Strengthening of administration and enforcement of IIT Law in China
The drivers and nature of increased IIT enforcement efforts by the Chinese tax authorities are considered in this chapter by Michelle Zhou, Chris Ho, Vincent Pang and Angie Ho
The PRC tax authorities have been strengthening their efforts on the administration and collection of individual income tax (IIT) from high income earners, including employees, through means of tougher enforcement and more frequent tax audits. This trend is considered likely to persist into coming years, driven in part by the need to compensate for tax revenue reductions arising from VAT reform. It should be noted that even greater changes are on the cards in subsequent years as China's 13th Five Year Plan looks to launch IIT reform and an estate tax.
IIT collection efforts spurred on by tax reductions arising from VAT reform
It has been three years since the Chinese government embarked upon an ambitious reform program in 2012 designed to replace Business Tax (BT) with a value added tax (VAT) throughout the services sectors of the Chinese economy. Though certain key sectors, such as the real estate and construction industries, the financial services and insurance industries, have yet to start the transition to VAT, the VAT pilot programme has expanded to cover most of the other services sectors.
According to the data released by the SAT, the VAT reform has resulted in a tax reduction for taxpayers in the three years since 2012 of Rmb374.6 billion ($58.8 billion), of which the tax reduction for 2014 is Rmb191.8 billion. For the period for 2015 recorded so far (January to June), the tax reduction due to the VAT reform has been more than Rmb110 billion.
Under the existing tax revenue distribution system, BT is distributed to the local government while VAT is distributed to the state at national level. While, with a view to promoting and supporting the VAT reforms, the VAT revenue arising from sectors and activity covered by the VAT reforms has been left for the moment with local governments, the tax reduction due to the VAT reform is obviously impacting the local government's revenue from taxation. Factoring in the future expansion of the VAT reform to cover all services sectors, the increasing VAT reduction resulting from VAT reform will continue to impact on local government revenues in the coming years.
In this connection, local governments have to seek more tax revenues from other tax sources, such as IIT, to meet their financial needs, given that IIT is one of the major sources of tax revenues retained by the local governments. As a result, strengthened IIT administration and collection will continue to be a focus of tax enforcement by local government in coming years.
IIT reform and estate tax are anticipated for future years
As one of the six reforms reviewed by the China's leading group for overall reform during a recent meeting, fiscal policy and tax system reforms will be vitally important under the 13th Five-year Plan (2016-2020), which was high on the agenda of October's plenary session of the Communist Party of China Central Committee.
Tax reform will focus on the introduction of real estate tax, adjustment of the consumption tax and an overhaul of IIT. The theme for the tax reform is to "cut indirect taxes" like consumption tax and "add direct ones" such as real estate tax.
The reform of IIT is not just about thresholds, but will also consider overall income and spending, such as mortgage costs . The reform aims to practise "comprehensive tax levying" in China. Individuals are taxed at different rates for different category of income, such as salary & wages, independent service income, capital gains and house rental income. Under "comprehensive tax levying", all income sources of an individual will be collectively taxed at a uniform rate. The more a person earns, the more he pays. This will make it possible for the government to adjust the national income distribution. It will also help to narrow the gap between the rich and the poor.
The basis of IIT reform is the anticipated introduction of an individual tax identification system. Each taxpayer will have one personal tax identification number in the future which will be valid for all of his/her life. As of today, there is still no clear schedule for the IIT reform.
In addition to the IIT reform, the government wants to use estate tax to boost social programmes. In recent decades the Chinese economy has expanded greatly. As is often the case in countries that experience rapid economic expansion, most of the new wealth is concentrated in a small percentage of the population. Communist Party officials have started discussing the implementation of an estate tax for China. There is also no clear schedule, however, for implementation. Before the IIT reform and estate tax are implemented, the government will continue to focus on the enforcement of IIT administration and collection.
Increased efforts on tax enforcement
A local tax bureau in southern China hosted a conference on the common IIT issues for expatriate employees working in China and issued a list of key points which it focuses on in tax audits. The local tax bureau has been strengthening the administration of expatriate employee's IIT, and investigating under-reporting or evasion of the tax. Using IIT assessments, this local tax bureau collected nearly Rmb230 million in tax payments.
Similar to this local tax bureau, the tax bureaus in most of the cities in China have been strengthening the administration and collection on IIT.
Widening the net for tax audits
In the past 12 months, we have observed the PRC tax authorities applying enhanced methods for enforcement of IIT collection:
comparison of employment income data collected from market research with income reported through tax withholding system to determine the reasonableness of income reported by the withholding agent/taxpayer;
exchange of information with immigration authorities;
making comprehensive assessments based on the filing documentation submitted by the withholding agent/taxpayer to identify targets with high risk of tax issues;
interviewing the withholding agent and/or taxpayer to identify potential tax issues;
pre-select companies with poor tax credit ratings to conduct self-assessment on potential tax underpayments; and
conducting tax audits on selected companies which are perceived as high risk companies
Enforcement of worldwide income taxation on expatriate employees
China is one of the few countries in the world that subject its citizens to worldwide income taxation irrespective of their residence. However, this appears to be less than fully effective for many of its citizens residing overseas, though the rule has been around for more than two decades. In recent years, we have seen the PRC tax authorities begin with efforts to properly enforce tax collection in this regard.
