Mainland China Individual Income Tax Reform
The Individual Income Tax Law (‘IIT Law’) of Mainland China was introduced in 1980 and has been amended 6 times since.
On 31 August 2018, the Draft Amendment IIT Law, which was released for public feedback on 29 June 2018, was approved by the National People’s Congress (‘NPC’) of the People’s Republic of China (‘PRC’). The new amendments do not only increase the basic personal tax deduction, but it also introduces additional tax deductions to ease individuals’ financial burden. It will be effective from 1 January 2019.
Major Amendments in the New IIT Law
(I) Tax residency rule
The new IIT Law adopts a 183-day rule to define resident and non-resident in Mainland China in accordance with international tax practice. The physical presence threshold for tax residency status has tightened from “a full year” to “183 days”.
An individual who has a domicile or no domicile but spends 183 days or more in Mainland China during the tax year will be considered a “resident” for IIT purpose. A PRC tax resident will be subject to IIT on his/her worldwide income, whilst a non-tax resident will be subject to IIT on income derived from Mainland China. For non-tax resident(s), see further also paragraph (C)(I) below.
(II) Grouping income with similar nature for taxation
The new IIT Law has grouped now four categories of income into one income category, the so-called “Comprehensive Income”, i.e. salary and wages, income from provision of independent personal services, income from author’s remuneration and income from royalties. As a result, one set of progressive tax rates will be applied for determining the IIT of the said Comprehensive Income. PRC tax residents will be taxed on an annual basis while non-residents will still be taxed on a monthly basis or when taxable income arises.
Meanwhile, income from operations, interest/dividend, income from property leasing, income from transfer of asset, incidental income and other income are still taxed separately at the rate prescribed for that category of income.
(III) Adjusting of taxable income brackets
Tax rates on Comprehensive Income – Income under this category will be subject to annual tax instead of monthly; the tax rates will be revised based on the existing rates applicable to salary and wages, i.e. widening the tax brackets with applicable tax rate of 3%, 10%, and 20%; narrowing the 25% tax bracket, and maintaining the tax brackets for three higher levels at 30%, 35% and 45%. The adjustment for taxable income brackets of the middle tax rates will be a great relief for the middle class.
(IV) Raising basic personal tax deduction on Comprehensive Income
The basic deduction amount for Comprehensive Income has raised from CNY 3,500 to CNY 5,000 per month (i.e. CNY 60,000 per year). The extra deduction of CNY 1,300 per month for foreigners will no longer apply.
(V) Set up deductions for special expenditures
In addition to the current deductible items, e.g. basic pension insurance, basic medical insurance, unemployment insurance, housing fund, the new IIT Law has set up additional deductions for specific expenditures, which are closely related to the people’s lives, such as expenditures for dependent children’s education, continuing education, serious illness medical treatments, mortgage interests/rentals for housing and support for the dependent elderly.
With regards to the deductions on special expenditures for foreign workers within the new IIT Law, they are entitled to children’s education, continuing education, mortgage interests/rentals for housing; meanwhile, they may also choose to enjoy the current allowance for children’s education, language training and rental.
(VI) Introducing general anti avoidance rule (‘GAAR’) for individuals
The new IIT Law empowers tax authorities to assess tax on individuals who are involved in transactions such as, asset transfers which are not at arm’s length, tax avoidance by use of offshore tax haven, deriving inappropriate tax benefits through unreasonable commercial arrangements. Where tax is assessed, late payment surcharge would also be imposed accordingly.
Reform’s Impacts on Taxpayers
As a result of the publishing of the new IIT, relevant regulations on deduction for special expenditures as well as regulations on the implementation of IIT have been drafted and released for public comments on 20 October 2018. Generally, the new IIT Law will have the following significant effects on foreign expatriates, frequent travellers working in Mainland China as well as Mainland Chinese high-net-worth individuals:
(I) New tax residency rule
Due to the strict 183-day rule, it would be much easier to become a Mainland Chinese tax resident, and to be subjected to Mainland Chinese IIT on his/her worldwide income. In particular, once the individual has been considered as a PRC tax resident, under the implementation of Common Standard Reporting/Automatic Exchange of Information, the financial information kept by him/her in other jurisdictions might be exchanged to the Mainland Chinese tax authorities automatically.
Another issue is about the existing exemption treatment for the ‘five-year rule’. The regulations on the implementation of IIT has clarified that individuals without domicile in Mainland China will only be subject to IIT on their worldwide income starting from the sixth year if (i) they have resided in Mainland China for 183 days or more each year for the five consecutive years, and have not left Mainland China for 30 days or more in a row during those five years; and (ii) they continue to reside in Mainland China for 183 days or more in the sixth year.
(II) Assets management in foreign jurisdictions
It is not uncommon nowadays for Mainland Chinese residents to set up an offshore company in jurisdictions with lower tax rate, such as Hong Kong, Singapore, Cayman Islands, etc. Due to the introduction of GAAR in the new IIT Law, the distribution of profits to the Mainland Chinese residents who have an interest in offshore companies may be qualified as taxable income by the Mainland Chinese tax authorise, i.e. may be subject to IIT as dividend income at the tax rate of 20%.
(III) Departure tax declaration for immigration purpose
An individual who would like to deregister his/her Mainland Chinese household registration due to migration has to perform a tax clearance. It cannot be guaranteed whether such individual will be required to provide complete information of assets and income derived in Mainland China and even overseas.
The reform of the IIT Law is considered to be the most significant reform of the Mainland China individual tax system since the past 38 years. Preparing for a “soft landing” with regards to the new IIT for Mainland Chinese individuals, foreign expatriates as well as the employers will be high on their agenda.