China Tax Alert: Extension of Individual Income Tax Preferential Policies

The extension of the individual income tax (“IIT”) preferential policies, which received great public interest, has finally been announced just before the New Year’s celebrations. On December 29th, 2021, Premier Li Keqiang hosted an executive meeting of the State Council, where three important announcements were made:

The IIT policy of not including annual one-off bonus in the current month's salary income and implementing the monthly progressive tax rate for separate taxation will be extended until the end of 2023;
The exemption of IIT repayment by those whose annual income does not exceed RMB 120,000 and who are required to repay tax not exceeding RMB 400 in annual tax reconciliation will be extended until the end of 2023; and
The IIT policy to separately count equity incentive income for listed companies will be extended till the end of 2022.

Such extension is expected to bring tax savings of RMB 110 billion a year for taxpayers.

On December 31^st, 2021, the State Taxation Administration (“STA”) and the Ministry of Finance (“MOF”) collectively announced the extension of the above policies, i.e., the Pronouncement No. 42.

In parallel, Pronouncement No. 43 was published, indicating that the preferential treatment of tenure reward to representatives of state-owned enterprises and the extension of the tax exemption treatment of benefits in kind for expatriates working in China, such as housing allowance, children education allowance, language training allowance, etc., will be extended until end of 2023.

We hereby provide our comments on the extension of these tax policies for your reference.

RSM COMMENTS

#1: Preferential IIT treatment for annual one-off bonus

On January 1st, 2019, China officially implemented comprehensive income tax mechanism, which means the income from wages and salaries, remuneration for labor, author’s remuneration and royalties are included in annual comprehensive income. However, to achieve a smooth transition, the annual one-off bonus, as wages and salaries, is still eligible under the previous preferential policy until December 31st, 2021 (i.e., dividing the annual one-off bonus by 12 months, using the derived amount to determine the IIT rate and quick deduction according to the monthly IIT rate table and calculating the IIT separately without consolidating it into the annual comprehensive income). The formula is as follows:

Tax payable = Annual one-off bonus x applicable tax rate - quick deduction.

If the policy had not been extended, starting from January 1st, 2022, annual one-off bonus would have been taxed as part of the annual comprehensive income. The impact of such change would have been extensive, particularly for taxpayers who receive most of their income through annual one-off bonus, which would have resulted in a significant reduction in after-tax income.

We have provided two scenarios below to illustrate the difference between IIT liabilities with or without the policy extension.

Scenario 1: Assume the individual is a PRC resident taxpayer with total annual employment income of RMB 672,000, including monthly salary of RMB 50,000 and an annual one-off bonus of RMB 72,000. He only has income from China. His total annual tax payable (without taking into account special deductions and special additional deductions) is calculated as follows:

Type Of Income	Annual Tax Payable With The Extension Of The Policy	Annual Tax Payable Without The Extension Of The Policy
Annual one-off bonus income	72,000 x 10% – 210 = 6,990	(72,000 + 50,000 x 12 - 60,000) x 30% - 52,920 = 130,680
Monthly salary income (full year)	(50,000 x 12 - 60,000) x 30% - 52,920 = 109,080	(72,000 + 50,000 x 12 - 60,000) x 30% - 52,920 = 130,680
Total annual tax payable	116,070	130,680

Scenario 2: Assume the individual is a PRC resident taxpayer with total annual employment income of RMB 672,000, including a monthly salary of RMB 35,000 and an annual one-off bonus of RMB 252,000. He only has income from China. His total annual tax payable (without taking into account special deductions and special additional deductions) is calculated as follows:

Type Of Income	Annual Tax Payable With The Extension Of The Policy	Annual Tax Payable Without The Extension Of The Policy
Annual one-off bonus income	252,000 x 20% – 1,410 = 48,990	(252,000 + 35,000 x 12 - 60,000) x 30% - 52,920 = 130,680
Monthly salary income (full year)	(35,000 x 12 - 60,000) x 25% - 31,920 = 58,080	(252,000 + 35,000 x 12 - 60,000) x 30% - 52,920 = 130,680
Total annual tax payable	107,070	130,680

