IIT assessment for sole proprietorships and partnerships
China has, for some time, imposed individual income tax (IIT) on sole proprietorships and partnerships on a deemed basis. This is applied, in place of an accounts basis, where these businesses (i) fail to set up account books; (ii) have account books that are not robust; or (iii) fail to file tax payments on time.
This approach exists as a backstop and the use of higher deemed profits was originally considered more likely to push businesses in the direction of preparing proper accounts if they could. However, it has now been realised that this approach, in certain instances, creates tax avoidance opportunities for individuals making equity transfers.
IIT on non-exchange equity transfer gains is applied at 20% (disposal of listed equity through exchanges is exempt). Through use of the deemed IIT approach, some individuals had been able to reduce their tax exposure below 20%.
To address this, on December 30 2021 the Chinese Ministry of Finance (MOF) and State Taxation Administration (STA) released joint Circular No. 41 (2021).
Starting from January 1 2022, sole proprietorships and partnerships holding equity investments shall be subject to account audits for IIT assessment and reporting purposes. They also need to fulfil certain reporting obligations (with their in-charge tax authorities) in relation to the equity investments held by them. Otherwise, sanctions will be imposed.
This is in line with China’s recent moves to increase scrutiny on equity transfers made by high-income earners. In recent times, local tax authorities and local market administrations, such as those in Beijing and Shenzhen, have enhanced inter-authority information sharing on equity transfers by individuals. Note that Chinese local market administrations maintain registers of changes in equity ownership in private companies.
Alongside this, the Chinese tax authorities are also focusing on tax avoidance by performers on live-streaming platforms, which have become a prominent part of China’s digital economy.
In late December 2021, the tax authority in Hangzhou imposed tax, late payment and fines of RMB1.34 billion ($210 million) on Viya, a well-known live streamer in China. This comes after the Hangzhou tax authority imposed penalties on another two high-profile live streamers in November 2021.
They were subject to tax recovery and fines of RMB66 million and RMB28 million respectively. The Hangzhou tax authority detected their tax avoidance cases by leveraging analysis of tax big data. This will continue to be a focus area for tax authorities in China.
Fringe benefits for foreign individuals
In China, foreign employees can enjoy a special fringe benefits exemption for IIT purposes. This covers school fees, accommodation costs and various costs of living. Normally, the fringe benefits can be fully excluded from taxable income as long as they were paid on a reimbursement basis. In 2018 however, in MOF and STA Circular No. 164 (2018), it was provided that these tax-exempt benefits would finish by the end of 2021.
Foreign employees, and the companies that employ them, have paid a lot of attention to the abolition of the tax-exempt benefits concession as it would raise their IIT burden significantly.
To keep China competitive in the global talent market, on December 31 2021 the MOF and STA released Circular No. 43 (2021) extending the tax exemption treatment of special fringe benefits to the end of 2023. This is a welcome development for foreign employees in China, and their employers.
Bonus and equity incentives
On December 31 2021, the MOF and STA announced in Circular No. 42 (2021) the extension of the preferential IIT treatment of annual one-off bonuses to the end of 2023, and of equity incentives granted by listed companies to the end of 2022. Both of these two treatments were due to expire on December 31 2021.
This means that these two types of income can continue to be treated as separate income, outside the annual comprehensive income calculation. The applicable IIT tax rate bracket can thereby be determined based on the bonus/incentive amount divided by six or 12 months (depending on the specific circumstances). This moves the bonus/incentive to a lower tax bracket than the individual’s marginal IIT rate.
While taxpayers may benefit from the extension of preferential IIT treatment, they need to look out for the enhanced tax administration on employee share schemes.
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