In order to achieve a better income distribution, to reduce the tax burden for taxpayers, to increase the domestic consumption and to boost the economy, the People’s Republic of China has started, in June 2018, a legislative process aiming to reform the Individual Income Tax Law.
The process started on June 19, 2018, with the first draft amendment of the IIT Law, and is still ongoing and further Circulars aiming to clarify several practical issues are expected.
The new Individual Income Tax Law and the subsequent announcements have introduced significant changes in the life of Chinese citizens and foreigners working in China.
Definition of tax residency
The new definition of tax residency is more in line with the international standards and defines as tax resident the individuals who have a domicile in China or individuals without domicile in China but that have resided in China for an aggregate of 183 days or more during the single tax year. On the contrary, individuals who have resided in China for less than 183 days in aggregate during the tax year shall be deemed as non-resident.
Taxpayers without a domicile in the territory of China that have not been tax resident in China for more than six consecutive years can continue to be exempted from the individual income tax on their foreign-sourced income that is not paid by a Chinese resident company or individual. If the individual leaves China for a continuous period of more than 30 days during the period of non-domicile in China, the six-period will restart. However, the six-year rule introduces a put-on-record filing required to claim tax exemption of the foreign-sourced income, and further clarifications are expected to be provided.
No-taxable area increased to 60,000 CNY
The no-taxable area has been raised to 5,000 CNY monthly (or 60,000 CNY yearly). Previously, Chinese citizens were entitled to a threshold of 3,500 CNY monthly, while foreigners were eligible to deduct 4,800 CNY from their monthly income.
Income consolidation and new tax brackets
Income from salaries and wages has been consolidated with the income from the provision of personal services, royalties and author’s remuneration into the comprehensive income. Resident taxpayers will be taxed on an annual basis, and the progressive tax rates have been revised: tax brackets have been widened for lower tax rates.
Income from the production and business operation conducted by self-employed individuals will be considered as business income, taxed according to adjusted rates ranging from 5% to 35%. The taxable income will be the income generated during the year less the deductible expenses incurred during the operations.
Introduction of special additional deductions
Along with the revision of the tax brackets, special additional deductions have been introduced for resident taxpayers, which are related to expenses for children’s education, continuing education, treatment of serious diseases, housing loan interest, house loan, and elderly care. The resident taxpayers that are entitled to benefit of these deductions can enjoy a significant tax relief.
Eligible resident foreign individuals can benefit of the special additional deductions or continue to enjoy the previous allowances for housing, meal, and education. However, from 2022, foreigners will be allowed to enjoy only of the special additional deductions, if eligible.
The taxpayer can enjoy the preferential tax calculation provided for the year-end bonus, by dividing the amount of the bonus by 12 and determining the applicable tax rates, without including the bonus amount into the comprehensive income. Alternatively, tax residents can also choose to include the bonus into the comprehensive income.
From January 1, 2022 taxpayers receiving the year-end bonus shall include the amount received into the comprehensive income of the year and calculate the personal income tax accordingly.
Withholding procedures and final settlement
Resident taxpayers earning a salary are subject to the individual income tax withholding based on the cumulative withholding method, which calculates the amount of withholding tax according to the cumulative tax payable. The other income included in the comprehensive income will be subject to IIT withhold separately.
The resident taxpayers may handle a final settlement of the IIT between March 1 and June 30 following the tax year if the withholding tax on their comprehensive income has not been correctly applied at source, if they earned overseas income, if they apply for a refund or if they earned taxable income in two or more different places.
Non-resident taxpayers will be subject to withholding tax according to the relevant withholding tax rates based on their monthly income.
In certain circumstances, tax authorities are empowered to make tax adjustments based on reasonable methods, especially if the transactions between the parties are not carried out under the arm’s length principle or if they provide improper tax benefits.
The new Individual Income Tax Law entered into force on January 1, 2019