China Extends Preferential Tax Policies for Individuals

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 (This article was originally published by China Law & Practice on 28 September 2023)

STANDFIRST: A number of preferential tax policies have recently been extended for four years, with implementing circulars also providing important clarifications on applicable rules.

Summary

* A set of joint circulars extend a number of key preferential tax policies on individual income tax until the end of 2027

* The policies affected relate to favorable tax treatment for income additional to salary, such as bonuses and equity incentives

* Venture capital partners and foreign skilled workers in the Greater Bay Area will also benefit from the tax policy extensions

A series of preferential tax policies on individual income tax ("IIT") were due to expire by the end of 2023. However, China's Ministry of Finance ("MOF") and State Taxation Administration ("STA") have jointly released circulars which extend those policies for another four years. The State Council has also released a notice to raise the standards of special additional deductions for IIT calculation. The key preferential IIT policies that are extended or updated include:

IIT exemption of subsidies and allowances for expatriate individuals (《关于延续实施外籍个人有关津补贴个人所得税政策的公告》（财政部 税务总局公告2023年第29号）); 

IIT calculation on a separate basis for an annual one-off bonus (《关于延续实施全年一次性奖金个人所得税政策的公告》（财政部 税务总局公告2023年第30号）); 

IIT calculation on a separate basis for income from equity incentives of listed companies (《关于延续实施上市公司股权激励有关个人所得税政策的公告》（财政部 税务总局公告2023年第25号）); 

preferential IIT treatment for individuals' income from venture capital (《关于延续实施创业投资企业个人合伙人所得税政策的公告》（财政部 税务总局 国家发展改革委 中国证监会公告2023年第24号）);

15% effective IIT rate for foreign talents working in the Guangdong-Hong Kong-Macau Greater Bay Area ("Greater Bay Area") (《关于延续实施粤港澳大湾区个人所得税优惠政策的通知》（财税〔2023〕34号）); and

raised standards for special additional deductions in calculating IIT payable (《国务院关于提高个人所得税有关专项附加扣除标准的通知》（国发〔2023〕13号）).

01

IIT exemption of subsidies and allowances for expatriate individuals

China has been granting an IIT exemption for expatriate individuals' subsidies and allowances in kind, such as housing subsidies, food allowances, relocation fees, laundry fees, travel subsidies, family visit fees, language training fees, children's education fees, etc. 

With the implementation of the amended PRC IIT Law in 2019 and the introduction of the special additional deductions, it has been clarified that, from January 1, 2019, an expatriate individual who is a Chinese tax resident may choose to claim special additional deductions for IIT at a standard level, or to enjoy the aforementioned exemption policy for subsidies and allowances in kind, but is not allowed to claim the special additional deductions and the tax exemption incentive concurrently. The option chosen must remain unchanged within a tax year. It was previously supposed that the tax exemption incentive might expire at the end of 2023.

In general, the tax exemption incentive would be more favorable to foreign individuals than the standardized special additional deductions, as there is no standard amount of subsidies and allowances in kind enjoyed by expats. These items are also allowed to be deducted from taxable income as long as they are authentic and reasonable. As such, the extension of this policy could reduce the tax burden for foreign skilled workers as well as the salary cost to their employers.

02

IIT calculation on a separate basis for an annual one-off bonus

With respect to an annual one-off bonus awarded to an individual, there has been a preferential treatment available whereby the tax payable can be calculated separately from the individual's annual comprehensive income (including wages and salaries, remuneration for labor services, author's remuneration, and royalties). The applicable tax rate and quick deduction will depend on the total amount of the annual bonus divided by 12 months, which effectively reduces tax liability of the bonus. The formula is: amount of tax payable = annual one-off bonus income × applicable tax rate – quick deduction.

A Chinese resident individual may also opt to incorporate an annual one-off bonus into their annual comprehensive income for the calculation of tax payable. Taxpayers can compare the tax burden under the two methods of tax calculation so as to choose the optimal one.

The preferential tax treatment for annual one-off bonus was previously supposed to expire at the end of 2023, and the annual one-off bonus was supposed to be combined into the comprehensive income of a taxpayer for a tax year from then on. As a result, individuals and employers were concerned about the potential increase of tax liability with respect to an annual one-off bonus. The treatment has now been extended for another four years until the end of 2027.

03

IIT calculation on a separate basis for income from equity incentives of listed companies

It has been a long-standing policy in China that equity incentives such as stock options, stock appreciation rights, restrictive stocks, and equity rewards obtained by a resident individual which meet the criteria stipulated in relevant regulations may be excluded from the amount of annual comprehensive income, and the tax due may be computed separately on the full amount by applying the comprehensive income tax rates. The formula is: amount of tax payable = income from equity incentives × applicable tax rate – quick deduction.

