Revisions to the China Tax Law for foreigners
This June, China’s Ministry of Finance has unveiled a series of Draft Amendments to its individual income tax (IIT) Laws. These proposed changes are aimed at easing the tax burden for lower-income earners in particular, while taking a tougher stance on both foreigner workers and high-income earners. Below are summarized parts of the Draft Amendments that may affect foreign in China.
The effects of the proposed changes are fourfold:
- raise the IIT threshold
- consolidate income categories
- introduce new deductible expenses
- tighten the IIT’s overall application and enforcement
Already confirmed by the State Council, the Draft Amendments have now been published for public opinion and will undergo further revision before finally coming into effect on January 1, 2019.
If these proposals are enacted, foreign companies should pay special attention to changes affecting the timing of the tax levy on foreign employees, foreign labor costs, contract profitability, and budgeting requirements, as well as the rippling effects they have on withholding and tax equalizations.
Foreigners living and working in China will now be subject to the 183-day test—a rule that draws upon recognized international practices. This test deems a foreign individual who resides in China for 183 days or more in a year a ‘resident’ and subjects them to Chinese tax on their worldwide income.
How to tell the tax identity of foreign individuals?
Foreign individuals reside in China ≥ 183 days (within a tax year）
Foreign individuals reside in China ＜ 183 days (within a tax year）
This new 183-day-test will replace the previous five-year-rule under which a foreign individual will be subject to Chinese tax on their worldwide income if they live in China for more than five years. Previously, IIT liability contained a well-known loophole whereby foreigners could ‘reset the clock’. The amendments in effect will make it harder for foreigners to avoid paying tax on their worldwide income tax liability by removing this loophole.
The graphic below is the CURRENT calculation of taxable income of foreign individuals. Once the Draft Amendments come into effect, this Five Year Tax Rule is no longer valid. Under the new system, a foreign individual who resides in China for 183 days or more in a year a ‘resident’ and subjects them to Chinese tax on their worldwide income.
For resident taxpayers, the Draft Amendments propose raising the personal deduction on comprehensive income from RMB 3,500 to RMB 5,000 per month, raising the annual threshold to RMB 60,000 per year, to take effect from October 1, 2018.
Additionally, resident taxpayers will be allowed to deduct certain additional items from the comprehensive income. These additional deductible items are categorized as ‘additional itemized deductions for specific expenditures’, which include:
- Education expenses for children
- Expenses for further self-education
- Health care costs for serious illness
- Housing loan interest
- Housing rent
For non-resident taxpayers, the RMB 5,000 per month standard deduction will also be applicable to them, to replace the current RMB 4,800 per month standard deduction.
However, the current deductible allowances applicable to non-resident taxpayers are no longer available. That is to say, the deductibles for non-resident taxpayers are very likely to be shrinking. If you don't know the current deduction and allowance, check the background below.
Foreign individuals employed in China are eligible to a standard deduction of RMB 4,800. On top of this, there are a number of allowances that may be deducted off an individual’s income, including the mandatory Chinese social security payments for foreigners. Note: at the time of writing, not all Chinese cities have implemented social security for foreigners yet.
The Chinese Tax Bureau allows foreign staff to deduct certain “allowances” before calculating the tax burden on their monthly salary. This is something that should be discussed between an employee and employer as part of the discussion of an overall salary package. These include:
- Allowances for housing, meals, relocation, and laundry expenses
- Relocation expenses upon commencement or cessation of employment in China
- Reasonable business travel expenses and two personal trips to the individual’s country of origin
- Reasonable allowances for language training and children’s education
- The tax authorities will only permit these allowances to be deducted if they are included in the employee’s contract. The employee needs to produce an official fapiao (receipt) every month for the expenses, in addition to meeting other conditions.
For comprehensive income: The lower tax brackets have also been expanded—meaning the lower tax rates are now applied on a wider range of income levels, while the higher tax brackets remain the same. Practically, this means that more people can access lower IIT rates.
For example, under the old system, an individual with a taxable income (after deductions) of RMB 10,000 per month will be subject to 25 percent of tax resulting in RMB 1,495 levy every month. Assuming their taxable income remained consistent, in a year they would pay RMB 17,940 in IIT.
Under the new system, an individual with the same taxable income will be subject to a 10 percent tax rate and will only need to pay RMB 9,480 (RMB 790 x 12 months) levy every year. Under the new system, the taxpayer would pay little over half the previous tax amount and save RMB 8,460 per year.
The formulas for calculating an individual’s tax payable are:
Monthly taxable income = Monthly income – RMB 4,800 – Allowances
Tax payable = Monthly taxable income × Applicable tax rate – Quick calculation deduction
The final revision will be coming into effect on January 1, 2019. These proposals form part of larger series of tax reforms being implemented by the Chinese Authorities in order to boost consumption amid a slowing economy. Authorities have promised to cut taxes by more than RMB 800 billion in 2018, which will have the effect of reducing government revenue by over five percent.
Still in its infant stages of development, many of the details of the Draft Amendments are yet to be released—including details of the residency rules for expatriates and elaboration on the implementation and ongoing administration of many of the rules.
If the draft amendment survives the final rounds of scrutiny, the tax burden will be alleviated for the working class of Chinese citizens. The adoption of an annual levy system and the 183-day residence rule also marks a gradual shift towards more international tax practices.