China Individual Income Tax (IIT): Key challenges and considerations for foreign employees and employers
In early 2016, the tax bureaus in China have made the tax compliance requirements for foreign employees and employers stricter. In China, all income related to employment (whether in cash, kind or any form of economic benefits) is subject to tax, except the following fringe benefits to foreign employees:
- Housing allowance
- Home leave travel allowance
- Relocation and moving costs
- Reimbursement of meals and laundry
- Children’s education
- Language training
However, there are certain requirements that must be met in order to enjoy non-taxable benefits:
Reasonableness:The fringe benefits must be a reasonable proportion of the overall remuneration package and the benefits exceeding the required limit may be subject to tax. The limit of fringe benefits that can be IIT exempt varies from city to city.
Supporting documents:The fringe benefits must be justified by fapiaos (invoices) and the fapiaos must be genuine. Therefore, when the benefits are received by the expatriate in the form of lump sum allowances or reimbursements, the amount that exceeds the justifiable amount is taxable. In order to avoid any complications, it is advisable that whenever possible, the employer directly pays the benefits on behalf of the foreign employees.
Further requirements for non-taxable fringe benefits:
- The rental payment must be supported by documents, such as official fapiao and rental agreement.
- Rental amount should not be much higher than the average market price, otherwise tax bureau will suspect the authenticity of the rental arrangement.
Home leave travel allowance
- Allowed up to two round trips a year for the employee
- Non-taxable allowance are only limited to transportation expense
- The transportation allowance is limited to the trip between working location and family location (including spouse and parents living location)
- Claim for travel allowance must be supported by documents, such as travel tickets, fapiao, etc.
Relocation and moving costs
- Limited to relocation to China for work and departure from China due to resignation.
- Genuine supporting documents will be required.
Reimbursement of meals and laundry
- Based on real expense incurred by expatriates.
- Official fapiao must be provided as a supporting document and the fapiao amount must be reasonable.
- The education points to public diploma education which excludes education in special technical and vocational school or institution for training.
- Supporting documents for education tuition and period is must
- Supporting documents is required.
Proper tax filing and monthly tax declaration
In an effort to tighten the tax compliance requirements, from early 2016, the local tax bureaus in Shanghai require the companies to provide a detailed breakdown of non-taxable fringe benefits while reporting the monthly IIT return for the foreign employees. In addition, the local tax bureaus require companies to register their non-taxable fringe benefit arrangements with the tax bureau in order to secure IIT exemption.
In a similar effort, Beijing is carrying out a special tax inspection on the non-taxable fringe benefits by reviewing the supporting documents, such as original fapiaos (official tax receipts), employment contract, company policy and guidelines.
Dual contract arrangements and IIT planning:
Dual contract arrangement is one where a foreign employee will enter into two employment contracts- one with the Chinese employer and the other one with the overseas employer. The salary will be split between two contracts and individual income tax will be paid partly in China and overseas. The employer has the obligation to withhold the taxes for the employees. However, usually it is seen that only the portion of the income allocated to Chinese contract is reported to the tax bureaus in China while excluding the income sourced from overseas and where Chinese employer has no statutory withholding obligation on the payment made by the overseas employer outside China. If the tax bureau becomes suspicious of the dual contract where IIT reporting for offshore income is being excluded and where the reported income is much below the norm, such contracts may be subject to closer scrutiny by the tax bureau. As a good practice, the employers in China should report the combined income of both the contracts even if the income from overseas contract is subject to tax overseas. The reporting requirements for income under dual contracts may vary from case to case.
- Make sure that the remuneration structure in the employment contract is detailed enough leaving no room for ambiguity.
- Have proper supporting documents in place in order to justify the non-taxable benefits.
- In case of dual employment contract, excluding overseas income from IIT reporting with the tax bureau, may expose the company as well as the foreign employee to higher risk.
- In an attempt to curb the tax evasion practices, in 2017, China is expected to implement the automatic exchange of tax information with the tax authorities of other countries which will make income disclosure requirements for expats even stricter. Therefore, arrangements under dual contracts should be dealt with early on for more transparent remuneration structure.