The Individual Income Tax Law

The present Individual Income Tax Law came into effect on 1 September 2011. The Individual Income Tax Law and the Individual Income Tax Implementing Rules (promulgated on 19 July 2011), the Law on the Administration of Tax Collection (promulgated on 28 April 2001) together with tax circulars issued by various levels of the People’s Republic of China tax administration, form the prevailing legal basis of individual income tax in China.

Historical background

The current law revisions, effective on 1 September 2011, represent the amended version of the old Individual Income Tax Law which was effective from 1 January 1994.

Before 1 January 1994, there were three individual income tax laws governing three categories of individual taxpayers working in China:

·Foreigners were subject to the former Individual Income Tax Law.

·Local residents were subject to the Individual Income Regulatory Tax Law.

·Local entrepreneurs were subject to the Income Tax Law.

Although the three former individual tax laws brought in revenue, they were confusing and enforcement problems emerged. A reform of individual income tax became necessary and the following objectives were put forward:

·to simplify the tax laws so that a framework could be readily defined and enforced;

·to create a level playing field for people working in China, and a more stable environment for investment;

·to deter tax avoidance and evasion activities;

·to act as a measure for redistribution of wealth (ie those who earn more, pay more tax).

      Present legal framework

With effect from 1 January 1994, the three former individual tax laws were amended and consolidated to become the present Individual Income Tax Law so as to streamline and simplify the individual income tax system in China. The additional changes from the amendments made in the 1 September 2011 law are ministerial in nature and do not substantively affect the operation of the 1994 law. The present Individual Income Tax Law applies to:

·foreigners;

·local residents; and

·local entrepreneurs (industrial or commercial households).

Residence-based tax

Individual income tax is a residence-based tax. The tax is levied on the worldwide income of individuals who have been domiciled in China or who have been resident in China for at least one year (although this rule is effectively modified by additional rules so that non-PRC nationals are only taxed on worldwide income if they are resident in China for at least five continued full years). China-sourced income of individuals who have resided in China for less than one year may be subject to tax.

Taxable income

There are 11 classes of taxable income, including wages and salaries, business income and various other prescribed items of income and compensation.

Exemptions and reduction

Certain classes of income are specifically exempt from individual income tax. These include monetary awards for technological achievements, interest on State treasury bonds and State-issued financial bonds, subsidies and allowances stipulated by the State Council, welfare benefits, insurance indemnities and income of diplomatic representatives, consulate officials and personnel of foreign embassies and consulates in China in accordance with the relevant Chinese laws. It is worth noting that as of 9 October 2008, savings deposit interest is temporarily exempt from individual income tax.

Assessment and tax rates

Individual income tax is assessed on a monthly basis for most categories of income. The tax rates for wages and salaries are progressive and range from 3% to 45% in seven tax brackets. For business income, the tax rates range from 5% to 35% in five tax brackets. For income derived from independent service, the tax rates range from 20% to 40% in three tax brackets. For other classes of income, a standard rate of 20% applies, but there are special rate reductions and additional tax levies that may apply.

Double tax relief

The Individual Income Tax Law contains a standard relief provision for double taxation on foreign-sourced income taxable in China. A deduction against PRC individual income tax is permitted for the amount of income tax paid on income sourcing from outside of China. The deduction is limited to the tax calculated according to the provisions of the Law. There is a five-year carry forward provision for excess credits, and proper documentation to support the foreign tax payment should be submitted with the claim for credit.

Registration, returns and payments

Foreign individuals usually need to register with the Chinese tax authorities as soon as they become liable to individual income tax. Registration usually requires the submission of a copy of the passport, salary certification, work and residence permits.

In most cases, an employer or any other person who pays taxable income to a taxpayer is obliged to act as a “withholding agent” and is responsible for filing tax returns and remitting tax payments to the tax authorities on behalf of individual taxpayers. However, if there is no withholding agent, an individual is responsible for filing his or her tax return and paying the tax assessed.

With effect from the year 2006, PRC domiciled individuals whose annual earnings exceeded RMB120,000, along with non-PRC domiciled individuals whose annual earnings exceeded RMB120,000 and who stayed in Mainland China for a full year, were obliged to submit an annual tax return in addition to the returns submitted by their employers and other withholding agents.

Investigation and resolving disputes

The Chinese tax authorities continue to focus closely on the enforcement of tax laws through tax audits and investigations, with special focus on high-income taxpayers and expatriates who generate income from China. If there is any dispute regarding tax liability, an individual has the right to appeal against the tax authorities’ decisions.

      Further reforms proposed

The authorities have indicated that further reforms will include the reclassification of income types so that all income subject to individual income tax is subject to the same rates and taxing schedule, for example earned income and income from services will all be treated as the same type of income.

There have also been indications that an inheritance-type tax will be introduced.

At the time of going to press, neither of the above two proposed reforms have been promulgated.