According to the above, the individual in Scenario 1 by receiving annual one-off bonus of RMB 72,000 would be subject to the same tax rate of 30% as the monthly salary income if the policy is not extended, while his annual IIT payable will be reduced by RMB 14,610 with the extension of the policy. In Scenario 2, the total annual remuneration remains unchanged. If the monthly salary is reduced to RMB 35,000 and the difference is paid through annual one-off bonus (i.e., the annual one-off bonus is increased to RMB 252,000), the extension of the policy will reduce his IIT payable by RMB 23,610.

Apparently, the group of taxpayers who will benefit the most from the extension of the year-end bonus policy are specific sectors (e.g., finance, real estate) and specific positions (e.g., sales personnel) whose compensation is more structured towards annual one-off bonus.

#2: Exemption of tax repayment

In addition to the extension of the preferential tax policy for annual one-off bonus, a second decision made at the State Council meeting on the 29th clarified the two conditions of the exemption of tax supplementation in tax reconciliation:

Annual income not exceeding RMB 120,000; and
Annual tax to be supplemented in annual tax reconciliation not exceeding RMB 400.

Considering that taxpayers who fall under the above criteria are mainly being low- and middle-income groups, the extension of such exemption will have a direct and effective effect on reducing the tax burden of low- and middle-income groups.

#3: Preferential IIT treatment for Equity Incentive Program

The third IIT policy now extended is mainly related to the middle and senior management groups of listed companies. Under the current tax legislation, equity incentive income obtained by the individual from listed companies is subject to the tax rate table of comprehensive income separately. According to the provisions of Circular 164, equity incentives obtained by resident individuals, which satisfy the provisions of the Circular of the Ministry of Finance and State Administration of Taxation on the Taxation of Individuals' Income from Stock Options (Cai Shui [2005] No. 35), will not be consolidated into the comprehensive income of the year and the full amount will be applied separately to the comprehensive income tax rate table for tax calculation until December 31st, 2021. The formula for calculating individual income tax on equity incentive income is as follows:

Tax payable = equity incentive income x applicable tax rate - quick deduction.

If a resident individual acquires more than two (including two) equity incentives in one tax year, the tax shall be calculated by combining the equity incentive income.

If the policy had not been extended, equity incentives in listed companies would have been taxed as part of the annual comprehensive income from January 1st, 2022. Below example is to illustrate the difference between IIT liabilities with or without the policy extension.

Example: The individual is a PRC resident taxpayer, receiving monthly salary is RMB 50,000. In the year, he also obtained RMB 500,000 of equity income from the employer who is a listed company. Assuming he has income from China only, his annual tax payable, without taking into account of special deductions and special additional deductions, is calculated as below:

Type of income	Annual tax payable with the extension of the policy	Annual tax payable without the extension of the policy
Income from equity incentives in listed companies	500,000 x 30% – 52,920 =97,080	(500,000 + 50,000 x 12 - 60,000) x 45% - 181,920 = 286,080
Monthly salary income (full year)	(50,000 x 12 - 60,000) x 30% - 52,920 = 109,080	(500,000 + 50,000 x 12 - 60,000) x 45% - 181,920 = 286,080

It is showing that with the extension of the policy, the individual's IIT liability will be reduced by RMB 79,920. Considering that equity incentive scheme is a commonly adopted by listed companies, the extension of such IIT preferential policy demonstrates that the authorities is willing to further promote the development of capital market and help enterprises to optimize the cash flow of employment spending.

#4: Tax exemption treatment on benefits in kind for expatriate employees

Another extension of the key preferential treatments is that, the benefits entitled to expatriates employees working in China, which are paid on reimbursement basis or directly paid by the employers, shall still be applicable to the non-taxable treatment until end of 2023 in accordance to the Pronouncement No. 43.

