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China’s income tax deductions for pensions and child-raising costs

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Lewis Lu of KPMG China discusses the developments in China’s personal tax space.

As China introduces deductions on individual income tax (IIT) for child-rearing costs, companies should be aware that many individuals may choose to access this deduction through their employer. In order to facilitate this, businesses should modify their tax information collection and HR policies and procedures.

Meanwhile, the Chinese government is encouraging its citizens to invest in private pensions. A similar scheme to the existing piloted IIT deduction for commercial endowment insurance plans could soon follow for private pensions to encourage uptake.

Government encourages private pensions

The ageing of China’s population is leading to increased demands on China’s state pension regime. In consequence, the government is seeking to encourage investment in private pensions. In due course, IIT deductions may be provided for private pensions, though no announcement on this has yet been made.

China’s national pensions framework consists of three pillars. These are:

  • The state pension regime, funded with social security contributions;

  • A so-called ‘enterprise annuity’ scheme under which companies can choose to fund pension benefits for employees. Corporate income tax (CIT) deductions are available for this, though the regime is little used in practice; and

  • Private pensions financed by individuals. 

Previously, the government had not provided much elaboration on the third pillar, but recently the State Council (that is, the national cabinet) announced a framework for the design of private pension plans to be offered by private insurers.

The State Council envisages voluntary participation by individuals (who continue to make their social security contributions), with annual contributed premiums of up to RMB 12,000 ($1,800).

Premiums can be invested in qualified financial products, such as bank wealth management products, saving deposits, and commercial endowment insurance. The State Council’s framework details the circumstances in which contributions can be withdrawn and how they should be handled for inheritance purposes.

In 2018, a pilot scheme for pension IIT deductions was run in Shanghai, Fujian, and Suzhou. This applied an exemption-exemption-taxation (EET) system, similar to the US 401K regime, for a special pension product termed a ‘commercial endowment insurance plan’.

The expectation is that something akin to this IIT deduction will eventually be rolled out at the national level, to buttress the State Council’s drive for greater use of private pensions.

IIT deduction for child-raising costs

On March 19 2022 the State Council announced the new IIT deduction in Circular Guofa No 8 (2022), and the State Taxation Administration (STA) followed on March 25 with detailed rules. This provides that from January 1 2022, guardians of infants under the age of three can take an IIT deduction of RMB 1,000 per child per month.

This is the latest step in the process of China adjusting its IIT regime so that tax burdens reflect the personal circumstances of individual taxpayers. Starting with the 2018 IIT reform, China sought to impose IIT based on taxpayers’ comprehensive income, rather than on separate tax calculations for each category of income. However, the schedular system of taxation remains for investment income types.

The move towards comprehensive income taxation was coupled with the introduction of IIT deductions for children’s education and further education for adults, medical fees for serious illness, mortgage interest and housing rental costs, and the expenses associated with supporting elderly relatives.

The introduction of a deduction for child-raising costs reflects the increasing expense of doing so, as well as the government’s desire to raise the national birth rate.

Administratively, the individual taxpayer can access the new deduction by providing supporting documentation to their employer (as a withholding agent) or through the filing of the post-fiscal year end annual reconciliation filing (March-June).

Given that a large number of employees may choose to claim the deduction through their employers, companies will need to modify their tax information collection and HR policies and procedures.

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