New IIT developments are intended by the government to support national mass entrepreneurship and innovation and promote economic structural transformation. This will provide more IIT planning opportunities in certain encouraged areas and industries. At the same time, the Chinese tax authorities are continuously strengthening their efforts in relation to the administration and the collection of IIT, which will bring more challenges affecting both employees and employers in China.
Preferential tax treatments for equity incentives
On September 22 2016, the Ministry of Finance (MOF) and the State Administration of Taxation (SAT) jointly issued Circular 101 (2016). This circular clarifies the IIT preferential treatments applying to employee equity incentives and the use of rights in technology as capital contributions to Chinese resident enterprises. It also sets out the incentive qualifying criteria and is supplemented by SAT Announcement 62 of September 28 2016, which provides for the administrative guidelines and detailed implementation rules. Both circulars are effective from September 1 2016 and underpin governmental support for national mass entrepreneurship and innovation to promote economic structural transformation. The preferential tax treatments apply solely to unlisted domestic resident enterprises, which should stimulate interest of those private companies and pre-Shanghai and Shenzhen Stock Exchange initial public offering (IPO) companies in the market for wider deployment of equity awards.
Since the SAT Circular 1030 (2007), concerning the IIT treatment of share options granted by unlisted companies, was annulled in January 2011, there has been no national tax policies offering guidance in this area, leading to inconsistent application of tax treatment across the nation. The promulgation of Announcement 62 and Circular 101 fills this gap and should act as a stimulus to promote the use of equity awards among unlisted companies as a tool to align employee interest and behaviour. In particular, the new policy allows the deferral of taxation of equity awards until the point of disposal, and reduces the marginal tax rate from 45% (top marginal tax rate applicable to employment related income) to 20%.
To illustrate the potential reduction in the tax burden with a numerical example, before the new rules came out, an employee with equity awards vested at the value of RMB 200,000 ($29,000) could be taxed at 45% (the marginal tax rate), resulting in a tax payable of RMB 90,000 on vesting. The shares would also be subject to a further 20% capital gains tax if sold at a premium later on. With an assumed capital gain of RMB 100,000 on disposal, another RMB 20,000 tax liability is due, which results in a total tax bill of RMB 110,000. Under the new rules, and assuming the facts remain the same, taxation of the equity awards would be deferred to the point of share disposal which relieves the employee from cash flow strain at vesting. The total gain realised from the share disposal should be taxed at 20%, which results in a total tax liability of only RMB 60,000, translating to a reduction of RMB 50,000 in the total tax bill compared to the tax treatment under the old system.
With the rollout of the new rules, the IIT preferential treatment is now available to equity awards granted by both listed and unlisted companies and the degree of tax benefit largely depends on the design of the plan.
Emerging trend of tax audits and investigations from data and analytics
Notwithstanding the fact that implementation of the Golden Tax III project since early 2016 has experienced some teething problems, the revamped nationwide online tax lodgment system should ultimately enhance the collection of tax data for ongoing monitoring of tax compliance by businesses. The new lodgment system is one of the many measures that the SAT has developed to curb tax avoidance and strengthen the collection of tax revenue.
Enhanced IT systems to facilitate information gathering and data analysis
In February 2016, the Shanghai tax authority launched a new IIT filing system, which is a part of the third project of the Golden Tax System (Golden Tax III).
An enhanced version of Golden Tax III, which covers all tax filings, has been launched in major cities across China including Beijing, Shenzhen and Guangzhou. According to the current plans, the Golden Tax III project will be rolled out in all locations across China by the end of 2016.
The Golden Tax III system aims to achieve consistent nationwide tax administration backed by information technology and processing of tax data in an efficient manner. For tax lodgement via the Golden Tax III system, in addition to requiring taxpayer details to be submitted in a standardised and consistent format, additional details on income are required to be declared. For example, the Golden Tax III system requires an employer to disclose each type of tax-exempt employment income of its employees on a monthly basis in addition to the regular monthly withholding tax reporting. The collection of standardised and additional information under the Golden Tax III system nationwide should provide the tax authorities with sufficient data to support benchmarking exercises and formulate new tax policies.
Furthermore, the Golden Tax III system will unify the national tax administration standards for data, compliance and penalties, establish an effective system for tax information exchange, and facilitate centralised processing and analysis of multiple data sources from the state and provincial levels.
Risk management divisions established to identify non-compliance
With the amount of tax-related data being collected with the assistance of the Golden Tax III system, the SAT and various local tax authorities are making efforts to improve how the data is shared and pooled across tax authorities. Most of the municipal tax authorities have established a risk management division to identify major tax risk areas as their basis for conducting in-depth tax audits or investigations.
Pooled data, including information from the taxpayer tax risk management systems and information on historic compliance, as well as business and transactional information, is then to be harnessed for the tax risk classification of taxpayers, referred to as a "tax credit rating". This allows for the concentration of audit resources on risky segments, with low risk taxpayers commensurately accorded a lower level of scrutiny and audit.
More frequent data and analytics-based tax audit and investigations performed
Based on the information gathered from the tax filing system and major tax risk areas identified via the tax risk management systems, more frequent tax audits and investigations could be performed by the local tax authorities.
Recently, more and more companies are being subject to tax investigations by the local tax authorities on tax exempted benefits provided to expatriate employees. Among other things, these investigations look at:
- Whether proper contractual and supporting documentation is in place for the provision of IIT exempted benefits to the expatriate employees;
- Whether the IIT exempted benefits provided are reasonable;
- Whether such benefits can be substantiated by valid tax invoices; and
- Whether the filing is performed where required by the local tax authority.