Notably, Chinese local tax authorities have begun dialogues with multinational companies headquartered in the PRC to enquire about the tax compliance status of outbound assignees. This is to ensure that regular monthly tax withholding continues for those staff staying on the PRC payroll and to ensure that year-end reconciliation tax returns are lodged to report offshore payroll.
For foreign expatriates working in China, tax authorities are now assessing their tax residency status to determine whether they are taxable on worldwide income in China, not only based on their cumulative period of physical residency in the PRC, but also relying on factors, such as availability of a permanent home in the PRC, place of vital interests and habitual abode.
In-depth review of application of preferential tax treatment to equity compensation
Certain equity-based compensation derived by employees of publicly listed companies enjoys a preferential tax treatment. This may apply where the corresponding equity-based compensation plan has been registered with the respective local tax bureau. The preferential treatment allows the equity compensation derived to be taxed as a separate source of employment income from the employee's regular monthly salary and wages derived in the same month, and subject to a lower marginal tax rate, which is determined solely based on the equity compensation. By applying this tax treatment the employee could lower his IIT liability on the equity compensation.
The aforementioned tax registration formalities are generally required at both the plan implementation stage and throughout the lifecycle of the plan. In this regard, companies not only need to fulfill the registration requirements at the time of implementation of the equity plan, but theoretically there are also subsequent tax registration requirements, that is, at the time of each new grant and each vesting/exercise after the equity plan is initially registered with the local tax bureau. Until recently, the subsequent tax registration requirements for equity-based compensation plans were not strictly enforced by the local tax bureaus in the PRC, and in certain cases, companies were applying the preferential tax treatment when withholding IIT from the equity compensation for its employees. We are, however, now observing that local tax bureaus in the PRC are catching up on this and requiring registration to be completed for all the events, and there have also been instances where application of preferential tax treatment was denied due to subsequent registrations not being completed. Companies are advised to review the tax registration status of their existing equity compensation plans to ensure that employees remain eligible for the preferential tax treatment.
The key theme in IIT practice that is expected to continue for some years to come is the enforcement focus on high income earners. With the wider net which the PRC tax authorities are beginning to use to collect and exchange information for tax enforcement, it is imperative for companies to conduct regular reviews of the IIT and visa compliance status of their employees. Companies should also seek periodic advice on regulatory and practice developments with respect to staff reward or incentive programmes in place,to effectively managing IIT exposures.
50th Floor, Plaza 66
1266 Nanjing West Road
Shanghai 200040, China
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Michelle 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, as well as, for example, topics covering remuneration packaging and equity based compensation structuring. 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 with the tax and foreign exchange registration of equity-based plans in China since the introduction of the relevant regulations. She has also actively participated in various projects relating to design, implement and roll-out 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.
50th Floor, Plaza 66
1266 Nanjing West Road
Shanghai 200040, China
Tel: +86 21 2212 3406
Chris Ho is the national Global Mobility Services leader of China, and is a partner in KPMG China's corporate tax practice. He has more than 22 years of corporate tax experience with the firm. For many years, Chris has specialised in providing international tax planning services to clients in the areas of inbound investments, M&A, structured finance, group restructuring and reorganisation.
Based in Shanghai, he focuses on providing transaction tax and regulatory advice to the firm's multinational clients.
Chris holds a bachelor of laws degree from the University of Hong Kong. He is a certified tax adviser and a fellow member of the Taxation Institute of Hong Kong.
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Beijing 100738, China
Tel: +86 10 8508 7516
Vincent is specialised in providing Chinese tax and regulatory advice. He has extensive experience in serving many companies in the industrial and consumer market sectors, in particular. He has in-depth knowledge of the interpretation and implementation of tax regulation by the PRC tax authorities in a wide range of technical issues.
Vincent started his career with professional accounting firms in Canada in 1991 and has experience in various disciplines including tax, auditing and consulting. He arrived Beijing in 1998 and started to focus on providing PRC tax services to foreign investors in the areas of tax structuring, tax planning, general tax advice as well as tax compliance services.
Vincent has also been active in assisting many foreign companies in designing their corporate and operational structures in China to meet their business objectives, as well as many Chinese domestic companies on their pre-IPO restructuring and outbound investments.
Vincent has also been providing Individual Income Tax services to foreign assignees working in China on the structuring of their compensation package as well as senior management of pre-IPO companies on the structuring of the equity plans and investment holding.
He is a member of the Institute of Chartered Accountants of Canada and the Certified General Accountants Association of Canada, and has bachelor of commerce degree from McGill University in Montreal.
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5001 Shennan East Road
Shenzhen 518001, China
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Angie 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 corporations 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.