The Implementation Rule of the PRC Individual Income Tax (“IIT”) Law has been officially announced and an update about certain preferential IIT regulations.

Highlights

The Implementation Rule of the PRC IIT law has been officially announced by the State Council on 28 December 2018. (Hereinafter as Circular No. 707 issued by the State Council, “Implementation Rule”). This means that the new PRC IIT law has been officially implemented along with the final Implementation Rule. Moreover, China’s Ministry of Finance (MOF) and the State Administration of Taxation (SAT) released Cai Shui (2018) No. 164 to further specify the transitional measures relating to certain preferential IIT regulations during the transitional period.

Summarised below are the key revisions between the final Implementation Rule and the Draft Implementation Rule released on 30 October 2018.  The transitional measures relating to certain IIT preferential regulations are also highlighted.

Recap of key changes

1. Five-year rule” to “Six-year rule”
   The “Five-year rule” has been changed to the “Six-year rule” in the final Implementation Rule. At same time, a full break of continuous years would start as long as non-China-domiciled individuals take a single consecutive 30 day absence outside China in a calendar year. This change would definitely attract foreign talents to come and work in China. It should be noted that the single consecutive 30 day absence should be within a calendar year which excludes a circumstance that the date of entry and the date of exit fall into two calendar years.
2. Calculation of taxable income derived from personal production and operation 
   The Implementation Rule specified that Allowed Additional Itemized Deductions (“AAIDs”) is applicable to those who generate incomes from personal production and operation rather than receiving a comprehensive income. That is to say, when computing the taxable income of such individual, Annual Standard Deduction (“ASD”) of RMB60,000, Itemized Deductions (three social security contributions and one housing fund), AAIDs and other deductions are allowed as regulated by the New PRC IIT law. AAIDs are allowed to be deducted from annual comprehensive income during Annual Tax Clearance Process (“ATC”) rather than on monthly basis.
3. Calculation of foreign sourced income and foreign tax credit (FTC)
   Compared to the Draft Implementation Rule, the final one deleted the clause “foreign sourced losses arising from the operation of a business (including where the business is conducted in the form of a sole proprietorship or partnership and an individual)” are not allowed to offset against domestic sourced business income. Detailed ruling may be published lately.

   The FTC would still be calculated on a “per country (region)” basis, while the calculation formula of FTC limitation is not shown on a “per country (region)” anymore.

4. Exchange rate application for incomes earned in foreign currency
   For incomes earned in foreign currency, they shall be converted into RMB at the central parity exchange rate on the last date of the month before tax filing. Where relevant PRC IIT has been paid on a provisional basis, it is not necessary to make any conversion during the ATC process. However, additional PRC IIT should be paid through the ATC process, the central parity exchange rate on the last date of the preceding calendar year should be adopted for calculating taxable income in RMB.
5. Circumstances where taxpayers should go through ATC process
   1. where a taxpayer derives general income in more than two places, and after deducting AAIDs, the balance of his annual comprehensive income exceeds RMB60,000;
   2. where a taxpayer derives one or more incomes from independent incomes, incomes from author’s remuneration, and royalty incomes, and after deducting AAIDs, the balance of his annual comprehensive income exceeds RMB60,000;
   3. where the amount of tax paid in advance during the calendar year is lower than the amount of tax payable; and
   4. where the taxpayer applies for a tax refund.

PRC IIT calculation methods based on the New PRC IIT Law

The methods for calculating IIT for PRC tax residents’ salaries and wages, and independent incomes on monthly “Cumulative Withholding and Pre-paid basis” and for Non-PRC tax residents’ salaries and wages, independent incomes, incomes from author’s remuneration and royalty incomes have been summarized as below:

1. The calculation method for PRC tax residents’ salaries and wages

   PRC tax residents are subject to IIT on monthly “Cumulative Withholding and Pre-paid basis”. The calculation formula is as below:

   Tax to be withheld and pre-paid for current month = (cumulative taxable income * withholding tax rate – quick reckoning deduction) – cumulative reductions or exemptions of taxes – cumulative tax already withheld and pre-paid for previous month.Please refer to PRC IIT Withholding Rates in Table 1)

   Note: if the tax to be withheld and prepaid for current month is negative, it is not allowed to apply for a tax refund. When the final tax payable becomes negative by the calendar year ends, the taxpayer should make tax adjustments for his annual comprehensive income through the ATC process.

