This time it’s personal: China IIT on the eve of a major revamp
In 2017, we saw significant new China individual income tax (IIT) enforcement trends in relation to outbound and inbound expat tax monitoring and audit, as well as equity incentive schemes. Michelle Zhou, Jason Jiang, Sheila Zhang, Angie Ho, and Murray Sarelius highlight areas to watch for in the future.
As 2017 comes to a close, the indications are that the IIT reform, initially anticipated for 2017, will now not happen until 2018. Nonetheless, 2017 has still seen notable IIT developments, with employees and employers facing increased IIT exposures and challenges arising from business expansion, transformation, restructuring, and overseas deployment, notably in the context of the Belt and Road Initiative (BRI). The continuously strengthened IIT administrative capacity of the Chinese tax authorities means that taxpayers need to repeatedly upgrade their management of IIT matters.
BRI outbound expansion increasing China outbound expatriate tax issues
The 2016 Statistical Communique on China's foreign direct investment was jointly released by the Ministry of Commerce, the National Bureau of Statistics and the State Administration of Foreign Exchange on October 9 2017. This observed that, by the end of 2016, 24,400 Chinese investors had made direct investments in 37,200 overseas enterprises in 190 foreign countries and territories. The accumulated total net outward investment was estimated to be $1.36 trillion. While there was some tempering of outbound investment in 2017, due to limitations imposed by the Chinese government on investments in certain sectors and asset types, the long-term trend continues to be towards expanding foreign investment (see the chapter, A thousand miles begin with a single step: tax challenges under the BRI).
In tandem with this overseas expansion, including into BRI countries, Chinese enterprises have been dispatching staff from China to overseas subsidiaries to cover management, technology, marketing and other roles. Attracting, deploying and managing a global workforce is a key element in enterprises undertaking 'go out' strategies.
Unfamiliar and varied overseas business environments, laws and regulations are creating significant challenges for human resource management in 'go out' enterprises. These challenges include, but are not limited to outbound expatriate selection, retention and motivation, salary strategy, employment and payroll arrangements, onshore and offshore taxes, entry and exit immigration administration, social insurance, labour law, and permanent establishment risk management. Failure by enterprises to prepare, and inadequate responses to issues, in any of these areas, may result in commercial losses, departure of talented staff, and damage to enterprise reputation in countries of investment. If the issues are widespread across Chinese 'go out' enterprises, this may hamper their overall engagement with globalisation.
The challenges arise not only overseas, but also within China, since Chinese citizens are subject to Chinese IIT on their worldwide income, including employment income derived during employment/assignment overseas. The 'go out' enterprise, as the home country employer dispatching its Chinese employee to its overseas subsidiaries, may still be responsible for monthly tax withholding and timely reporting of the employee's overseas employment status to the Chinese tax authorities. The individuals may be required, in the year-end tax reconciliation, to report their offshore taxable income, and may look to claim foreign tax credit on tax paid overseas on the foreign sourced income.
The China filing obligations for overseas employment income were, in the past, overlooked by a lot of Chinese nationals while working overseas, as well as by their dispatching employers. However, with the progressively higher use of tax information exchange mechanisms by Chinese tax inspectors, and the planned implementation of the common reporting standard (CRS) from 2018, the authorities are increasingly equipped with more powerful tools for supervision of such enterprises and individuals – see the chapter, A brave new world in tax transparency: CRS in China, Hong Kong and Taiwan. Recently, we observed that some Chinese companies who have been sending Chinese employees overseas were required by the local tax authority to report both details of the outbound assignees' contracts and activities, as well as their IIT reporting status. Obviously, this could become one of the core focus areas of tax audit/inspection in the future.
To better deal with the above challenges, 'go out' enterprises should consider taking the following steps:
Pre-assignment: Get well prepared by setting up outbound staff dispatch-related policies (i.e. salary determination, employment and payroll arrangements, tax policies, etc.), standard operating procedures for dispatched employees, and secondment budget planning;
During-assignment: Minimise the compliance risks in respect of labour law, immigration, tax, social security, etc. through full assessment and continuing monitoring of the local requirements; and
Post-assignment: Review the compliance status of the assignment on completion, and draw on lessons learned to improve the policies and procedures for subsequent assignments.
Enhanced IIT enforcement for China inbound assignees and foreign workers in China
Over the past year, the Chinese tax authorities have significantly increased the frequency of IIT tax audits and self-inspections, with IIT treatment of foreign workers in China particularly in the spotlight. Foreign employees in China, both those assigned from overseas and those with local employment contracts, benefit from IIT exemptions on certain specified benefits (e.g. housing costs, meal/laundry expenses, relocation costs, home leave travel fares, child and personal tuition costs). These exemptions, which need to be claimed with supporting tax invoices (fapiao), lower the effective IIT rate on the income of foreigners from the high Chinese marginal tax rates (i.e. 45% top rate) that kick in at relatively moderate levels of income.
