China’s Revised Individual Income Tax Law – The Impact on Expats
The People’s Republic of China brought a reform of the Individual Income Tax (IIT) regime into force on 1 January 2019. The amendments, which were approved by the Standing Committee of the National People’s Congress last August, are the most significant revision of the IIT regime in decades and will impact many expatriates working in China.
The new law introduces the concept of ‘resident’ and ‘non-resident’ for personal tax purposes. A new ‘183-day rule’ will replace the previous one-year rule, essentially cutting in half the amount of time a foreign national has to spend in China in order to be considered a tax resident.
The revised IIT regime consolidates four previous categories of income – salaries and wages, remuneration for independent services, author’s remuneration, and income from royalties – into a single category called ‘comprehensive income’. Comprehensive income is subject to progressive tax rates across seven tax brackets ranging from 3 to 45%.
Effective as of 1 October 2018, the lower tax brackets for comprehensive income have been expanded. This means that the lower tax rates are now applied on a wider range of income levels, while the higher tax brackets remain the same.
At the same time, income from production or business operations conducted by self-employed persons will be reclassified as ‘Income from Operations’. Income from operations, interest income, dividends, property leasing, transfer of assets, incidental income and other income will still be taxed separately at the rate prescribed for that category of income.
For China residents, the IIT on comprehensive income is assessed on an annual basis and collected through the withholding of taxes in advance, which are remitted to tax authorities by the payers on a monthly or transactional basis, followed by a final reconciliation and settlement by taxpayers at the time they file their annual tax returns.
For non-residents, the IIT on comprehensive income is assessed on a monthly or transactional basis and generally collected through the withholding of taxes, which are remitted to the tax authorities directly by the payer.
Perhaps the most concerning element of the revision for foreign nationals was how the proposed changes to the definition of tax residence would impact upon the existing ‘five-year rule’ exemption period before their worldwide income – income sourced within and outside of China, regardless of origin – became subject to tax in China.
Crucially, under this rule, foreign nationals could ‘reset the clock’ by spending at least 31 consecutive days (more than 30 days) continuously or 91 days cumulatively abroad in a single Chinese tax year. Following the IIT revision, it was feared that foreign nationals would become subject to worldwide tax after only 183 days.
In December 2018, prior to the new law taking effect, the government clarified these tax residency rules. The ‘five-year rule’ has now been extended to six years for foreigners living and working in Mainland China. This policy includes Taiwan, Hong Kong and Macau passport holders who have moved to Mainland China for employment.
Foreign individuals who have no domicile and are living in China for 183 days or more per calendar year are considered tax residents. However, foreign tax residents can be exempted from Chinese taxation on their overseas income if they stay in China for no more than six years or leave China for at least 31 consecutive days before completing the six-year term and have filed with the relevant tax authorities in advance.
An important change under the new rules, is that foreign national employees will only be able to apply for the existing tax-exempted allowances – such as housing, education, language training and home visits ¬– until 31 December 2021. From 1 January 2022 they will be limited only to ‘special additional deductions’ – children’s education, continuing education expenses, healthcare costs for serious illness, housing mortgage interest, expenses for supporting the elderly and housing rent.
China’s tax authorities have been given additional powers over tax avoidance schemes, particularly in relation to transactions involving non-arm’s length asset transfers and commercial arrangements where inappropriate tax benefits are derived. Government bureaus and institutions will be communicating to minimise tax avoidance and will be fully utilising exchange of information mechanisms under the OECD’s Common Reporting Standard (CRS), to which China is a signatory
Given the scope of the changes and the potential for closer regulatory scrutiny from tax authorities, businesses are advised to assess and implement relevant changes to their payroll policies. Anyone with concerns over their existing arrangements would be advised to contact Sovereign China.
Sovereign China assists clients to maintain a good working relationship with local tax authorities and to ensure that all accounting documents and records are fully compliant by providing a dedicated team of licensed, bilingual tax accountants that is experienced in meeting both international standards and local requirements.
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