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China: Individual Income Tax (IIT) Law draft implementation guidance released
On August 31 2018, the revised IIT Law was passed by China's Parliament, the National People's Congress (NPC). The revised law will come into full effect from January 1 2019. In advance of this, revised IIT standard personal deductions and tax rates tables have applied from October 1 2018. Following on from this, on October 20 2018 the Ministry of Finance (MOF) and the State Administration of Taxation (SAT), released draft IIT Law implementation rules, as well as the draft guidance on itemised deductions thresholds, both for public consultation. The consultation period has now ended but the final rules are still to be released.
The draft guidance moves to clarify important areas of uncertainty under the revised IIT Law:
- Foreign expatriate five-year concession retained: At the moment, foreign nationals working in China are subject to China IIT on their worldwide income if they have been resident in China for five full consecutive years. However, the existing rules allowed for the consecutive five year presence to be broken by a period of absence from China – this can be either an aggregate period of 91 days or more during a year, or for a single period of at least 31 days. This is typically referred to as a 'tax break', and is a common practice for foreign expatriates working long term in China. Following a tax break the 'clock' resets on the five-year calculation, and the foreign expatriate will not be taxed on his/her income sourced outside China.
The revised IIT Law had altered the basic tax residence rule; whereas previously a non-domiciliary of China would only be treated as a tax resident of China if he or she spent nearly a full year within China, this was lowered to 183 days. Given the change to the residence rule, initially many predicted that the five-year concession would also be abolished. However, to the relief of many foreign employees, it has been confirmed in the draft implementation rules that the five-year concession will be retained; albeit now a continuous 31-day absence is required, the aggregate 91-day period will no longer suffice.
- IIT itemised deductions: Under the revised IIT Law, new itemised deductions for a range of personal living expenses are being introduced alongside the existing deductible items (these are primarily for social security contributions, and private health and pension plans). The new deductions cover expenditure on dependent children's education, outlays to support elderly dependants, expenditure on serious illness medical treatment, expenditure on continuing education, and mortgage interest or rental payments.
The draft measures now set out the qualifying conditions for the new deductions, set annual standard fixed amount limits for deductions (e.g. RMB 12,000 ($1,700) for mortgage interest), as well stipulating which individuals can claim the deductions. Foreign employees may elect to retain the tax-exempt benefit concessions they already enjoy; these cover many of the same expenses for which IIT itemised deductions are now provided, including rentals and education costs. While foreign employees could elect to claim itemised deductions under the new system in place of their existing concessions, they are unlikely to do so given that the itemised deductions are subject to much lower caps.
- Anti-avoidance rules: Further clarifications on the details of the new IIT general anti-avoidance rule (GAAR), and the specific provisions addressing related party transactions and controlled foreign companies, are set out in the draft implementation rules. These draw heavily on the equivalent corporate income tax (CIT) rule guidance, though with important differences. It is important to note that, following the merger of the state and local tax bureaus in summer 2018, enforcement of cross-border IIT and CIT matters will be overseen by unified international tax departments at provincial level, meaning a step-change in enforcement effectiveness.
In addition, from October 10 2018, the Chinese tax authorities launched an enforcement campaign requiring film-making companies, studios and performing arts companies as well as high-income actors and actresses to carry out 'self-inspections' on all of their tax declarations filed since 2016. For those who voluntarily pay up tax arrears before the end of this December, the administrative punishment and penalties may be relieved. For those not so complying, severe penalties may subsequently be applied.