Income Tax and Social Security Reforms
Two upcoming reforms are causing concern among foreign employees and foreign companies in China: the amended Individual Income Tax (IIT) Law and the reform to China’s social insurance system.
1.Changes to China’s IIT Law
Approved in August 2018, the latest amendment to China’s IIT Law is the most significant revamp since its introduction in 1980.
- Deductible expenses (effective Jan. 2019)
Chinese employees will be able to deduct certain expenses from their taxable income, an option that was previously only available to foreigners.
For foreigners, some expenses may no longer be deductible, for example travel costs to an employee’s home country.*
- Residency rules for foreigners (effective Jan. 2019)
Foreigners without a domicile in China will be considered taxable residents if they stay in China for 183 days during a tax year, down from a threshold of one full year.
It is unclear whether this amendment will override the current “five year tax rule”, which states that foreigners’ global income only becomes taxable after spending five uninterrupted years in China.*
- Tax cuts (effective Oct. 2018)
Lower tax brackets were broadened to reduce the tax burden on low and middle-income earners. E.g. people earning RMB12k-25k per month will pay an IIT rate of 20%, down from 25%. The standard monthly deduction (i.e. the amount that can be automatically deducted from an employee’s taxable salary every month) will rise to RMB 5,000, up from RMB 4,800 for non-residents.
* These changes will only be confirmed once the implementation guidelines for the amended IIT law are released, which is expected to happen later this year.
2.Reform to China’s Social Insurance System
Amounting to 39.5% of payrolls on average, China’s mandatory social security rates are as high as in Northern European countries. Employers and employees are both required to contribute, but companies bear the heavier burden.
Until now, loopholes in the collection system have made it relatively easy for companies to under-pay by under-reporting the base salary of employees. In many cities, including Beijing, collection has been in the hands of social security authorities which have no information on employees’ actual incomes.
The Reform of National Tax and Local Tax, set to become effective on January 1st, 2019, will close evasion loopholes by making local tax bureaus responsible for the collection of social insurance payments. The same authority handles individual income taxes, so it has full information about employees’ real salaries.
Implications for Foreign Businesses
Higher costs – starting next year, companies need to ensure that social insurance contributions are based on the full salary of their employees. For businesses who have been under-paying, this could increase costs by around 20%-30% depending on the region’s social security rates.
Employer’s Social Insurance Contribution Rate by Region
Other compliance issues – the reform will make it easier for authorities to spot inconsistencies in the location of social insurance declarations. By law, social insurance must be paid in the city where a business is located. But when companies hire employees in places where they have no branch, they often find ways around this to suit the employee’s convenience. It is still uncertain whether authorities will focus on penalising this type of non-compliance, but businesses should prepare by reviewing their practices and thinking of possible solutions.
Can We Expect the Reform to be Softened?
The Chinese government introduced the reform to tackle the problem posed by its aging population and rising pension deficit.
However, they are aware that the reform might hurt China-based businesses at a time when margins are already squeezed by rising costs and slowing growth. In a statement by Premier Li Keqiang on September 18th, he called on local governments to avoid over-burdening enterprises.
Although the social security reform is on course to being implemented in January, there is a possibility that the central government will soften its impact on businesses by lowering social security rates.
Contact our Tax Advisors to discuss the implications of these reforms in detail and request assistance.