The disclosure of more information on IIT-exempted benefits by the withholding agent/taxpayer via IIT filings through the Golden Tax III system enables tax authorities to set risk control standards on the reasonableness of tax exempted benefits. This information is them assessed to determine whether the tax exempted amount is within a reasonable range. If not, the tax risk management system would push the case to the tax investigation department to arrange a tax audit or investigation.
Furthermore, certain tax bureaus in northern China are performing tax investigations on taxpayers who have abnormal IIT filing records. Specifically, individuals who have performed "nil filings" are being required by the local tax authorities to provide explanations on the technical basis for the nil filing position adopted.
Given the extensive number of sources that the Chinese tax authorities are beginning to utilise to collect and exchange information for tax enforcement, it is imperative for companies to conduct regular reviews of their IIT positions to effectively manage their IIT exposures.
CRS and the Chinese IIT impact
China, as one of the countries committed to adopting the OECD's common reporting standard (CRS), is now focusing on CRS.
On October 14 2016, the SAT released draft management measures on tax-related information due diligence for non-resident financial accounts, which requires financial institutions to commence conducting customer due diligence. This includes:
- Reviewing for reasonableness the self-certifications and other declaration documentation provided by customers; and
- Gathering details of their account holders' tax related information.
Due diligence work will commence from January 1 2017 and it is intended to facilitate China to undertake the first exchange of information with other countries in September 2018.
CRS provides a common global approach for jurisdictions to obtain financial information from their financial institutions and to automatically exchange that information with multiple jurisdictions on an annual basis. After implementation of the CRS, from a Chinese IIT perspective, the following individuals who are subject to the IIT on their worldwide income would be impacted:
- Individuals who are domiciled in China; and
- Individuals who are not domiciled in China but are a tax resident of China for five full consecutive years and deemed a tax resident of China in the year concerned.
Generally speaking, an individual, who is domiciled in China, is subject to China's IIT on his worldwide income. An individual who is domiciled in China is defined as an individual who, by reason of his household registration, family or economic interests, habitually resides in China. An individual with a Chinese passport or a 'hukou' (household registration) is generally deemed to be domiciled in China.
An individual, who is not domiciled in China, is taxed in accordance with the length of their residence in China. They would be deemed to be a resident of China if they have not been physically away from China for more than 30 continuous days or 90 cumulative days in a calendar year.
An individual, who is not domiciled in China, but is a resident of China for five years or less, is taxed on income derived within China only.
An individual, who is not domiciled in China, but is a resident of China for five full consecutive years, would be taxed on their worldwide income in China, if they are deemed a tax resident in any of the years thereafter.
The above tax rules were introduced in 1994 and are still valid. However, the taxation of overseas income was not strictly enforced in the past. This was due to the lack of tax authority resources and difficulties for the tax authorities in gathering information on individual personal income derived from overseas. After the implementation of CRS, a China tax resident's income information from an account in a CRS participating country will be automatically transmitted to the Chinese tax authorities. This will facilitate the tax authorities to monitor the tax status of the overseas income.
It is imperative for individual taxpayers to periodically review their tax residency status in China and plan their financial and tax arrangements accordingly. If it is determined that an individual is subject to Chinese IIT on worldwide income, the individual should comply with the Chinese IIT filing requirements to avoid any penalties being imposed on noncompliance.
Increased efforts to conclude social security totalisation agreements with other countries
China's Social Insurance Law requires employers and their employees to participate in the Chinese social security system by contributing towards social insurance schemes, including pensions, medical, unemployment, maternity insurance, and work-related injury insurance. While all five types of schemes are mandated for employers, employees are required to contribute to three of these schemes.
Since October 15 2011, expatriate employees lawfully working in China are also required to participate in the social security system in China.
Generally speaking, the mandatory social insurance contribution basis is determined on the basis of the employee's average wage in the prior year. The social insurance contribution calculation basis is subject to a ceiling of 300% of a city's annual average wage of workers in the prior year, but cannot be lower than 60% of a city's annual average wage of workers in the prior year. As the mandatory contribution basis and rates vary by city, social security contributions are location specific.
- Among the categories of contributions in China, the contributions required to be made to the pension scheme create the greatest burden. According to the current pension contribution rate and base for 2016-17, the monthly contribution required to be made to pension schemes by employers and employees, respectively, in Beijing and Guangzhou are as follows: Monthly maximum social security contributions in Beijing:
- Employer: RMB 4,039
- Employee: RMB 1,701
- Monthly maximum social security contributions in Guangzhou:
- Employer: RMB 2,321
- Employee: RMB 1,326
To mitigate duplicate contributions of social security by cross-border employees, the Chinese government has concluded – or is in the process of concluding – social security totalisation agreements with the countries listed in Table 1.
At this juncture, the Chinese government is negotiating with a few other countries on entering into totalisation agreements. It is anticipated that the conclusion of these totalisation agreements will encourage cross-border business operations and promote global mobilisation of employees.
|Countries||Status||In force by|
|Belgium||Under negotiation||Not in force|
|Canada||Concluded on April 2 2015||Not in force|
|Denmark||Concluded on December 9 2013||May 14 2014|
|Finland||Concluded on September 22 2014||Not in force|
|France||Concluded on October 31 2016||Not in force|
|Germany||July 12 2001||April 4 2002|
|Korea (Rep.)||Concluded on October 29 2012||January 16 2013|
|Switzerland||Concluded on September 30 2015||Not in force|
|The Netherlands||Concluded on September 12 2016||Not in force|
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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.
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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.
8th Floor, KPMG Tower, Oriental Plaza
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 Chinese 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 China 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-initial public offering (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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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 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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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.