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Foreign national employees may see higher taxes under new law

Income taxes for many foreign national employees are expected to increase as a result of amendments to the Individual Income Tax (IIT) Law approved on August 31, 2018. The amendments, which will come into force on January 1, 2019, will also likely result in decreased taxes for most Chinese national employees.

The amendments approved by the Standing Committee of National People Congress generally reflect the proposed revisions in a draft that was circulated this summer.

Some of the key changes include:

• The standard monthly personal deduction is a uniform RMB 5,000, an increase from the current RMB 3,500 that applies to PRC nationals and from the RMB 4,800 for foreign nationals. The RMB 5,000 monthly personal deduction will become effective on October 1, 2018, three months prior to the other changes.

• Chinese nationals and foreign nationals, who are deemed to be PRC tax residents, will be entitled to deductions including children’s tuition, medical expenses, housing rental, and expenses for “elder care”, which are expected to be limited to care for parents and other relatives.

• The top marginal IIT rates of 45%, 35%, and 30% remain unchanged, but the previous marginal rate of 25% will decrease to 20% or 10%, depending on an individual’s annual taxable income. The previous marginal rate of 20% has been reduced to 10%, and the previous lowest marginal rate of 10% will fall to 3%.

• Salaries, wages, service income and royalty fees are aggregated as “comprehensive income” and will all be taxed at the same rates. This represents a major change from the earlier arrangements for taxation of service income, such as fees paid to independent contractors, which had previously been subject to a flat rate of 20%.

• A uniform 20% expense deduction applies to calculate taxable income derived from service income and royalty fees.

• The catch-all category of “other income” has been deleted from the amended IIT law, which may produce uncertainty in the classification of some types of income.

• The period for determining PRC resident taxpayer status of foreign nationals—as well as residents of Hong Kong, Taiwan and Macao— is reduced from the previous threshold of one-year of presence in China to 183 days, thereby more closely aligning with international practice. This change may result in more foreign nationals being subject to PRC tax on salaries and other income paid for services provided outside of China. The new amended IIT law also signals a possible overhaul of the IIT policies applicable to foreign nationals, such as the elimination of the“5-year rule”, meaning that more foreign nationals in China would become subject to income tax on their worldwide income.

• Anti-tax avoidance rules will be introduced in order to provide legal grounds for the Chinese tax authorities to combat tax avoidance. More generally, the tax authorities are expected to tighten their supervision in the future, especially on high net income individuals and their transactions and business structure arrangements.

By introducing the updated IIT rates, a new deduction system, stringent tax resident recognition, anti-tax measures, and a new tax withholding/reporting mechanism, the new IIT law will have significant impact not only on employees, including PRC nationals and foreign nationals, but also on employers.

Standardize social insurance collection may mean increased costs 

Employers and employees may face higher social insurance costs as a result of changes in the way that social insurance contributions are collected, beginning on January 1, 2019.

According to a reform announced by national authorities on July 20, 2018, local tax bureaus will have sole responsibility for the collection of the contributions. Previously, there was no clear ruling on where responsibility lay, leading to a situation where collection was made by social insurance authorities in some jurisdictions, such as in Shanghai and Beijing, and by tax bureaus in others, for example in Guangdong and Jiangsu.

Social insurance contributions are made by employers and employees to fund statutory pension programs, and medical, work injury, unemployment and maternity insurance programs. Funding of social insurance programs has come under increased pressure due to China’s rapidly aging population and shrinking workforce. The reform does not affect the collection of housing fund contributions, which remains the responsibility of housing fund authorities.

With their additional powers to undertake audits and to enforce the law and with greater resources at their disposal, the tax authorities are likely to be more aggressive in collecting contributions than social insurance authorities. In particular, given that they are likely to have more information on employee income and taxation, tax authorities are well placed to prevent the underpayment of contributions by any employer that attempts to use lower employee income as the basis for calculating contributions.

In a related development, on September 19, 2018, the State Council instructed local governments and authorities that they should not initiate unauthorized audits or inspections of employers for historical social insurance underpayments and that they are to maintain their current social insurance contribution arrangements until January 1, 2019. This instruction appears to have come in response to complaints from employers facing audits and inspections during the transitional period in such places as Heilongjiang province, and Changzhou, Jiangsu.

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