In conducting tax audits on such claims, tax auditors have focused on the 'reasonableness' of the claim amounts, the nature of the payment, and corresponding accounting treatment of the expenses in the books of the employing enterprise. The authenticity of the supporting documentation (e.g. fapiao and rental lease agreements) has also been scrutinised.
Based on the local tax authorities' internal investigation guidelines, the authorities have identified and focused on the following common issues.
Meal and laundry expense claims
Certain tax bureaux in northern China have, in the course of tax audits, determined that meal invoice claims in excess of certain amounts are unreasonable and the IIT exemption claim is consequently invalid. Different tax bureaux may set different standards – we have observed cases where one tax bureau set CNY 1,500 ($226) per invoice as the ceiling for determination of the reasonableness, while another set CNY 2,000. Audited employers have consequently been instructed to withhold the tax arising from the full amount of such invalid invoices, with retroactive effect. However, as there is still no unified standard to assess the reasonableness of invoice amounts this is subject to the relevant local tax authority's discretion, heightening the compliance challenges for employers.
Property management fee for housing rental
Rental lease agreements in China typically combine a housing rental fee, a property management fee, as well as other administrative fees, into a bundled fee. According to the existing IIT regulations, only rental fees can be claimed as non-taxable benefits. We have observed that in certain cases, where there have been no supporting documents to certify the amount of the housing rental fees, separately from other related costs, the tax authorities have been rejecting the total rental cost claim (i.e. the bundled fee). Consequently, the total rental cost reimbursed by the employer has, in these cases, been included in the employee's taxable income subject to IIT.
Home leave travel costs
In the course of tax audits, issues have been raised that some employee home trip flight ticket expenses are significantly higher than for other employees at the same level. The employer was then required to validate the flight tickets and explain the reasons.
The above requirements on meal costs, property management fees and home leave costs were not specified either under the existing tax regulations or any guidelines released by the tax authorities, but were simply asserted by the tax authorities as a function of their right to interpret the IIT regulations. As such, companies should exercise extra caution when implementing benefits programmes for foreign employees, retain full supporting records for tax inspection purposes, and keep up-to-date on the latest IIT administration developments. Further areas requiring close attention are the following.
Insurance (including both social insurance and commercial insurance), purchased overseas by domestic or overseas enterprises for expatriate individuals employed in China, needs to be consolidated with wages and salaries and subjected to China IIT. This includes social insurance contributions made by both employers and employees to overseas social security regimes. Notably, the authorities have also been subjecting these contributions to IIT in cases where the employers/employees are exempt from making Chinese social security contributions according to China's international social security agreements, including those with Germany, Korea, Switzerland and others. Enterprises need to ensure that they have properly consolidated overseas commercial and social insurance and subject it to IIT.
IIT preferential commercial health insurance
The Ministry of Finance (MOF), State Administration of Taxation (SAT) and China Insurance Regulatory Commission (CIRC) jointly issued Cai Shui  No. 39 (Notice No. 39) earlier this year, introducing nationwide favourable tax treatment on premiums paid for qualified commercial health insurance products. The programme was rolled out from July 1 2017. Individuals will be allowed to claim up to CNY 2,400 per annum (or CNY 200 per month) as IIT deductions in respect of premiums paid for qualified commercial health insurance products.
So far, CIRC has identified batches of insurance companies that are permitted to sell qualified commercial health insurance products. Companies can obtain such lists from the official website of CIRC, and assist their employees to purchase qualified commercial health insurance products.
Employing companies, as IIT withholding agents, are obliged to establish mechanisms to administer the tax deduction claim for allowable premiums and file the necessary documents in the Golden Tax III system. This is to ensure that IIT deduction claims are made in accordance with Notice No. 39 and the requirements of local tax authorities.
