Individual Income Tax in China By the end, you will understand: Main Factors of IIT Liability The Influence of the Level of Income The Influence of the Duration of Stay The 5-year Rule Salary Structure Penalties Within a survey of 10 consulting companies the German Institute for Service Quality (DISQ) announced ECOVIS as the Best Auditor for Medium- Sized Enterprises in Germany for 2013!
The Ground Rules First of all, it needs to be clear which portions of the money an expat receives from the employer are deemed to be taxable income by the Chinese authorities. This includes the base salary, incentive compensations such as commissions and bonuses, cash allowances and contributions to an overseas insurance scheme. The tax rate levied on that taxable income then depends on its cumulated amount. China adopts a progressive taxation system where the tax rate for freelancer s incomes progresses in three levels from 20% to 40% and the tax rate for regular employees in seven levels from 3% to 45%. A tax exemption of 4800 RMB per month for expats and of 3500 RMB per month for locals are granted. Furthermore, for each individual taxation grade there is a quick deduction amount that will be exempted for this level of taxable income. Table 1 gives an overview of IIT taxation grades. Main Factors of IIT Liability To understand when foreigners working in China will be liable to pay IIT, it is important to know about several key factors. Whether IIT needs to be paid by an expat in China or how much IIT needs to be paid depends on: How much the expat earns Thus, a quick formula to calculate the IIT burden is: [(Gross Monthly Taxable Income 4800) * Tax Rate] Quick deduction How long the expat stays in China Who bears the expat s income What kind of positions the expat is holding in his host country and home country company Level of Income Duration of Stay and Payment Source Furthermore, it has to be determined which part of the worldwide income the expat might receive for various assignments from various sources is deemed taxable in China. The second important factor in determining an expat s IIT liability is therefore the duration of his/her stay in China. The relevant thresholds for IIT liability are 1 day, 90 (respectively 183) days, 1 year and 5 years. In combination with the third important factor, the source of payment for the expat s income, we can then determine which part of his/her worldwide income an expat needs to pay IIT in China. 2
Grade Gross Monthly Taxable Income (RMB) Tax Rate (%) Quick Deduction 1 1.500 3 0 2 > 1.500 4.500 10 105 3 > 4.500 9.000 20 555 4 > 9.000 35.000 25 1005 5 > 35.000 55.000 30 2755 6 > 55.000 80.000 35 5505 7 > 80.000 45 13505 Table 1: Overview of IIT Taxation Grades If the expat is being paid for his assignment in China by a Chinese company i.e. his income is borne by a Chinese legal entity then he/she will be liable to pay IIT from his first day on. In contrast, if the expat s income derived from China is borne by an overseas entity, and he/she stays in China for more than 90 days, this income is subject to PRC IIT. If there is a tax treaty between China and the expat s home country, this threshold is usually extended to 183 days. well. If he stays in China for less than a year, he will not have to pay IIT on the income derived outside of China. However, there is one exemption to this. In the case where the expat should hold a dual senior management role in China and another country and should the payment for his work outside of China be borne by a Chinese entity, then the expat will have to pay IIT on the income derived from out of China from the very first day. Furthermore an expat might not only have to pay IIT in China on his income derived from activities in China, but possibly also on additional income derived from outside of China. Again, IIT liability on worldwide income depends on the duration of stay and the source of payment for that income. If the expat s out-of-china income is borne by a Chinese legal entity and the expat stays in China for more than one year, he will have to pay IIT on this income as The final and most tax-intensive case where the expat will be liable to pay Chinese IIT on his worldwide income is referred to as the Five-Year-Rule. It applies when the expat has been staying in China continuously for a period of more than five years, i.e. has been a tax resident for more than five years. Then, all income derived from overseas and borne by overseas entities will also fall under the Chinese IIT regime. Table 2 gives an overview of the discussed scenarios. 3
