After three years’ grace period, it is expected that starting from Jan 1 2022, the preferential Individual Income Tax (“IIT”) policies which have been granted in the PRC to foreigners for almost three decades will be cancelled. The change will substantially affect the policies on hiring and retaining foreign employees in Chinese businesses in the future. Foreign companies pay great attention to the changes. What are the changes, what actions can be taken by employers? What employment documents shall be prepared in advance.

Background

On 27 December 2018, the Ministry of Finance and the State Taxation Administration jointly released Circular 164 entitled “Notice of issues concerning the transitional policies on preferential tax treatments under the amended PRC IIT law”. In this circular, preferential calculation methods for determining PRC IIT payable on annual bonuses, equity-based incentives and certain expatriate fringe benefits-in-kind were outlined and are said to be applicable until 31 December 2021.

Comparison

Overview on the potential financial impact to individual taxpayers, should the preferential IIT policy cease to apply at the end of December 2021.

Annual bonus

Employee A who is a non-PRC-domiciled individual earns a monthly salary of RMB100,000, and receives an annual bonus of RMB 300,000 in December

PRC IIT treatment

The employee’s PRC tax residency in the year in which the income is received should be evaluated in advance based on contractual terms and the other factors, and the amount of tax payable should be calculated accordingly.

—The resident scenario

Applicable tax treatment

Choose one of the two options:
1.Tax on annual bonus is calculated without aggregating it with one’s regular salary, and based on the marginal tax rate applicable to 1/12 of the annual bonus amount (the marginal tax rate varies depending on the quantum of income, so this calculation approach lowers the marginal rate applicable) ; or
2. Annual bonus is aggregated with one’s regular salary for the month, and subject to PRC IIT at the marginal tax rate applicable for the aggregate value

Annual bonus is aggregated with one’s regular salary for the month, and subject to PRC IIT at the marginal tax rate applicable for the aggregate value

Financial impact

Where option 1 is adopted, PRC IIT on annual bonus is RMB 72,340 (1)

• PRC IIT on annual bonus is RMB 135,000 (2)
• PRC IIT increases by approx. 86% compared to 2021
• 1.Tax payable on bonus = 300,000 x 25% - 2,660 = 72,340 (tax is borne by the individual)
• 2.Tax payable on bonus = 300,000 x 45% =135,000 (tax is borne by the individual

—The non-resident scenario

Applicable tax treatment

• PRC IIT is calculated on the bonus amount separately from the taxpayer’s other comprehensive income derived in the same month
• Applicable formula: tax payable on = [(bonus amount ÷ 6) × applicable tax rate – quick deduction] × 6
• This method can be applied only once in a calendar year

Financial impact

Tax payable on the bonus is RMB 63,540 (3)