Compliance requirements on equity incentives
Although no new tax regulations have been issued in 2017 in relation to equity-based incentive plans, companies (including both listed and unlisted companies) are getting ever more interested in such schemes. They are looking either to the implementation in China of equity incentives, which have been adopted on a global basis by their enterprises, or to the design of a local China plan for long-term incentives for key employees. Subject to conditions being met, equity incentives can be taxed preferentially in China:
Deferral of taxation of equity awards until time of disposal – this can reduce the marginal tax rate from 45% to 20%; or
Equity awards may be taxed as a separate source of income from the employee's regular monthly salary and wages. This can lower the applicable marginal tax rate by averaging the taxable value of the award over the period for which the income is attributable (capped at 12 months). If an award is added as normal, and in full, to the income of the month in which it is granted, this would readily push the taxpayer into the highest 45% tax bracket, leading to a loss of much of the award value through tax. By subdividing the value of the award over, say, 12 months, the taxpayer may avail of lower marginal rates on each part of the award; or
Equity awards can be averaged and taxed over a maximum period of six months. For example, an individual may add one-sixth of the taxable gain to his monthly ordinary salary and wages and compute the China IIT on the combined income over a consecutive six-month period. In such cases, the taxpayer may not only pay IIT in six instalments but also avail of lower marginal rates on each instalment.
However, for implementation of an equity incentive plan in China, the employer may also be subject to certain compliance requirements, including:
An equity incentive plan, with other relevant details should be registered with the local tax authority throughout the lifecycle of the plan; and
An equity incentive plan could also be subject to foreign exchange rules in China where the underlying awards are publicly listed overseas. This is because the outward remittance of funds, for acquisition of awards by employees, and the inward remittance of funds, as payments are made to employees after the disposal of awards, are all regulated by the State Administration of Foreign Exchange (SAFE).
Appropriate tax planning should be conducted before the implementation of an equity incentive scheme in China. Organisation restructuring (i.e. M&A and/or spin-off), should also prompt a revisiting of the tax implications (including tax, foreign exchange, etc.) to ensure tax administrative and compliance requirements are met, and to make necessary employee communications. Without appropriate arrangements in advance, we have observed cases where:
Penalties were issued by the respective authorities for non-compliance;
Companies were denied preferential tax treatment for equity based income, resulting in a higher tax bill; and
Remittance and repatriation of foreign exchange for the implementation of the plan could be complicated.
Necessary advance planning should be conducted and a set of standard operating procedures should be formulated for continuing administration and fulfilment of reporting requirements.
Revamped immigration permit system for foreigners working in China
There were significant changes to the foreigners' China work permit application requirements and processes in 2017, which aimed to simplify the application process, improve efficiency of the administration, and enhance the continuing monitoring of application procedures. At the same time, the Chinese government is looking to encourage the inflow of more high-skilled talents, while controlling the influx of lower-end foreign labour resources.
Attracting high-skilled foreign graduates
Effective from January 6 2017, it has been possible for eligible foreign graduates who have completed a master's programme or above within the last year from either a domestic university or a well-known international institution to obtain a work permit in China. The previous regulation required foreigners, who intended to work in China, to have at least two years of related working experience, putting an obstacle in the way of enterprising young foreign workers who sought opportunities, post-graduation, in China.
Simplifying the work visa application process
Effective from March 13 2017, foreigners wishing to apply for a work visa (also known as a 'Z visa') have no longer been required to submit a government-issued invitation letter as one of the visa application supporting documents. Foreign applicants can apply for a Z visa with an overseas Chinese embassy, consulate or air/sea port visa office by submitting their passport or equivalent ID, and a work permit notification letter issued by the respective labour bureau in China. This change, along with a series of other recent administrative enhancements, is expected to reduce the lead time for Z visa applications by approximately one to two weeks.
New employment permit
After six months of trial implementation in 10 provinces, the new nationwide administrative measures on foreigners' applications for employment permits (officially known as the notification of employment permit for foreigners) were launched on April 1 2017. A foreign national should obtain both an employment permit and a Z visa/work-type residence permit to work in China. According to Waizhuanfa  No. 40, the former alien employment permit and foreign expert certificate, which were issued by two different government authorities, have been consolidated into the new single permit, and this will be issued in electronic form. The new employment permit is in line with the goal of 'one lifetime code per person', which provides the foundation for the nationwide administration of foreigners' employment in China.
The new system administers the issuance of employment permits using a points-based methodology. This refers to factors including age, annual salary level, educational background, working experience, Chinese language ability, working location in China, etc. The system classifies foreigners into the following categories:
Category A: highly-skilled talents;
Category B: professionals; and
Category C: others.
Foreigners who attain more than 85 points, or meet one of the special conditions in the classification standard (e.g. world-renowned award winners), fall into Category A. The new points-based classification methodology reduces the extent of application documents required for Category A applicants, and simplifies the application procedures. A restrictive quota will be set for Category C applications.
