China's Income Tax Changes and Their Impact

After proposed changes in June 2018, amendments to China’s Individual Income Tax (IIT) will go into effect January 2019. These changes will have administrative ramifications on every company in China. In January 2019, the law will increase the reporting and compliance burden of companies: new tax-deductible expenses for Chinese employees, reduction in deductible expenses for the expatriates, new rules of residency for foreigners, and modified tax slabs to ease the burden on low and middle-income employees.

Introduction of Tax Deductible Expenses

Until now, only expatriates could “offset” their tax burden through what is called the special additional deductions. The latest amendment will make all employees, regular Chinese employees as well as expatriates, eligible for the special deductions and lower their IIT obligation. All employees will need to report their expenditures that qualify for the deduction to their employer’s finance or HR departments every month.

Employee expenditures that qualify for special deductions include the following.

  • children’s education
  • self-education
  • treatment of serious illness
  • interest on home loan
  • housing rent

Accounting for all these expenses is expected to increase an employer’s administrative burden, especially as the law is strict about denying valid deductions that employees show. As this amendment will apply to foreigners as well, these individuals now face the prospect of a fewer items that are eligible for tax deductions; flight tickets home, laundry and meal allowances are some deductibles currently allowed for foreigners that may be discontinued.

Changes in Statutory Deduction and IIT Rates

Currently, the amount of salary not liable for taxation, or statutory deduction, is CNY 3,500 for Chinese employees and CNY 4,800 for foreigners. It will be raised to CNY 5,000.

The IIT rate of 3% applies on the current lowest tax bracket of up to CNY 1,500, which will be revised to CNY 3,000.

The tax bracket of CNY 9001-35,000 is currently taxed at 25%, which will be revised to 25,001-35,000. Similar modifications to lower tax brackets will apply from January 2019.

The effect of these revisions is beneficial for Chinese nationals in the country: the tax on an income of CNY 40,000 per month would come down from CNY 8,195 to CNY 6,090, even before including special deductions.

Changes in Residency Requirements

With the announcement of the IIT law amendments, there is some ambiguity regarding taxation requirements for foreigners. On the one hand, the new law reduces the residency period requirement from 1 year to 183 days. This would mean the individual could be taxed.

On the other hand, the “5-year tax rule” is still in force, making a foreigner’s global income taxable in the country only once they have stayed in the country for 5 years or more. It is not clear whether the 5-year requirement will be done away with or not.

New Amendment to Prevent Tax Evasion

The new amendments greatly emphasize keeping tax evasion in check, mainly in the following two ways.

  • Recapturing income earned overseas by the businesses of Chinese residents
  • Giving greater authority to tax officers for review of IIT tax reductions claimed by individuals

In view of these changes, both Chinese residents and foreign-resident taxed individuals in China must review the structure of their global business. Any profit distribution or global income structure that they cannot validate could lead to an expensive tax audit.

Foreign Companies Need to be Prepared

When these IIT changes go into effect, tax compliance will prove a difficult task for foreign companies. It is important to review your payroll and tax declaration processes and have a smooth transition from the current to new process. Additionally, Chinese nationals must learn what supporting documents to collect for claiming tax relief and foreigners whose deductibles have reduced may need to be compensated.

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