TAX BRIEF -- JULY 2011

China’s legislature has approved an increase in the individual income tax free threshold to RMB 3500 for Chinese nationals and a new streamlined schedule of tax brackets, down from nine to seven. The new rates will come into effect from September 1st.

Foreigners will also be subject to the new rates; however, the tax free threshold for foreign workers will remain at RMB 4800.

The lowest tax bracket will be reduced from 5 to 3 percent and will cover a larger number of workers in a move widely viewed as a reaction to public concerns over inflation and rising food prices. Inflation has proven a sore political issue in China with accelerating rates responsible for keeping real deposit rates negative. China’s May CPI rose 5.5% year on year, outpacing a one-year deposit rate of 3.25%.

New Individual Income Tax Rates from September 1^st 2011

The new threshold comes after an initial draft proposal of RMB 3000 was withdrawn following a public consultation period that saw the revised figure criticized as too low. The percentage of income earners paying individual income tax drop from 28 to 7.7 percent, reducing government tax revenue by around RMB 160 billion per year.

It is likely given the shortfall that the government will look to increase IIT collection through tougher enforcement on higher income earners. This approach was earlier in 2011 with the release in April of SAT circular Guoshuifa [2011] No.50 (“Circular on Effectively Improving IIT Collection from Individuals with High-income”).

Circular 50 focuses on collecting tax income from increasingly diversified sources of personal wealth creation. With high-income earners now generating more wealth through non-employment income, Circular 50 places greater scrutiny on some of these methods, including:

• Income derived from equity investments, including interest and dividend income;
• Individual income from business operations;
• Income from transfer of properties.

In addition, the circular will bolster IIT collection and administration on high-income earners and individuals who are involved certain “high income industries,” including private equity, real estate, mineral resource investments, and trust investments. The circular also requires tax bureaus to share more information and maintain communication to encourage improved administration.

The new IIT schedules and recent circulars go hand-in-hand, as the government shows its desire to monitor and tax high-income earners and wealth generated from non-employment income to offset the tax revenue lost from raising the IIT threshold.