Details of the special additional deductions (entitled by all PRC residents) and tax exemption subsidies for foreigners are as follows:

Non-Taxable Benefits	Special Additional Deductions	Year 2022 and 2023	Year 2024 and onwards (if no further extension)
Children’s tuition	Children’s tuition	To legally enjoy the tax exemption; or claim the special additional deduction.	No longer applicable to the exemption, but to claim the special additional deduction instead.
Housing allowance	Housing rent or House mortgage interests
Language training fee	Continuing education
Home visit expense	Elderly support	To legally enjoy the tax exemption; or claim the special additional deduction.
Relocation allowance	Serious illness medical
Meal and laundry allowance	Serious illness medical

Example: The individual is a foreign expatriate working in China, who is regarded as resident individual in the tax year. During his/her assignment period in China, the company offers an annual package of RMB 1,200,000 and in addition, entitles non-taxable benefits of RMB 456,000 in total, including meal allowance of RMB 96,000 and housing allowance, language training and children’s tuition of RMB 360,000 in total, all of which are paid on actual reimbursement basis.

Impact on IIT payable from the policy change – Tax Borne by Employee

IIT Calculation Items	Claim Special Additional Deductions	Enjoy Non-Taxable Benefits
IIT Calculation Items	Claim Special Additional Deductions	During the Extension	After Expiry
Salary before tax	1,200,000	1,200,000	1,200,000
Allowance	456,000	456,000	456,000
Tax exempted allowance	-	(456,000)	(96,000)
Special additional deduction	Housing rent: (18,000) Child education: (12,000)	-	-
Standard deduction	(60,000)	(60,000)	(60,000)
Taxable Income (gross)	1,566,000	1,140,000	1,500,000
IIT rate	45%	45%	45%
Quick deduction	181,920	181,920	181,920
IIT payable	522,780	331,080	493,080

Impact on IIT payable from the policy change – Tax Borne by Employer

IIT Calculation Items	Claim Special Additional Deductions	Enjoy Non-Taxable Benefits
IIT Calculation Items	Claim Special Additional Deductions	During the Extension	After Expiry
Salary after tax	1,200,000	1,200,000	1,200,000
Allowance	456,000	456,000	456,000
Tax exempted allowance	-	(456,000)	(96,000)
Special additional deduction	Housing rent: (18,000) Child education: (12,000)	-	-
Standard deduction	(60,000)	(60,000)	(60,000)
Taxable Income (net)	1,566,000	1,140,000	1,500,000
Quick deduction	181,920	181,920	181,920
IIT rate	45%	45%	45%
Taxable income (gross)	2,516,509.09	1,741,963.64	2,396,509.09
IIT payable	950,509.09	601,963.64	896,509.09

Obviously, in the case where the preferential tax policy for the non-taxable benefits expires, it will make great difference on the IIT burden of foreign employees working in China and/or the salary cost borne by employers. With the official announcement of its extension, the tax burden of foreign expatriates will, by the end of 2023, remain at the same level as before 2022, while employers shall still focus on the compliance status of their employees’ preferential tax policies and shall also pay attention to any future updates or replacement rules released on this policy.

RSM OBSERVATION

In the context of the ongoing fight against the pandemic, this offered "tax bonus" is particularly important and meaningful. We suggest that Finance and HR departments of enterprises keep an eye on the relevant tax policies and prepare relevant plans in advance (e.g., review and optimize the remuneration system of employees, perform record filings for equity incentives in time to enjoy the IIT benefits) in order to effectively communicate with employees and bring in effective motivation.

Regarding the non-taxable benefits entitled to foreign employees, enterprises shall understand and more importantly pay attention to relevant tax compliance requirements when enjoying such preferential policy. Eligibility and compliance self-assessment of the tax exemption policy is suggested, especially the reasonableness of the tax exempted allowances enjoyed in accordance with relevant tax regulations.

In the long run, enterprises shall continue to pay attention to any updates and follow the latest policy, while preparing back-up plans for any changes or the expiration of the policy, e.g., regional tax incentive policies or certain tax efficiency schemes, where necessary and timely communication with the foreign employees shall be required.

Should you have any question, please feel free to contact us: [email protected]

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