Good news on individual income tax in China

Tax exemption for non-cash benefits for foreign passport holders

In China, tax resident employees who do not hold a Chinese passport have been able to receive non-cash benefits from their employers free of individual income tax – if the benefits fall within specified categories and if they are reasonable and agreed in advance in the employment contract. Such categories include expenditures for relocation, housing, children’s education, meals, laundry and Chinese language classes (Guoshuifa [1997] No. 54). All of these items have to be documented through official VAT invoices.

This tax privilege for non-Chinese passport holders was already meant to be abolished as of December 31, 2021, by Caishui [2018] No. 164, but was then extended for another two years until December 31, 2023 by the Ministry of Finance and the State Taxation Administration’s Announcement [2021] No. 43.

Considering the economic importance of this tax privilege for many foreign employees and their employers, this exemption of non-cash benefits has now been further extended by Announcement [2023] No. 29 for another four years until December 31, 2027.

This is remarkable news for two reasons: First, the extension was announced in August, relatively early in the year by Chinese standards, giving foreign companies more time to plan ahead for new employee secondments. Second, the extension covers an additional four years, the term that employee secondments typically run.

Special additional deductions for Chinese employees

Employees with a Chinese passport (as well as those with a foreign passport who do not opt for the above tax exemption for non-cash benefits) can take “special additional deductions” when calculating their taxable income. These include expense items like children’s education, continuing education, medical expenses, mortgage interest, rent and elder care.

Standardized deduction amounts have been introduced or increased by Guofa [2023] No. 13 for the following three items:

• Infant care (i.e. care for children less than 3 years old): RMB 2,000 per month
• Children’s education (for children 3 years and older): increased from RMB 1,000 to RMB 2,000 per month
• Elder care (i.e. for parents): increased from RMB 2,000 to RMB 3,000 per month (an amount that may need to be split among multiple children)

The deductible amounts are standardized and can be claimed via an official app issued by the tax administration, so they typically do not require additional paperwork. It should be noted, however, that the deductible amounts are significantly lower compared to the items subject to non-taxable treatment for non-Chinese passport holders.

Preferential treatment of the annual bonus

Employees in China are entitled to receive their annual bonus once a year subject to a preferential calculation of the tax rate, if certain conditions are fulfilled. Under this treatment, the annual bonus can be separated from other employment income and divided by 12 to identify the applicable tax rate. With that, it is possible to effectively reduce the tax rate progression for higher income brackets.

This preferential treatment goes back to a time when individual income tax was calculated and levied on a monthly instead of an annual basis. The intention back then was to avoid excessive taxation of an annual one-off payment in a specific month.

As of 2019, China migrated to a combination of monthly and annual taxation system for individual income tax purposes. Still, a three-year grandfathering period until December 31, 2021 was implemented for preferential treatment of the annual bonus. The grandfathering period was later extended until December 31, 2023.

This preferential treatment has now been extended for another four years until December 31, 2027 in the Ministry of Finance and the State Taxation Administration’s Announcement [2023] No. 30 – welcome news for all employees, whether they hold a Chinese or foreign passport.

Preferential treatment of equity incentive income

Finally, under China’s rules for individual income tax, preferential treatment is also given to income from equity incentives for employees of listed companies. This preferential treatment has also been prolonged for another four years until December 31, 2027, by the Ministry of Finance and the State Taxation Administration’s Announcement [2023] No. 25.

Conclusion

While all the above is good news for both employees and employers in China, it should be noted that after a period of increased public spending on Covid-related measures, tax authorities are becoming stricter when they review preferential tax treatments. Individuals and companies should therefore pay attention to how such preferential arrangements are applied in practice and whether the amounts involved are reasonable. Moreover, they should be sure to retain any supporting documents. Finally, professional support should be sought whenever doubts arise as to which actions are appropriate.