The PRC Ministry of Finance and the PRC State Administration of Taxation jointly released the Consultation Draft on the Detailed Implementation Rules (DIRs) of the PRC Individual Income Tax (IIT) Law (DIRs Draft) and the Provisional Implementation Measures of the Additional Itemized Deductible Items (Provisional Measures) on October 20, for soliciting public comments. Considering both the DIRs Draft and the Provisional Measures serve as important integral foundations of additional IIT implementation rules and interpretation going forward, there has been a high level of public attention since their release.
We share the following key points of these two important consultation drafts and our insight for your reference.
- Taxation of foreign individuals
- Guidelines on additional itemized deductions
Taxation of Foreign Individuals
New “five-year rule”
The five-year rule which has attracted a lot of attention will be retained but with modifications.
Under the new IIT Law, individuals without domicile in Mainland China are considered China tax residents once they have resided 183 days in China during the calendar year concerned. This new definition of China tax resident is also adopted for the new five-year rule. Unlike the current five-year rule requiring non-China domiciled individuals to spend more than 30 consecutive days or 90 days in total outside of China during a calendar year to restart the five-year count, non-China domiciled individuals can spend any minimum of 31 consecutive days outside of China before reaching the five-year threshold.
One important point to note is that exemption from worldwide taxation requires completion of record filing with the in-charge tax bureau.
In essence, non-China domiciled individuals would not be subject to IIT on their worldwide income under the following situations:
- Have not resided 183 days or more in China for five consecutive years.
- Have resided 183 days or more in China for five consecutive years but also have spent more than 30 consecutive days outside China during these years and have completed the required record filing with the in-charge tax bureau.
Accordingly, non-China domiciled individuals who do not meet the “more than 30 consecutive days outside China” requirement would start being subject to IIT on their worldwide income from their sixth consecutive year of having resided 183 days in China.
The proposed changes to the “five-year rule” echo China’s policy of attracting and retaining talent. In addition to easing the worldwide taxation concern of foreigners working in China; if passed, this change would also be good news for companies.
Besides the record filing requirement, another interesting point to some non-China domiciled individuals is the transition from the current rule to the new rule. How will physical presence in China prior to 2019 be considered under the new five-year rule? For those who have already resided more than five consecutive full years in China, can they still restart the five-year count by spending less than 90 days or 183 days in China during a calendar year?
Additional implementation guidelines will be needed to answer these questions.
Non-taxable benefits for foreign individuals
Another concern of foreigners working in China and their employers is the continuity of the non-taxable benefits available to foreign nationals under the new IIT Law. Based on the DIRs Draft and the Provisional Measures, the current understanding is that there will be no change, and foreign nationals may also be able to enjoy some of the additional itemized tax deductions (Table 1).
The key point to note is that for expenses of similar nature, foreign nationals cannot enjoy double benefits from expenses incurred of the same nature under both the non-taxable benefits rules and the additional itemized deductions rules.
Guidelines on Additional Itemized Deductions
The increase of standard monthly deduction and the introduction of additional itemized deductions will increase the deductible amounts claimed by taxpayers. The DIRs Draft specifies how much taxable income can be decreased by deductible items and also mentions the principle of no carry-forward of unused deductions.
The Provisional Measures are summarized in Table 2.
In addition to those mentioned above, other points worthy of attention include:
- If individuals’ tax residency status cannot be determined at the beginning of the year, they can adopt non-tax resident status for their tax filings during the year. When their tax resident status can be confirmed at year-end, annual reconciliation filing is required.
- Considering the diversity of an individual’s income types and the complexity of the means of earning such income, tax authorities under special circumstances can hold the entity with the information plus control over the earning process as the tax withholding agent, and require it to fulfill its tax withholding obligation.
- The required tax clearance applicable to Chinese residents who cancel their household registration when immigrating overseas does not include only reconciliation of comprehensive income and business operation income from the current year and tax settlement of other income; it also includes tax due related to prior years.
- We still have to wait for further clarification for answers to how many years are covered under “prior years,” the scope of tax audit and its process, etc.
- According to the new IIT Law, tax authorities can enlist support such as information sharing from other authorities during the supervision process.
This round of solicitation of comments on these two consultation drafts was limited to two weeks. This signifies the authorities are putting tremendous effort in ensuring the relevant details will be available for a comprehensive implementation of the new IIT Law on January 1, 2019.
We expect more relevant administrative policies and implementation rules will be promulgated by the authorities. For example, details for annual reconciliation filing, application of anti-avoidance principles and adjustment of tax liability. The new IIT Law includes many changes and new stipulations – including those additional itemized deductions widely anticipated by employees and the potential implication to foreign employees – plus its January 1, 2019 effective date is very soon.
Therefore, we recommend companies to start working on the necessary changes to their relevant policies and guidelines, communicating the changes to their employees as well as implementing effective tools to manage the additional administrative work going forward.