The New China Individual Income Tax (IIT) Law
In this article I will summarize a meeting with AmCham Shanghai and KPMG regarding details about the new individual income tax laws. I wanted to also recognize David Allgaier at Deloitte, a member of AmCham Shanghai and head of the tax committee.
The new laws were discussed at the Chinese thirteenth Congress Session this past June and implemented in the law last Friday (August 31, 2018). The new laws affects everyone – non-Chinese people, Chinese people, and companies. These changes will take effect on January 1, 2019; however, there is a transition period starting from October 2018, which will include some of the new policies, such as the additional income allowance, and some of the current policies, as it will not include the additional deduction categories.
There are three primary changes:
1. Raising the individual tax threshold
2. Consolidation of the income categories
3. Additional new deductible expenses and combining tax bracket categories
In general, David summarized the situation well when he said that there are more questions than answers. As in typical Chinese fashion, the laws were passed but there are a lot of unknowns to the new system. We think there will be more details provided within the coming weeks and plan to write a follow up article then.
Overall the new tax system plans to reduce the tax burden on the middle class and deepen income distribution.
KPMG mentioned that there are ten major changes to the tax policies, three of which are most important to individuals and companies.
1. Tax Residence
Individuals will be considered a tax resident of China if they are in China 183 days or more per year. This differs from current policy where it is based on one year. If individuals spend more than 183 days per year in China, then they are subject to Chinese taxes on worldwide income (such as salary, investments, rent, and other personal income). With this said, if you pay tax to a foreign government, you will get the equivalent percentage in a tax credit. Note that this does not specifically say for those working in China. People that are in China 183 days or more are affected. This extends to tourists, business people, temporary or contract-based workers, etc.
Many people know about the “five year rule” in that if one is out of China for more than 31 days continuously, not including travel days, then their five years will reset, avoiding worldwide tax to China for that amount of time; however, the laws passed last week did not discuss this issue. We will wait for details about this issue soon.
If this does not continue, then this will lead to many considerations for both individuals and organizations.
Firms will consider their hiring practices, depending on who will be responsible for the additional taxes
China recently released guidelines opening more industries for foreign investment and to allow foreigners to start businesses here in such industries. If such a policy is discontinued, it will not promote foreigners to work, do business in China, and/or start a business here as high income earners or high net worth individuals are directly affected
It is too impractical for most people that are working in China or have started a business in China to only be in China for 183 days per year, not including travel days, especially if you have a family here
2.Anti-Avoidance Rules – addressed below in bullet point
3.Deductions
For individual income
Current categories:
Pension payments/housing fund
Commercial health insurance
Additional categories:
Dependent children education, expenses for dependent parents
Continuing education
Mortgage interest/rent
For both individuals and companies, the changes will affect both Chinese and foreign employees
Currently, if you receive a fapiao (Chinese government invoice) then the entire amount is tax exempt, but in the future there may be a cap on the maximum that one can deduct for certain expenses. This is likely to be low because it includes both Chinese and foreigners
Other important notes are below:
Under the new system, tax residents of China will be taxed annually while non-residents will be taxed monthly (when the income arises)
Both foreigners and Chinese will be subject to the same deductions and likely to be filed in the same manner; however, it is unclear, at this time, how the filing of the tax returns will work
For both foreigners and Chinese, the first 60,000 rmb of salary income is likely to be not taxed, if you are eligible to itemize, but if you are not eligible to itemize then it is likely that this is taxed
Much like in the US system, tax payments will be made in advance and between March 1 and June 30 of the following year tax filing will be conducted. If you will be subject to worldwide tax to China, then you can file for extensions in China until your foreign returns are submitted, as some investments overseas do take longer than the Chinese timeframe to post results
The Chinese Government plans to use all resources available to them to acquire the information about individuals around the world, such as public information, government sharing systems, information within other government departments, treaties, etc
Chinese tax rules and definitions will apply, so for example, if investments are tax exempt overseas, but not in China then it will be taxable in China. This also means some deductions may apply overseas but not in China
China taxes on a gross basis and not a net basis
If an overseas jointly owned asset earns interest or income, then it will also be taxed by China, regardless of the China status of the other person
For an employee of a company overseas, if they are sent to China, then they are subject to Chinese tax, even if they are not paid in China as according to Chinese taxes it depends on where the work was done, and this has not changed
Expenses outside China are not tax deductible on the worldwide tax assessment by China
Other implications:
This will particularly affect people that have investments in tax haven places, if they are subject to worldwide taxes paid to China, because then no tax credits will be given for those investments (as mentioned about tax credits above)
The question of who will pay for the additional taxes, whether the employer or the employee is important for both individuals and companies to consider, and this could lead to further employee management and acquisition changes
We are likely to see some small variations to the new tax laws in its implementation between cities
It is unclear about possible inquires and consequences from other government departments, for example, if you hold a travel or business visa here and spend more than the 183 days per year in China. For example, your true intentions and how you are financing your life in China could be subject to further questioning
A follow up article will follow when more information is released.
About the Authors:
Julian runs a company that works with individuals and organizations doing business between the US, China, and Africa. He has been based in China for a number of years.