Coming changes to the Individual Income Tax treatment on expatriates in China

On 27 Dec 2018, the Ministry of Finance (“MOF”) and the State Taxation Administration (“STA”) have jointly stipulated a regulatory circular to clarify the Issues Relating to the Transition of Preferential Policies following the Revision of the Individual Income Tax Law (MOF and STA Public Announcement [2018] No. 164, “Circular 164”). According to Circular 164, two favorable tax policies that have been applicable to the expatriates for a long time will become invalid starting from 1 Jan 2022.

  1. Tax free allowances

Currently, the expatriates working in China can enjoy the individual income tax (“IIT”) exemption on certain benefits-in-kinds provided that those benefits are actually incurred with reasonable amounts and are reimbursed to the employees based on valid tax invoices (regulatory basis: Caishui [1994] No. 20). Applying the above preferential tax treatment, the expatriates in China can benefit from a lower tax rate than the Chinese domiciled individuals who are at the same remuneration levels. For your easy reference, those tax-free benefits generally include:

    1. rental allowances;
    2. meal allowances and laundry expenses;
    3. language training allowance;
    4. children school fees;
    5. home visit expenses (two flights per year of the employee from hometown to China);

Starting from 1 Jan 2022, the foreigners working in China will not be eligible to claim IIT exemption on the tax free benefits (regulatory basis: article 7.2 of Circular 164).

Following the abolishment of the preferential tax treatment, the foreigners can claim the itemized deductions stipulated by the IIT law if those foreigners stay in China for 183 days and above in a calendar year. Considering the itemized deductions shall be limited to the qualified scope and subject to the corresponding deduction limit, the expatriates cannot benefit a lot from the itemized deduction. For example, the deduction limit of the rental expense is RMB 18,000 per year per family in Shanghai, the deduction limit of the children school fee is RMB 12,000 per year per child.

  1. Annual Bonus

According to Circular 164, if an expatriate’s stay time in China reaches the 183-day threshold in a calendar year, he is eligible for a preferential tax treatment on his annual performance bonus. To be specific, the annual bonus will be taxed separately from the other employment income at an applicable IIT rate that is determine by 1/12 of the bonus amount. Such preferential tax treatment on annual bonus will become invalid starting from 1 Jan 2022. The foreigners who stay in China for 183 days and above in a calendar year shall include the annual bonus to his annual income to determine the annual IIT burden (regulatory basis: article 1.1 of Circular 164).

Unless the STA stipulates other preferential rules, the above changes stipulated by Circular 164 will obviously increase the overall tax burden on the employment income derived by the expatriates in China starting from 2022. Considering there are only four months left in 2020, we consider the following measures would help the employer and the employees to get well prepared for the coming changes:

  • review the existing remuneration structure,
  • estimate the potential change to the overall tax burden and
  • Consider the possible ways to manage the cost increase (e.g., allocation of the cost increase).

If you have any questions of the above or need our further assistance, please feel free to contact us.