Period in China Income derived from China Income derived out of China (e.g. Germany) Income borne by China entity Income borne by Overseas entity Income borne by China entity Income borne by Overseas entity 90 days 183 days (with treaty) Pay Exempted Exempted* Exempted > 90/183 days but < 1 year Pay Pay Exempted* Exempted 1 year and 5 years Pay Pay Pay Exempted > 5 years Pay Pay Pay Pay * taxable for expatriates who hold dual senior management role. Table 2: Overview of Discussed Scenarios Practical Advice However, the 5-year-rule does not necessarily apply to every expat who would like to live in China for a prolonged period of more than 5 years. There are two possible scenarios in which IIT liability on the expat s world income could be avoided. 5-year-rule Five years is an important threshold for determining expat IIT liability: an expat who is a tax resident in China for a consecutive five years will have to pay PRC IIT on all of his income, no matter where it was derived and no matter by whom it is borne. That is, after five years of tax residency an expat will be taxed in China on his/her worldwide income. This rule should always be kept in mind, since going over the 5 years can significantly increase an expat s tax burden. Scenario 1: Before the fifth year The first scenario is that the expat leaves China, be it for business purposes or for visiting his home country, for more than 90 days consecutively or more than 30 days for a single trip within any given year before he/she has been a tax resident for 5 years. By doing this, the expat has broken tax residency and the clock for the 5-year-rule will be reset. For example, the expat can arrange to leave China for the necessary time period in the fifth year of his tax residency. Upon his return, tax residency will then be calculated from year one again. 4
Scenario 2: After the fifth year In the second scenario the expat might have missed the deadline for leaving China for an appropriate amount of days and has already been a tax resident for more than 5 years. Now there are two possibilities for the expat: (1) For the sixth year, the expat could arrange to spend more than 90 consecutive or more than 30 days in a single trip outside of China. This would mean that the expat has broken tax residency in this year. All of his China source income will be subject to IIT, but his world income will not be. However, this measure will not reset the clock of the 5-year-rule and has to be repeated in the seventh and all the following years. (2) If in the sixth year the expat stays in China for less than 183/90 days (depending on the tax treaty between his home country and China) then the tax residency is also broken. Only his/her China source income borne by a Chinese entity will be subject to IIT. Furthermore, the clock of the five year rule will also be reset and this measure thus does not need to be repeated every year. In other words, if the expat manages to travel out of China for more than half/three quarters of the sixth year, the five-year-rule will not be applicable anymore. In addition, upon his return, his tax residency will be calculated from year one again. Salary Structure Apart from considerations of basic IIT liability on different parts of the expat s income, there are also tips on keeping the IIT that the expat already needs to pay at a reasonable level. A very effective method of reducing the IIT burden is to structure the expat s salary in the right way. When designing the expat s labor contract, the employer and employee can cooperate to achieve a higher net salary for the expat while keeping the gross salary low at the same time an arrangement both sides will benefit from. There are two possibilities for doing this: the introduction of fringe benefits into the labor contract and the introduction of an annual bonus. Tax Exemption for Fringe Benefits For foreign nationals working in China the Chinese regulations allow for certain benefits provided by the employer to be exempt from IIT, i.e. those benefits will not be part of the expat s taxable income. This includes the Chinese social security insurances, allowances for meals, laundry, relocation and housing, home-leave for the expat for up to 2 round-trips per year, fees for Chinese language training and tuition fees for the education of the expat s children. For such benefits to be tax-exempt, certain conditions need to be met. Otherwise they will be treated as normal taxable income. First of all, the overall amount of benefits provided has to be reasonable, which means it generally should not exceed about 30-40% of the gross base salary. Furthermore, the benefits cannot be provided on a cash basis, but rather need to be paid to the employee on a non-cash or reimbursement basis, for which an official tax receipt (Fapiao) is mandatory. For example, a housing allowance can only be taxexempt if (a) either the employer pays rent to the landlord directly or if (b) the employee pays the rent on his own and then provides the Fapiao for his/her payment to the employer, who reimburses the amount. 5
