increased to RMB60,000 (applicable for PRC tax residents) for calculating the taxable "comprehensive income" for PRC tax residents on an annual basis; and RMB5,000 (ie, RMB60,000/12) for calculating the taxable income of salaries and wages, remuneration for personal services and manuscripts and royalties derived by PRC non-tax residents respectively from China on a monthly basis.
- There are new tax deductible items applicable equally for both local PRC residents and non-residents under the "Specialized Deduction Items" and "Specialized Supplementary Deduction Items." The tax deductible items generally include deductions for dependent education expenses, major illness medical expenses, continued education, mortgage interest, rental expense and elderly care expenses. The relevant standards and conditions for claiming the aforesaid tax deductions will be further determined and announced by the State Council.Under current PRC IIT rules, foreign individuals enjoy tax deductions on certain items; it remains to be clarified whether these deductions will be continued under the new rules.
The above re-categorization of taxable income and introduction of new tax deduction items will likely trigger the taxpayers (both local PRC and foreign individuals), as well as their employers, to review and restructure their remuneration packages and asset/wealth planning in a tax efficient manner.
4. Tax anti-avoidance provisions
The incorporation of tax anti-avoidance provisions into the Amended IIT Law is another significant change to individual taxpayers. With the tax anti-avoidance provisions expressly stated in the Amended IIT Law, the PRC tax authority will now have the authority to make adjustments on any of the following stipulated unreasonable tax arrangements by adopting reasonable methodologies.
- Business transactions between an individual and his or her affiliate which are not carried out under the arm's length principle and not supported by any justifiable reason, and which would result in reduction of the taxable income of the individual or his or her affiliate.
- An enterprise established in a country (region) where the actual tax is obviously lower, which is controlled by a PRC resident or jointly controlled by a PRC resident and a resident enterprise, does not distribute profits that belong to such PRC resident or distributes such profits in a smaller amount, without reasonable business needs.
- An individual who makes other arrangements, without justifiable business purposes, for the purpose of seeking unjustified tax benefits.
While waiting for issuance of the detailed implementations or guidelines on the above tax anti-avoidance provisions, it is advisable for the relevant individuals to review their current tax structure and tax planning arrangements and ascertain whether any modification or restructuring is necessary in light of the newly added tax anti-avoidance provisions.
5. Enhanced tax administration and collection
In order to strengthen the PRC IIT administration and collection, the Amended IIT Law provides the following new measures:
- The Amended IIT Law requires individual taxpayers to file their own IIT returns in certain situations. Among the other situations2 is that of a PRC national who plans to deregister his or her permanent household registration for emigration purposes; in that situation, a new IIT filing obligation will arise. In such case, any outstanding historical IIT liabilities of the relevant individual may need to be settled before the de-registration.
- According to the Amended IIT Law, authorities such as the Ministry of Public Security, the People’s Bank of China and financial supervision authorities are required to assist tax authorities to verify taxpayers’ identities and financial accounts information as needed.
Meanwhile, in support of the taxpayers' claiming tax deduction under the Specialized Supplementary Deduction items, the Ministry of Education, Ministry of Health, Healthcare, Ministry of Civil Affairs, Ministry of Human Resources and Social Security, Ministry of Housing and Urban-Rural Development, the People’s Bank of China and financial supervision authorities should provide the tax authorities with the requisite information as needed.
- The Amended IIT Law also makes it clear that, in the event of transfers of immovable assets (eg, real properties) and shares by an individual, the individual will require to present IIT payment receipts for income so derived from the transfer to the relevant registration authority for completion of the transfer procedures. Prior to the issuance of the Amended IIT Law, local tax authorities might have local regulations on the tax filing and settlement requirements applicable to the transfer of immovable assets and shares, and the practice of local registration authorities in different localities might also vary. The promulgation of the Amended IIT Law provides a unified and clearer guidance to taxpayers in handling the assets and share transfer tax filings with both tax and registration authorities in different jurisdictions in China.
6. Timetable and transitional arrangement
The Amended IIT Law will come into effect on January 1, 2019. Prior to the official effective date, individual taxpayers will be allowed to claim the new standard deduction of a monthly amount of RMB5,000 and apply the new IIT bracket to calculate the monthly IIT payable for the period from October 1, 2018 to December 31, 2018.
