Start Preparing for 2022's IIT Reform
In 2018 the Chinese government introduced a new tax reform related to Individual Income Tax (IIT). This policy change will officially be enacted at the beginning of 2022, and is expected to affect all companies that hire foreign employees in China.
You have probably already seen the topic of the new IIT reforms appearing on several event flyers and discussed around on WeChat groups. It has also been at the heart of many meetings at all of the chambers of commerce. And for a good reason; the new reform will intensify the trend we are seeing happening in the last couple of years; less and less expats are relocating to China.
What is the fuss all about?
Frankly speaking, for many years foreigners doing business in China have enjoyed lucrative tax benefits, much more than our local counterparts.
These included allowances and incentives that were added to the salaries (such as rental fees, flights back home, language training, annual bonuses, etc.), and a long line of expenses that were covered by the company.
These incentives were introduced to minimize the challenge of moving far away from home and adapting to what used to be a developing country. But China, as we all know, and especially the main cities, have developed a lot since then.
After these tax benefits have ostensibly achieved their goal, China is now seeking to re-equalize the status of local and foreign taxpayers. Therefore, the updated Individual Income Tax law introduces a new tax system that will affect tax-exemption benefits for foreigners in main three categories: housing, children’s education and language training. The new deduction system will subtract a smaller portion of the overall income.
This regulation is going to take effect in January 2022, which marks the end of the 3-year transition period determined by the government.
What is going to change and how
As all expats with children in international schools know, a foreign expat family does not have the option of sending their children to a Chinese school, and therefore the only available option is an international school, where tuition fees range from 200-300K RMB per child, per year. In terms of housing options, we have all been experiencing the rise in the costs of housing, especially in the big cities where most expat communities live.
What does it mean in practical terms?
Are there ways to prepare?
Increased tax burden for foreign employees
The most apparent outcome of this regulation is a greater IIT payable by foreigners in China and thus a decrease in disposable incomes. In some cases, this change can be radical.
For example: for a family with two children, and considering that at least one of the parents is in a management position (in SH):
Annual income from work – 600,000 RMB
Annual tuition for two children – 400,000 RMB
Annual rental fee – 220,000 RMB
Until now, the IIT was 30-45%, which were deducted solely from the basic salary (tuition and rental fees are subsided by the hiring company). In this example, this means that the employee would pay around 180K in tax.
After the IIT policy implementation, the employee will be required to pay IIT (and the highest tax bracket) for ALL income sources (salary and allowances combined). In the aforementioned example, the calculation is 45% X 1,220,000 RMB, which amounts to 549,000K in income tax. This leaves the employee with much less for family expenses throughout the year.
Based on this calculation, families with more than two children will have to pay for the right to work in China, since their cost of living is predicted to be higher than their work income.
Increased hiring costs for employers
Companies are expected to experience a significant surge in the hiring costs of foreign employees. Although the IIT is a personal tax, the hiring companies will be the ones to bear the costs, so as not to worsen their employee’s conditions and weaken the attractiveness of certain positions.
A survey conducted in February 2021 by the European Chamber of Commerce in Shanghai found that 45% and 28% of respondents rated the tax-exemption benefits on rent and children’s education as the most important benefits in attracting foreign labor to China.
We’ve seen a mix of reactions among foreign companies; Multinational firms are not overly panicked by this expected change. In many cases, employees have already paid their taxes in full, whether in China or their country of origin, and will therefore not be affected. In other cases, a marginal cost for a few dozen employees will not constitute a significant obstacle, due to the companies’ size.
Those most likely to be more affected are SMEs, which usually employ one foreign manager. It is already rather difficult to offer a new manager a relocation to China amidst the COVID-19 pandemic; and for those who founded their own companies, these new costs might even affect the decision whether to stay or close down.
It is important to note that local regulations regarding the enforcement and facilitation of the new IIT reform haven’t been introduced at local levels yet.
In various statements China did declare its intent to promote and increase foreign investment opportunities in China. But like other changes in China’s laws and regulations over the last couple of years, this one too will change the business landscape.
Make sure you prepare accordingly and continue developing with those changes, that is if you want to stay and enjoy the Chinese Dream.
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