All in all, this means that for the benefits provided, supporting documentation has to be kept, including for example lease agreements, Fapiao and of course the employment contract, which needs to contain a detailed and correct account of all applied benefits. This should always be kept in mind when implementing this type of salary structure in practice. Three of the four bonus payments will be treated as being part of the base salary: the amount of those bonus payments will be divided by twelve and added to the monthly base salary in order to determine the tax rate. Note that in some cases, when the base salary is lower than in this example, this might also lead to the base salary itself being taxed with a higher rate, since adding the bonus payments could push the salary in to a higher tax bracket. In our case however, the base salary with the bonus payments will still be taxed with a rate of 45%. The IIT burden on this part of the bonus is therefore: 3* RMB 50,000 * 0.45 = RMB 67,500 Structure of Annual Bonus Another way of structuring a salary to reduce the IIT burden for (foreign and Chinese) employees is the implementation of an annual bonus. Such a bonus will receive preferential tax treatment: it will be divided by twelve to determine the corresponding monthly amount and will be taxed according to the respective tax bracket of this monthly amount. This leads to lower taxation than the same amount being paid together with the monthly salary. However, this preferential treatment will only be applied to one bonus payment per year, other bonus payments will be taxed with the regular rates. An example serves to illustrate this: Scenario 1: Quarterly bonus Assume an employee with a base salary of RMB 85,000 per month and a quarterly bonus of RMB 50,000. The tax rate for the base salary is 45% and the IIT burden on it will be RMB 22,585. This is calculated by: [(85,000 4,800) * 0.45] 13,505 = 22,585 The fourth bonus payment however will receive preferential treatment and be taxed with a rate of 10%, since this corresponds to the tax rate that one twelfth (50,000/12 = RMB 4,167) of the bonus would be taxed with. The IIT burden on this part is therefore: (RMB 50,000 * 0.1) 105 = RMB 4,895 The total IIT burden on the bonus is now RMB 72,395. Scenario 2: Annual bonus Consider now an employee with the same base salary of RMB 85,000 and the same total annual bonus amount of RMB 200,000, but paid only once per year instead of quarterly. The tax burden on the base salary is of course still RMB 22,585. The tax burden on the bonus is lower though, since the whole bonus now receives preferential treatment. It will be taxed with a rate of 25%, as the amount of one twelfth of the bonus (200,000/12 = RMB 16,667) falls into this tax bracket. The IIT burden on the bonus is therefore: (RMB 200,000 * 0.25) 1,005 = RMB 48,995 As opposed to the first scenario, a total of RMB 23,400 per year can be saved on IIT: RMB 72,395 RMB 48,995 = RMB 23,400 6
Did you know? By violating any of the described regulation concerning the individual income tax in China, you will be responsible and can face the potential penalties as outlined in the table below. It is not an issue that should be taken lightly. Violation Penalties Late filing RMB 10,000 Late payment surcharge 0.05% per day Under-declaration of IIT by tax payer 50 % - 500 % Tax payer involved in falsifications and misreporting of figures RMB 50,000 7
One specialist covers only his area ECOVIS Over 4,500 employees in more than 50 countries Tax advisors Auditors Accountants Lawyers Your contact in Beijing a team of specialists masters everything. Richard Hoffmann Grace Shi Partner Partner Phone: +86 (0)10-65616609 (811) Phone: +86 (0)10-65616609 (806) Mobile: +86 (0)18601318781 Mobile: +86 (0)18610805757 Fax: +86 (0)10-65616501 Fax: +86 (0)10-65616501 E-Mail: richard.hoffmann@ecovis.com E-Mail: grace.shi@ecovis.com Internet: www.ecovis-beijing.com ECOVIS R&G Consulting Ltd (BJ) Room 10820, Building A, Galaxy Soho, No.7A Xiao Pai Fang Hutong, Dongcheng District, Beijing, 100010 P.R.China About ECOVIS R&G Consulting Ltd. WWW.ECOVIS.COM ECOVIS is a leading global consulting firm originating from Germany. It has over 4,500 professionals in more than 50 countries. Its consulting focus and core competencies lie in the area of tax consulting, accounting & auditing, and legal advice. Furthermore, ECOVIS has been announced the best auditor for medium-sized enterprises in Germany. Our team at ECOVIS R&G Consulting Ltd. Beijing consists of highly qualified and experienced international and Chinese professionals, including Certified Public Accountants (CPA), Certified Tax Agents (CTA), and Attorneys at Law (LL.M.). Our expertise and competences ensures all around professional service for our international clients. As needed by clients our international staff speaks Chinese (Mandarin), English, and German. A member of ECOVIS International tax advisors accountants auditors lawyers in Argentina, Austria, Belarus, Belgium, Bulgaria, China, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Great Britain, Greece, Hong Kong, Hungary, India, Indonesia, Ireland, Italy, Japan, Republic of Korea, Latvia, Lichtenstein, Lithuania, Luxembourg, Republic of Macedonia, Malaysia, Malta, Mexico, Netherlands, Norway, Poland, Portugal, Qatar, Romania, Russia, Serbia, Singapore, Slovak Republic, Slovenia, Spain, Sweden, Switzerland, Tunisia, Turkey, Ukraine, USA (associated partners) and Vietnam. ECOVIS International is a Swiss association. Each Ecovis Member Firm is an independent legal entity in its own country and is only liable for its own acts or omissions, not those of any other entity. ECOVIS R&G Consulting Ltd. (BJ) is a Chinese Member Firm of Ecovis International. 8