Illustrations:

Example 1:

Employee A’s base salary is RMB12,000 per month in 2019, the MSD is RMB5,000 per month, the Special Deductions (three social insurances and one housing fund) are RMB2,000 per month. He only claimed for AAIDs for one item: children’s education (i.e. RMB1,000 per month) from January 2019. His tax to be withheld and pre-paid on monthly basis are as below:

January: (12000-5000-2000-1000)×3% = 120；
February: (12000×2-5000×2-2000×2-1000×2)×3%-120 = 120；

Cumulative income for the whole year is RMB48,000, the withholding tax rate of 3% would be applicable till the month of September 2019, and effective from October 2019, the withholding tax rate of 10% would apply. The tax to be withheld and pre-paid for the first 9 months remains same, RMB120 per month.

Example 2:

Employee B’s base salary is RMB30,000 per month in 2019, the MSD is RMB5,000 per month, the Special Deductions (three social insurances and one housing fund) are RMB4,500 per month. He only claimed for AAIDs for two items: children’s education and dependent care for the elderly (i.e. RMB2,000 per month) from January 2019. His monthly tax to be withheld and pre-paid on monthly basis is as below:

January: (30000–5000-4500-2000）×3% = 555；
February: (30000×2-5000×2-4500×2-2000×2）×10% -2520 -555 = 625；
March: (30000×3-5000×3-4500×3-2000×3）×10% -2520 -555-625 = 1850；

The cumulative month to date taxable income for February is RMB37,000 and the withholding tax rate of 10% would apply. As such, the tax to be withheld and pre-paid would be increased effective from February 2019 and onwards.

Even though the monthly income remains the same, the withholding tax rate and cumulative taxable income would be changed. The reason is that the applicable withholding tax rate is determined by the cumulative month to date taxable income, the higher one would be applied step by step.

2. The calculation method for PRC tax residents’ independent income, the income from author’s remuneration and royalty.

   1. To calculate the taxable income

   The taxable income shall be the above three incomes less allowable deductions. In particular, the taxable portion shall be 70% of the total income from author’s remuneration.

   Where the income does not exceed RMB4,000, the allowable deduction is RMB800; and while if the income exceeds RMB4,000, the taxable portion shall be 20% of the total income.

   2. To calculate the tax to be withheld and pre-paid which is equal to taxable income times the withholding rate.

   For the independent income: three levels of withholding rates would be applied (Please refer to Table 2 PRC IIT Withholding Rates); for the income from author’s remuneration and royalty, the flat withholding rate of 20% shall apply.

 Table 2 — PRC IIT withholding rates

Example 3:
If a PRC tax resident earned RMB2,000 income from providing his personal services, the tax calculation would be as below:

Taxable income: 2000-800 =1200
The tax to be withheld and prepaid: 1200×20% = 240

As stated above, the independent income are subject to PRC IIT based on the Table 2 and the income from author’s remuneration and royalty are subject to the flat rate of 20%. However, during the ATC process at the year-end, such three types of incomes, as part of annual comprehensive incomes, should be subject to a progressive tax rate ranging from 3% to 45%. Therefore, it is very likely that a tax refund should be applied through the ATC process.

Moreover, Value-Added Tax (“VAT”) would be imposed for the individual taxpayers who earned incomes from providing their personal services. They should file VAT returns and apply for original VAT invoices by themselves. The paying unit (in most cases it is an enterprise) has withheld and paid PRC IIT for the individual taxpayers, so the enterprise could use the original IIT payment receipts as a proof for pre-tax deduction before Corporate Income Tax (“CIT”).  While there is still a potential risk the individual taxpayer does not file VAT return eventually, it is not allowed to deduct relevant cost before CIT without support of original VAT invoices.

3. The calculation method for Non-PRC tax residents’ salaries and wages, independent income, the income from author’s remuneration and royalty.

   Where Non-PRC tax residents earned one or more than one of the above incomes, they should be subject to PRC IIT based on the Table 3 on monthly basis or when the tax event occurs.

Table 3 – PRC IIT rates

An update about certain preferential IIT regulations – Cai Shui (2018) No. 164

Contributor:
Eva Tian – Tax Director
Chung Rui Tax, China
E: tianwenyan@crtax.com