Individual Income Tax in China
By Klaus Koehler, Managing Director, Klako Group

The recent years have witnessed rapid advancement in the collection of individual income tax in China. The country’s individual income tax revenue in the first 10 months of 2003 totalled 119.24 buillion yuan (14.4 billion US dollars), up 19.3 percent over the same period of last year. According to the State Administration of Taxation, personal income tax has become one of China’s fastest-expanding tax categories, surging from 4.68 billion yuan in 1993 to 121.1 billion yuan in 2002.

The country’s tax authorities this year stepped up tax collection methods in order to curb any form of tax evasion, especially from high income earners. The State Administration of Taxation is developing a nationwide managing system specifically for collecting income tax from individuals.

Individual Income Tax Regulations

Individual income tax in China is primarily governed by the “Individual Income Tax Law,” which took effect in January 1994. It was introduced to meet the requirements of a socialist market economy. Under this legislation, Chinese mainlanders and foreigners are taxed at the same rates, based on a progressive scale ranging from 5% to 45% on wages and salaries, while other categories of income such as royalties, interest, dividend are charged at 20%. There is a monthly allowable deduction of 800 yuan for locals and 4,000 yuan for foreigners.

In the past, a mixture of high rates and law enforcement policies encouraged many individuals to simply disregard their obligations. Tax authorities, however, are acting more aggressively and have intensified tax audits, on individuals and firms, to ensure compliance. Ignoring tax liabilities has become an increasingly risky option, and a comprehensive understanding of how the tax regime is applied is important.

Generally, in china, it is the employer’s obligation to calculate their employees’ tax liability and withhold any tax payable on behalf of the employee. Thus, the taxation authorities will hold the employer responsible and seek retribution through its entity, not through the individual. Penalties for non-compliance will be borne by the employer. Foreign companies that have not properly reported their expatriate staff’s tax obligations for a number of years may face substantial penalties.

Expatriate Staff

Tax liabilities of expatriates generally depend on the period of time an individual spends in China and the source of income. Individuals who spend lass than 90 days in one calendar year in China are exempt from Personal Income Tax if the employment income is paid by an overseas entity. Residents of countries that have signed a double taxation treaty with China may stay in China for up to 183 days without facing any tax obligations in this case. If an individual is paid by a China entity, any income derived from working in China will be taxable.

Individuals who stay in china for more than 90 (183) days but less than a year are subject to personal income tax on their employment income derived from work performed in China – regardless of which entity is paying. A foreign individual who holds the position of director, general manager or deputy general manager of a China-based entity is liable for paying income tax also on employment income derived from work performed outside China and paid by the China-based entity.

Individuals who reside in China for more than one year, but less than five years, are subject tp Personal Income Tax on both China-sourced and foreign-sourced income borne by a China-based entity. Finally, foreign individuals who reside in China for more than five years are taxed on their worldwide income.

Expatriates who are employed by a foreign enterprise in China are liable for Personal Income Tax from the first day they arrive in China. They must file a monthly tax return as well as an additional annual return. Penalties for late filing can be up to five times the amount that was due. Foreigners are provided with a lump-sum deduction of RMB4000 from their monthly salary and may receive various non-taxable allowances for housing, relocation, children’s education, business travel and home leave. These additional benefits may amount to as much as 40% of the total employment package.

Expatriates working in china, short term or long term, should be registered with the local tax authorities – no matter whether they are ultimately required to pay tax in China or not.

Local Staff

Local employees receive a minimum lump-sum deduction of RMB800from their total salary. Some cities in China with a higher cost of living, such as Shanghai and shenyhen, allow a larger deduction of up to RMB 1600.

Chinese employees of Foreign Representative Offices must be employed through a government agency called FESCO. Employees of Wholly Foreign Owned Enterprises and Joint Ventures may be employed directly by the foreign entity.

Staff employed through FESCO are also provided with social security and medical benefits. Payments of such benefits may be split between the employer and the employee, or may be covered fully by the employer.

Tax Reforms

According to the Ministry of Finance, the Chinese government is planning to revamp the country’s personal income tax policies in order to create a more transparent and balanced taxation system. WTO accession is driving force in prompting the Chinese tax system to integrate with international standards as the country has to change it’s tax system and related laws in accordance with WTO requirements.

As the income gap between China’s rich and poor has widened significantly over the last ten years, the Central Government intends to strengthen the country’s middle class income earners. Lower tax rates imposed on this group of residents and preferential tax incentives are supposed to stimulate overall consumption and spur the country’s economic growth.

China’s present personal income tax system is based on income source, which neglects control over the total annual income and makes it difficult for the authorities to calculate an individual’s real income. Unlike most Western countries, in which a person’s income records can be easily tracked, China’s banking information system lacks adequate transparency. Presently, wage earners often are required to pay higher tax rates than wealthy citizens because they do not have the means to spread the tax burden and pay lower rates of tax on incomes from sources other than wages and salaries.

A dispute remains as to whether China should adopt a single, standard nationwide system, or if varying schemes should be imposed geographically. Given the wide disparity in economic development between eastern and western China, the central government may allow provincial tax bureaus to implement different tax policies according to the levels of regional economic development.

If you require assistance with the above subject, please contact us at info@klako.com with your detailed questions.

All information in this report is verified to the best of our ability and is assumed to be correct at time of release; however, Klako Group does not accept responsibility for any losses arising from reliance on the information provided within.