China’s New Individual Income (IIT) Tax Reform 2018
Understanding and complying with the taxation system is vital for any company or individual in China. With many differences from taxation schemes in other countries, and frequent changes, it is important to stay up to date. The latest area to get an overhaul is Individual Income Tax (IIT), which will see the most significant changes in its 38 year history- China Individual Income Tax (IIT) reform due to being implemented starting in October 2018.
The proposed reforms will make changes to many areas of IIT law and implementation. This is not the first time that changes have been made (there have been at least six previous revisions), however most of the previous amendments have been just to tax rates, brackets or permitted deductions. This time the government intends to go further and make deeper changes to the system, in areas such as residency rules and control/enforcement.
This article will look at the new IIT reforms and discuss the following:
- Why such major changes are proposed?
- The main areas of IIT to see changes. These include:
- Changes to tax income categories
- Changes to the tax brackets
- Changes to tax calculation and filing methods
- New method for determining tax residency status
- Deductible taxable benefits changes
- New rules for tax enforcement
- The impact on foreign companies and employees in China
- The expected timetable for implementation of changes
China IIT employment cost calculator
HROne has developed a China employment cost calculator to facilitate the understanding on the total cost breakdown of an employee based in Mainland China. The calculator takes into account the latest Individual Income Tax Reform imposed in October, 2018.
Find out an employee’s net salary and its corresponding Individual Income Tax (IIT) schemes and social insurances (Social Security + Housing Fund) contributions.
What is your employees’ total cost of employment?
Why make changes?
Without doubt, the proposed changes are significant – the most comprehensive since IIT law was introduced in China 38 years ago. Why then is this happening now?
Firstly, there has been an ongoing effort in recent years to move many areas of China’s business, audit and tax laws more in line with international standards and practices. Many of the changes (such as residency tests and increased enforcement) which help achieve this.
Secondly, many of the reforms are a response to the current economic environment in China. Tax revenue has been growing much faster than per capita income and GDP (Many of the reforms (such as widening lower tax brackets and increasing deductions) are therefore aimed at lowering the tax burden for low and mid-level earners, and with it increasing their consumption power.
Main areas of change under proposed IIT reform
We group together and describe here the most significant changes that are currently proposed as part of the IIT reform. Note that some of these areas may be modified or further defined before implementation.
1. Changes to Income categories
One of the major proposals in the IIT reform is the revision of the tax categories and structure. This will remain the case, but wages and salaries will be joined by service income, author’s remuneration and royalties () to form a single consolidated category known as “comprehensive income.” This aggregate income will then be taxed on the same progressive scale.
In addition, operations income from sole proprietors and merchant’s production and business operation, and income from contracting / leasing services will be combined into a single category of “business operation income,” again with aggregate banded progressive tax rates.
Taxation of other areas of interest and dividends, leasing / transfer of properties, contingent and other forms of incomes will remain the same at a fixed rate of 20%.
The following table summarises these proposed changes.
2. Changes to taxation brackets
One of the reasons for the changes to IIT is to lessen the tax burden for those on lower incomes. Under the new IIT scheme, comprehensive income (which includes all standard wages and salaries) is taxed using the same seven band progressive system (from 3% to 45%) as, but the lower bands have been widened. The higher bands remain the same. This means more people will be able to access the lower IIT rates.
In addition, there is a second progressive tax system for business operation incomes. For this, all five bands have been significantly expanded, as shown in the table below.
3. Changes to tax calculation and filing
Unlike many of the previous revisions to IIT, the current proposals don’t just change the tax rates and bands, they make some significant changes to the tax system itself.
One of the most relevant such changes for foreign companies is the alteration of the tax assessment basis. Currently all IIT is assessed monthly, but this will change under the new system. Resident taxpayers will be assessed annually, whilst non-residents will continue to be assessed monthly.
For tax residents, this will be handled as advance tax payment withheld and remitted by the payer monthly, and an adjustment / settlement carried out by the taxpayer annually after the year end.
Another major change is the introduction of individual IDs for taxpayers. This is not currently enforced, but under the reformed system each taxpayer will be assigned an ID
4. New method for determining tax residency status
One of the major changes for foreign nationals working in China will be the proposed alteration to the determination of residency status for IIT. This will move to a more internationally recognised “183-day” test whereby any individual spending 183 days or more per the calendar year in China will be considered resident for tax purposes.
Any resident taxpayer (so those who meet this 183 days test as well as Chinese domiciled individuals) will then be subject to tax on their worldwide income, not just China-sourced income.
