2018 was an eventful year for reform in Chinese employment law, as it seeks to open its labour market to foreigners and residents from Hong Kong, Macau and Taiwan. Some of the changes have significant ramifications to foreign enterprises operating in Mainland China.
This article shall revisit some of the key events in 2018, and will provide our brief insight on the likely ramifications for employers.
1. Changes to Individual Income Tax Law
The Standing Committee of the National People’s Congress passed the amendments to the Individual Income Tax (IIT) Law on August 31, 2018 (Amendment). The Amendment became effective on January 1, 2019, and will have major impact on foreigners working in mainland China.
The key change that will impact on foreign expats is the expansion of definition of “tax resident”, which will make it easier for foreign expats to be subject to China tax on their worldwide salary income and even other types of worldwide income. In addition, the Amendment introduces various tax-deductible expenses that apply to both locals and expatriates, and so far it is unclear how this may need to be administered by employers and whether this has any impact on the tax-free allowances currently enjoyed by foreign expatriates only.
China Tax Resident Test
Under existing IIT law, if a foreigner without domicile in China stays in the territory of China for less than one full year, his/her salary income outside China can be fully or partially exempt from IIT in China based on application of certain time apportionment formula. Staying less than one full year can be achieved by a tax break (e.g. more than 30 days during a trip or cumulatively more than 90 days over numerous trips within a tax year).
However, based on the Amendment, when determining the tax residency status of individuals without domicile in China, the physical presence threshold will be reduced from ‘one full year’ to ‘183 days’ spent in China. This makes it potentially easier for foreign expatriates to fall under the definition of tax resident and be subject to China IIT on their salary income. Specifically, salary borne by an employing entity in China while the expat spends time outside China will be subject to China IIT as soon as the expat hits the 183 days rather than the 1 year requirement.
What it means for employers: Employers in China have the obligation to withhold IIT of its employees. This change to the residency test will mean that employers in China will need to look at the travel schedules of their foreign expats in China to ensure they are paying IIT in compliance with the new rules. In particular, foreign expats who are seconded into China or who perform roles inside and outside mainland China under dual contracts may need to have their contracts updated to reflect the new tax position.
Tax Break on Worldwide Income
According to existing IIT laws, even if an individual without domicile in China spends more than 1 full year in China, he/she will not be subject to IIT for his/her worldwide income (but only income effectively linked to China) until he/she has resided in China for five consecutive full years. In order not to reside in China for five consecutive full years, an individual without domicile in China only needs to plan absences from China, i.e., tax breaks, (more than 30 days during a trip or cumulatively more than 90 days over numerous trips) once every five years.
The Amendment does not specify whether and how the above “5-year rule” and the “tax break” will be changed. The impact will only be clear after the new IIT Law comes into effect, or even after the new detailed implementation rules being released.
As a worst case scenario, the 5-year rule may be cancelled, bringing all worldwide income of foreigners within the ambit of China as soon as a foreigner works inside China for 183 days or more in a tax year. It may also be possible that the “5-year rule” will be retained, such that global income (not just global salary income but salary, business, investment and other income) will only be subject to IIT after 5 consecutive years, but it will take 183 days instead of the current 30/90 days to break the continuous stay for the purpose of the 5 year rule.
What it means for employers: Employers should review the past record as well as future plans of their foreign employees’ duration of stay in China, in order to assess how best to take advantage of any future tax break as well as the current tax break to the extent they are available to reduce exposure to IIT on worldwide income. If possible, consider whether it is feasible to arrange a tax break for expats now.
Tax Exempt Allowances
Under the existing IIT rules, in order to encourage the high end foreigners to work in China, various allowances paid by employers to foreign employees for expenses in housing, meal home visit, children’s education and language education are exempt from IIT.
However, the Amendment introduces various tax deductible expenses, including: commercial health insurance eligible for IIT incentive, commercial endowment insurance eligible for IIT deferral treatment, elderly-support, dependent education, major illness medical expenses, continued education, mortgage interest/rental expense, which are applicable to both Chinese and expatriates.
The Amendment does not specify whether the existing tax free allowances for foreigners will be replaced, or how it may be affected (if at all) due to the introduction of the tax-deductible expenses. It is likely that the tax deductible expenses which apply to local Chinese and foreign expatriate employees under the new rules will not be as generous as the existing tax free allowances which apply to foreigners only. It is also unclear what obligations employers have in administering the tax deductions for their local and expat employees.
What it means for employers: Employers should keep abreast of the development in this space so as to be able to inform or respond to questions from its expat or local employees about any changes that may affect their take home pay. Employment contracts or internal policies in relation to foreigner’s tax free allowances may need to be updated.
2. Exemption from Work Permits for Hong Kong, Macau and Taiwanese Residents (“HMT Residents”)
On 23 August 2018, the Ministry of Human Resources and Social Security (MHRSS) issued the Notice on Employment Matters of Hong Kong, Macao and Taiwan Residents in Mainland China (Notice).
The Notice confirms that there is no need for HMT Residents to apply for work permits starting from 28 July 2018. In the absence of work permits, HMT Residents could use either the above Residence Permits or the regular travel permits they use to enter into mainland China (i.e. Hui Xiang Zheng or Tai Bao Zheng) to enroll in social insurance and other services. Further, they could use their labor contracts (hiring contracts), payroll receipts or social insurance contribution records to prove their employment in mainland China.
The Notice left unaddressed the issue of whether corresponding employer obligations that apply to local nationals also apply to HMT residents, or whether they would be treated as foreign nationals as in the past. This is exacerbated by the fact that, at the same time as it issued the Notice, the MHRSS abolished the key piece of regulation that governed employment of HMT Residents, the Regulations on Administration of Employment of Hong Kong, Macao and Taiwan Residents in Mainland China.