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China extends tax-exempt benefits for foreigners working in the country

The Chinese Ministry of Finance announced that it will extend preferential income tax policies for foreigners residing in the country to Dec. 31, 2023, from a previous measure that would have stopped certain income tax deductions by Jan. 1, 2022.

With the objective to ease the burden on taxpayers, the Chinese authorities decided to extend two more years some income tax exemptions. The government pledged to further cut taxes and fees in 2022 to support struggling businesses.

Previously, foreigners working in China were to lose some tax benefits, such as housing rental, children’s education costs, and language training costs. This would have resulted in larger tax liability for some higher-earning foreign workers.

China’s decision to extend tax exemptions on expatriate allowances for two more years was welcomed by foreign business groups, though there are still worries about rising costs, travel restrictions due to the Covid-19 pandemic and market access.

Foreign professionals working in China are entitled to several tax-exempt benefits. However, due to the implementation of the new Individual Income Tax (IIT) Law from January 2019, certain non-taxable benefits will be replaced by additional itemized deductions, while others will cease to be exempt at the end of 2023.

There are eight categories of tax-exempt benefits for non-China domiciled foreigners: housing expense, education for children, language training, meal fee, laundry fee, and relocation, business travel and home leave expenses.

These expenses should be in a reasonable amount and claims must have the correct supporting documents, such as invoices (fapiao), as well as other more specific requirements depending on the category of the expense.

With the intention of making tax benefits fairer between locals and foreigners, the new IIT law that took effect on Jan 1, 2019, planned for the elimination of tax-exempt benefits for non-Chinese nationals during a three-year transition period.

From January 1, 2019, to December 31, 2021, non-China domiciled tax residents (who do not have a domicile in China and live for 183 days or more in China in a given tax year) could choose between claiming tax-exempt benefits-in-kind; or six additional itemized deductions.

The six additional deductions are: children’s education expenses, continuing education expenses, housing mortgage interest, rent, healthcare costs for serious illness and expenses for taking care of the elderly.

During the transition period, the two policies cannot be combined. And once decided, non-China domiciled tax residents are not permitted to change their preference within a given tax year.

According to the IIT law, starting on Jan 1, 2022, expatriate employees would no longer enjoy preferential tax-exemption policies, including housing, language training, and children’s education.

These three categories would be replaced by the corresponding additional itemized deductions (housing rent, continuing education expenses, and children’s education expenses).

The policy does not state if the other five categories (meal fee, laundry, relocation expense, business travel expense, and home leave expense), will continue to be tax-exempt.

According to experts, employers should prepare for possible changes as early as possible to avoid concerns from expatriate employees.

Compared with the six additional itemized deductions, the eight tax-exempt benefits are believed to be more beneficial to foreigners who have a higher income and level of expense.

The tax-exempt benefits are deducted based on the actual cost of each expenditure, although the amount is subject to the limit of a “reasonable” amount, based on local living standards. A proportion of around 30 to 35 percent of the expatriate’s monthly salary is usually acceptable by the tax authority.

However, most additional itemized deductions (except for healthcare costs) are deducted based on a standard basis. The deduction fee for children’s education, for example, is RMB 1,000 monthly per child, an amount much smaller that the actual cost of international school’s tuition.

Expatriates with children in such schools will face a significantly higher overall tax burden.

On the other hand, the policy transition makes things easier for foreigners, who previously, to enjoy the tax-exempt benefit, had to provide corresponding invoices or receipts every month for each expense.

Foreigners whose income is not that high and cannot enjoy the tax-exempt benefits, will now be able to access the six itemized deductions if they are resident taxpayers. They can also claim itemized deductions directly through their tax filing or via their employer, once they obtain their tax ID in the tax bureau. The application process will be much easier than submitting a pile of invoices or receipts.

The IIT changes could result in up to 13 percent reduction of an employee’s net pay. In order to lower the tax burden on expatriates, companies should re-examine the labor contracts and consider restructuring the employee’s salary package.

Having an early contingency plan to avoid disputes and promote transparency, could provide peace of mind for both the expatriate employee and the company.

Companies could consider compensating foreign employees for their increased tax burden. This could be easier done by multinationals but rather difficult for small and medium enterprises that are already struggling under the current circumstances.

Some regions of China have been introducing preferential IIT policies to reduce the tax burden on foreign talent. Certain multinationals are considering relocating to the Greater Bay Area to take advantage of these regulations.

The Guangdong-Hong Kong-Macao Greater Bay Area is offering IIT benefits to “high-end” and “urgently needed” foreigners, which can lower their tax rate to 15 percent until the end of 2023. These individuals must work in one of the nine cities in Guangdong province and satisfy some basic conditions and requirements on contract terms and income, as set out by the municipal governments.

Hainan Free Trade Port also announced a similar IIT initiative to attract foreign talent until the end of 2024. From 2025 to 2035, Hainan FTP will continue to reduce IIT rates to 3, 10, and 15 percent (three tax brackets) for eligible talents’ taxable income earned in the area.

Other regions may consider offering the same benefits to stay competitive in the labor market.

Joerg Wuttke, president of the European Chamber of Commerce in China, said the extension of non-taxable allowances, announced by the Ministry of Finance and the State Taxation Administration, is highly significant for foreign firms and benefits China as well.

“We believe this solution provided by the Chinese authorities will stem the flow of foreign talent from China, which will help to maintain a high level of competition and innovation within the Chinese market, while also improving international relations in general,” he said in an online statement.

To learn more about our services in China, contact our Head of Business Advisory - Ms. Kristina Koehler-Coluccia at kristina@woodburnglobal.com.

DISCLAIMER: All information in this article is verified to the best of our ability and is assumed to be correct at time of release; however, Woodburn Accountants & Advisors does not accept responsibility for any losses arising from reliance on the information provided within. The information provided is for general guidance and does not replace specialized advice.

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