Foreign Employees Exemptions in China
With many regional and city governments in China undergoing fiscal tension, local tax bureaus are increasing their scrutiny of the tax practices of foreign enterprises in their jurisdictions. The IIT-exempted items for foreign employees are an area that authorities can often find non-compliance and obtain greater tax revenue. If you are managing a foreign enterprise in China, exemptions on individual income tax (IIT) for your foreign employees is an area to pay attention to and do your homework to ensure compliance, while taking full advantage of these exemptions.
To start the discussion, let us remember what income is subject to IIT and how the tax rate is determined. The income subject to IIT depends on how long the individual is living in China and the nature of their income earned abroad. If the individual is living in China for less than 90 days, only income paid by a Chinese entity for work done in China is taxable. Income both sourced and earned abroad is exempt, provided that it is not paid by the Chinese entity. In other words, the income paid by an overseas entity for work done in China is exempt during this period. Beyond 90 days, all income earned for work done in China is subject to IIT. For foreigners living in China between 90 days and a year, income sourced abroad remains exempt unless the individual is an upper manager of a domestic Chinese company. For foreign residents staying in the country between one and five years, overseas income is subject to IIT if paid by a Chinese company or individual. Starting the sixth year, income earned overseas is not exempt.
The tax rate on monthly income conforms to the following scheme:
This is 183 days if there is a tax treaty.
Thus, IIT is calculated as:
Monthly income * tax rate – (quick deduction+ any other deductions) = IIT
Foreign employees are now required under national legislation to participate in Social Insurance. Participation in China’s social insurance affects the employee’s IIT burden. The Chinese social welfare system’s five insurances are pension, medical, work related injury, unemployment, and maternity (excluding housing, which foreigners do not participate in). Employee contributions are tax deductible and are added to the standardized pretax deduction. The employer’s contributions are non-taxable. As with Chinese nationals, the employer withholds the contributions from the employee.
The required contributions of the employee and employer vary by region and are based on the income of the employee. The maximum, tax-free contribution is 3 times that of the average salary of the municipality. Residents from countries with signed and ratified totalization agreements with China, including Germany, South Korea, Canada, Switzerland, Finland, and Denmark are exempt from participation in Chinese social insurance.
Some other IIT-exempt benefits, or so-called fringe benefits, are permitted. However, these are increasingly strictly monitored for compliance with associated regulations. Tax authorities will scrutinize the “reasonableness” of such expenses. Contributions beyond an amount deemed a reasonable portion of the employee’s remuneration package will be subjected to tax. The required limit and standards for “reasonableness” will vary from region to region as this is under the jurisdiction of the local tax bureau.
Full documentation of expenditures and justification is required. A fapiao on all the below expenses (an official receipt) is strictly required for the purchases to be IIT exempt. Such benefits paid for in cash will likely not be exempt from IIT. Therefore reimbursing the employee for their expenses is an appropriate option for ensuring exemption.
The following fringe benefits are permitted:
Housing allowance: This must be supported with rental agreement and other official documentation. This may not greatly exceed the average market rental price.
Home leave travel allowance: Transportation for two-round trips between work location and family is permitted. Travel tickets are required.
- Relocation and moving costs.
- Reimbursement of meals and laundry: Must be reasonable amount and based on real expenses incurred.
- Children’s education.
- Language training.
It is important to ensure that your company policies are congruent with the benefits given to employees. Local tax bureaus have been known to review this in recent years. If they believe that the fringe benefits exceed those outlined in the company’s regulations, it may be subject to IIT. Additionally, these benefits must be stipulated in the employee’s contract.
Taxation on Bonuses
Bonuses may be a more significant part of the total compensation package of senior managers that come from overseas. Annual bonuses receive beneficial tax treatment with the tax rate being considered separately from monthly taxable income. Other bonuses, however, are included in monthly taxable income and are subject to the normal IIT rate.
To calculate the tax rate on annual bonuses, the company should divide bonus amount by 12 and refer to the relevant monthly taxable income rate. For example, if the lump sum bonus is RMB 40,000, the employer should divide this by 12, and consider the quotient (RMB 3,333) as though it were monthly taxable income to find its relevant tax rate. Thus the bonus would be taxed at 10%.
There are inconsistencies between regions regarding foreign IIT exemptions, due to administration on the municipal level. Beijing in particular has doubled down on efforts to ensure compliance and, often very thoroughly, reviews all required documentation. Other regions may not be as strict.
As another example, though on a national level foreign employees are required to participate in social insurance, some city-level legislation, such as that of Shanghai, does not require this. Therefore, since social insurance is managed regionally, some local authorities may not penalize companies for not signing up foreign employees.
Companies using foreign talent in multiple cities should bear in mind that what works in one city may not work in another, and it is vital that your accountants are well versed in the taxation realities of the particular area for which they are responsible.