Looking to the future, China's top leadership are giving detailed thought to how to bring a new balance to the next stage of China's economic development. In President Xi's landmark speech, on October 18 2017, to the 19th National Congress of the Communist Party of China, repeated references were made to the primacy of tackling inequality as a policy goal (quotes below). It is clear that the IIT reform will have a key role to play in this process.
"As socialism with Chinese characteristics has entered a new era, the principal contradiction facing Chinese society has evolved. What we now face is the contradiction between unbalanced and inadequate development and the people's ever-growing needs for a better life…" "While China's overall productive forces have significantly improved and in many areas our production capacity leads the world, our problem is that our development is unbalanced and inadequate…" "We will continue to follow the principle of distribution according to one's work while improving our institutions and mechanisms for distribution based on factors of production, so as to make income distribution fairer and more orderly...We will expand the size of the middle-income group, increase income for people on low incomes, adjust excessive incomes, and prohibit illicit income. We will work to see that individual incomes grow in step with economic development, and pay rises in tandem with increases in labour productivity...We will see that government plays its function of adjusting redistribution, moves faster to ensure equitable access to basic public services and narrows the gaps in incomes."
In light of these objectives, the final shape of IIT reform is greatly anticipated in the coming Year of the Dog.
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Michelle Zhou leads the KPMG global mobility service (GMS) practice in the eastern and central China region, and has more than 10 years of experience in assisting multinational clients across a broad spectrum of industries on personal income tax compliance and advisory needs. In particular, she has experience in Australian, Chinese and US expatriation taxation, and has served on accounts of various sizes during her career with KPMG to date.
Over the years, she has undertaken speaking engagements at events held by the American Chamber of Commerce, Australian Chamber of Commerce, Canada Business Council and EU Chamber of Commerce to update their members on the latest regulatory developments and trends in Chinese individual income tax; remuneration packaging topics; equity-based compensation structuring; and others. Michelle has also delivered lectures to students in the finance discipline of Fudan University on expatriation taxation. In recent years, Michelle and her team have successfully assisted clients in the tax and foreign exchange registration of equity-based plans in China since the introduction of the relevant regulations in China. She has also actively participated in various projects relating to design, implementation and rollout of employee incentive plans, including equity-based compensation plans.
Michelle has a master's degree in commerce (advanced finance) from the University of New South Wales, and is an associate member of the Taxation Institute of Australia.
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1266 Nanjing West Road
Shanghai 200040, China
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Jason Jiang is a director at global mobility services team in KPMG Advisory (China). He has more than 15 years' experience in providing individual income tax compliance and advisory services to multinational clients from a wide range of industries with international assignment programmes covering both Chinese inbound and outbound assignees.
He has assisted multinational enterprises operating in China with managing their individual income tax compliance processes and is experienced in advising clients on:
Jason is also a regular speaker at KPMG and public seminars and workshops.
Jason is a Certificate Public Accountant of China and a Certificate Tax Agent of China.
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Beijing 100738, China
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Sheila Zhang provides various services to foreign investment companies, domestic companies and private companies from an individual income tax, social security, foreign exchange and immigration perspective. She has extensive knowledge of individual income tax (IIT) policies, tax planning and tax negotiations in China.
Sheila has advised a variety of clients on regulatory and IIT issues for foreign direct investments in China and outbound investments by Chinese companies. Sheila specialises in assisting multinational companies planning remuneration packages for expatriate employees working in China and assisting companies to administer the IIT risk from a company perspective.
Sheila services clients in a wide range of industries including investment funds, energy and resources, high tech, consumer, financial services, media and NGOs.
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Shenzhen 518001, China
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Angie Ho is the KPMG Southern China region leader for global mobility services. She has more than 18 years of experience in providing tax services to multinational enterprises in Hong Kong and China.
Before joining KPMG, Angie worked for an international accounting firm and the Inland Revenue Department in Hong Kong. Angie specialises in advising assignment related matters, including tax compliance and cross-border taxation, expatriate tax planning, equity compensation planning, remuneration design, tax audit defence and social security, forex and others. Angie is a frequent speaker at tax seminars and workshops for clients and the public.
Angie is fellow member of the Association of Chartered Certified Accountants and a Certified Tax Agent of The Taxation Institute of Hong Kong.
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Murray Sarelius is a partner based in Hong Kong, and head of global mobility services (GMS) for KPMG China. He has more than 20 years of experience with tax issues impacting individuals and businesses operating internationally.
Murray's experience spans the international aspects of both personal and corporate tax planning. He works extensively with businesses that are operating or investing internationally. For international businesses, his focus is on helping them to manage the expatriate and employer tax issues associated with an internationally mobile workforce, including executive remuneration, employee share schemes and international tax planning for employment and investment.