With global tax revamp afoot, multinational companies are facing more tax-related challenges operating across the globe. However, changes are inevitable. China will follow the change to reform its taxation policy over the next five years.
Since 1994, China has granted its working foreigners tax benefits via its individual income tax policy. This preferential policy granted the tax-free status for 8 categories of expenses including rent, children’s education, language training, meal, laundry, relocation, business travel and home visit expenses.
However, it has now become the most prominent concern to expats, as two years ago China decided to end the preferential policy to equalize benefits between local and foreign workers.
In a policy implementation document Cai Shui  No. 164, China set a transition period to allow companies and expats a three-year period in preparing for transiting from the existing preferential policy to the unified Special Addition Deduction policy.
During the period from 1 January 2019 to 31 December 2021, a foreign individual who satisfies the resident individual criteria may opt to claim special additional deductions for individual income tax as Chinese residents or opt to continue enjoying the existing preferential tax-exemption policy. Once the foreign individual decides on which tax deduction policy he/she wishes to enjoy, the option cannot be changed within a tax year.
Most expats working in China still prefer opting for the existing tax exemption policy for the 8 tax-exempted allowances, of which the purpose was to attract high-level foreign talents to relocate and work in China.
In principle, under the existing tax exemption policy, allowances can be exempted from individual income tax so long as the expenses incurred are reasonable with legitimate supporting documents. Due to discrepancies of consumption levels among different cities, the amount of allowances which can be deemed as reasonable is different city by city. However the existing tax-exempt policy provides a much higher amount of deduction for IIT purpose compared to the Special Additional Deduction Policy introduced by the new IIT Law. Additionally, compared to the preferential tax-exempt policy for expats, the Special Addition Deduction policy provides deductions in fixed amounts. This exposes their pre-tax income to China’s 45% top income tax rate.
After the expiry date, expats in China must follow the same deduction method as Chinese residents according to the revised Individual Income Tax Law (IIT Law) which was enacted on 1 January 2019. If conditions are met, Chinese residents deriving comprehensive income can claim deductions on child education, continued education, mortgage interest, rental expense, elderly care and major medical expense when calculating the annual taxable income using the Special Addition Deduction policy.
Alongside, foreign companies have become increasingly worried as the deadline (31 December 2021) approaches. It is estimated that the change would force a multinational company to pay an additional 785,000 yuan (US$119,000) in taxes for a foreign employee with two children receiving a typical allowance of 960,000 yuan (US$145,500) for housing and school tuitions annually. The employee would have to pay extra tax of 432,000 yuan per year.
As an example, consider rental expenses. Imagine that a multinational company headquartered in Brazil sends a Brazilian technician to its Chinese subsidiary located in the city of Shenzhen. According to the accommodation standard provided to the expatriates in Shenzhen, the reasonable range of monthly rent for this Brazilian expatriate may be from RMB 8,000 to 10,000. The Brazilian technician can deduct the actual cost of renting the apartment before taxes so long as his/her monthly rent is within the reasonable range. However, if a Brazilian technician chooses the Special Additional Deduction Policy, the maximum deduction for his/her rent is only RMB 1,500 per month, which is drastically lower than using the existing tax-exempt policy.
Considering the upcoming inevitable changes, responding to the expiration of the transition policy cannot be overlooked. Taking no action will certainly cause a substantial rise of foreign employees’ individual income tax burden. Given this expected outcome, what actions can a business take to reduce the impact on its financial operations? Here are our suggestions:
Review the status of foreign employees already in China, including their salary and benefits, and estimate the increased tax burden according to special additional deduction policy. Timely adjust the company’s cash flow plan according to the increased tax burden.
Modification of Labor Contract
Review the labor contracts of existing foreign employees. If it is necessary to modify, consult the relevant legal personnel to modify the relevant provisions.
Provide training to foreign personnel
Foreign personnel must be trained and given proper guidance on the special additional deduction policies. Employers should assist employees to determine the amount of each special additional deduction item and clearly inform foreign employees of their rights and obligations.
Although there is no official explanation for the termination of the existing tax-exempt policy, it is undeniable that the increase in the tax burden of existing foreign employees will ultimately be transferred to the companies. In such case, the operating cost of hiring or dispatching foreign personnel will substantially increase.
Businesses always try to reduce costs. Considering cost control for businesses with the new change, foreign companies would be more cautious about whether to invest in China in the future. In addition, existing multinational enterprises would also be more cautious in planning the dispatch of foreign personnel to China.
Written by Delilah li, CW CPA