Following the implementation of the amended PRC IIT law in 2019, the preferential policy of calculating the tax on the income from equity incentives of listed companies separately from the annual comprehensive income was supposed to expire at the end of 2023. The new four-year extension enables enterprises to better use equity incentive tools to attract and retain skilled workers and reduce the tax burden thereof.

04

Preferential IIT treatment for individuals' income from venture capital

For the purpose of continuously supporting the development of venture capital investment, the MOF, STA and other relevant ministries announced the extension of the preferential IIT policy for individual partners of venture capital partnerships until the end of 2027. The policy was first implemented in 2019 and was originally due to expire at the end of 2023.

As a general principle, an individual partner's income received from partnerships selling off the underlying investment is subject to excess progressive tax rates from 5% to 35%; in practice, the individual partner's effective tax rate with large proceeds would be higher than 30%. The preferential IIT policy provides that, if the partnership is a qualified venture capital partnership, the individual partner may choose to calculate IIT payable at a flat rate of 20% of their income received from partnerships selling off the underlying investment.

Besides the different tax rates, there are other differences between the two calculating methods, such as whether the expenditures incurred (e.g. the management fees and carried interest of the general partners are allowed to be deducted, and whether the investment losses can be carried forward. Qualified venture capital partnerships are allowed to choose the best suited calculating method based on the specific circumstances of the investments.  Once the method is selected, it cannot be changed within three years. 

05

15% effective IIT rate for foreign skilled workers in the Greater Bay Area

Qualified overseas high-end skilled workers, and skilled workers in short supply working in the Greater Bay Area (including nine cities: Guangzhou, Shenzhen, Zhuhai, Foshan, Huizhou, Dongguan, Zhongshan, Jiangmen and Zhaoqing), are able to apply for subsidies from the local governments in the form of an IIT rebate after the annual IIT settlement is completed. The rebate is calculated as the difference between the actual IIT paid by the individual and 15% of the individual's taxable income. The IIT rebate is exempted from IIT. Each city government sets up its own application processes as well as requirements for the qualifying foreign talents.

This policy aims to offset differences in the IIT treatment between Chinese mainland and Hong Kong SAR, so as to attract foreign talents to work in the Greater Bay Area. As with the other policies described, this policy first came into force in 2019, and has now been extended until the end of 2027.

06

Raised standards for special additional deductions in calculating IIT payable

According to the PRC IIT law and relevant regulations, special additional deductions are deductible items when computing the taxable income amount of a Chinese resident individual's comprehensive income, including infants nursing under three years old, children's education, further self-education, health costs for serious illness, housing mortgage interest, house rent, and support for the elderly.

For the purpose of further reducing the expenditure burden on families for childbirth, rearing and support for the elderly, the State Council announced it would raise the standards for certain items of special additional deductions as follows:

Observations

The four-year extension of preferential tax policies for foreign individuals could be an effective way to curb the brain drain of foreign talent. 

Furthermore, the policies relating to foreign and Chinese individuals send a signal that the Chinese government is committed to reducing the tax burden on individuals in general, enhancing personal consumption capabilities, and welcoming foreign investment. It is expected that the relevant individuals and enterprises will want to make full use of the various preferential policies.

Authors

Duan Tao（Daisy）

Partner

Regulatory & Compliance Group

daisy.duan@cn.kwm.com

Areas of Practice：PRC tax and business advisory services

Daisy has more than 17 years' experience in the tax field, mainly providing tax advice for MNCs, domestic/foreign enterprises and individuals. Specifically, her service scope includes tax consultation and planning for non-resident enterprises, tax planning for cross-border investments, M&A and restructuring projects, establishment and dismantling of red-chip structures, privatization projects, wealth management of high net worth individuals, equity incentive, asset securitization, and turnover tax, as well as tax due diligence and tax dispute resolution. Daisy has rich experience in assisting enterprises in coping with tax inspection, transfer pricing investigation, anti-tax avoidance investigation as well as tax administrative review/litigation and has successfully represented clients to accomplish a number of highly challenging tax dispute cases. Daisy's clients cover diversified fields including but not limited to medicine, finance, culture and entertainment, real estate, Internet, energy and manufacturing.

Wang Yan

Senior Associate

Regulatory & Compliance Group

Li Cuishi

Associate Assistant

Regulatory & Compliance Group

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