At present, it is easier for non-domiciled individuals to avoid this, under the current “5-year” rule, with the ability to reset the 5 years required for residency with 91 days absence within a year.
5. Deductible taxable benefit changes
There are 2 areas of change proposed to IIT deductions:
The first of these relates to the personal deduction for comprehensive income. This will be increased (with effect from 1 October 2018) to 5,000 RMB per month
- Housing rent and loan/mortgage interest
- Health care costs for serious illness
- Education expenses for children
- Expenses for continuing education
- Support for elderly parents
As part of the IIT reforms, new laws will be introduced that give authorities more power in the areas of tax anti-avoidance. This has to date been weakly defined in IIT law. In particular, tax authorities will have more power to initiate tax adjustments and collect additional tax required in the following areas:
- Where transactions between related parties do not confirm with the “arm’s length principle.”
Where a resident taxpayer controls an enterprise in a jurisdiction with a significantly lower tax rate (so-called “tax havens”), and does not distribute profits, or distributes less than it should without business justification.
Any other commercial arrangement that is structured to allow an individual to obtain improper tax benefits, without a reasonable business purpose.
In addition, a number of new anti-tax avoidance measures will be made available to tax authorities. These are still to be fully defined but drafts include new arrangements for sharing information between relevant authorities, and the ability to link taxpayer and withholding agent’s information to credit information systems.
On 2018-10-20 Ministry of Finance and State Administration of Taxation released a first draft of Interim Measures for the Special Additional Deduction of Individual Income Tax, the interim is open to comments until 2018-11-04.
The interim proposes expenses in six sectors can that can be deducted from the taxable individual income.
1. Children`s Education
12,000 RMB per year per child (1,000 RMB per month per child). Both parents can deduce 50% or one parent can deduce 100%. Includes pre-school education and academic education.
2. Continuing Education
Whilst receiving continuing education, 4,800 RMB per year (400 RMB per month during the academic education period). For the year receiving the relevant professional certificate, 3,600 RMB per year.
3. Severe Diseases
Severe Diseases Medical expense is the part exceeding 15,000 RMB of the self-paid part of the Social Health Insurance (includes diseases not covered in the Medical Insurance Catalogue). Capped at 60,000 RMB per year.
(Deducted by the taxpayers themselves during the individual income tax annual return)
4. Mortgage Interests
If the taxpayer or its spouse purchase the first house using loans from commercial banks or housing fund, whilst repaying the loans the loans interests are deducted up to 12,000 RMB per year (1,000 RMB per month)
5. House Rents
If the taxpayer and its spouse do not own a house in its working city, the house rent can be deducted in the following manners:
- In the major cities, 14,400 RMB per year (1,200 RMB per month)
- In other cities whose population is over one million, 12,000 RMB per year (1,000 RMB per month)
- In other cities whose population is one million, 9,600 RMB per year (800 RMB per month).
If a couple share the same working city, only one of the two is entitled to the deduction. If the couple works in different cities, both are entitled to the deduction.
6. Care for the elderly
24,000 RMB per year for expenses supporting parents over 60 years old or other legal dependents. The deduction is shared amongst the children and a unique child would have the entire deduction.
Amongst these six kinds of deductions, severe diseases are deducted by the taxpayers themselves when declaring individual annual tax settlement. The other five could be applied for monthly deduction by the withholding person.
Impact on foreigners in China
The IIT revamp of course affects all taxpayers in China, not just foreign residents. We highlight here a few of the areas that foreign companies need to pay particular attention to.
It will become much harder for foreign nationals to be classed as non-resident for tax purposes. If the 183 days residency test is adopted and the 5 years test removed, many more foreign nationals will be taxed as residents. Those affected should look at options and tax treaties etc. in place.
The full situation for IIT deductions is not clear. What items are deductible for non-resident tax payers will be important for many foreigners. Companies offering non-taxable benefit schemes will, of course, have to review this in light of the new rules.
Employer’s obligations for IIT withholding will remain much the same. There may be additional support needed for annual reviews, and for control of new tax IDs.
The new rules for residency, and for anti-tax avoidance, means that high worth individuals with cross border tax and business arrangements, in particular, should fully review their tax situation under the new rules.
Timeline for changes
It should be noted that whilst the Decision has been released for the amendments of the IIT Law, some select aspects will be implemented as of October 2018. Since the new IIT Law is effective as of January 2019, many of the practicalities and application areas are still to be fully defined.
A two-phase implementation of IIT reform is expected:
From 1st October 2018 the new tax rate tables will be introduced, along with the application of the raised standard tax deduction of 5,000 RMB per month.
The remaining changes will all be introduced from 1st January 2019.