Expat Tax-Free Allowances Extended to 2023

[dropcap]T[/dropcap]he Ministry of Finance and the State Administration of Taxation issued on December 31, 2021, the Circular [2021] No.43 on the Continuation of the Preferential Policies on Individual Income Taxes such as Foreign Personal Allowances and Subsidies.

Circular no. 43 extended the implementation of the preferential policy on tax-free allowances and subsidies for foreign individuals, repealing the provisions included in Circular [2018] no. 164 issued in 2018.

Foreign employees working in China can continue to enjoy preferential tax-exemption policies for housing subsidies, language training expenses, and children’s education expenses until the end of 2023.

Expatriates working in China enjoy various tax-exempt “benefits-in-kind” (BIK) – sometimes referred to as tax-exempt “benefits” or non-taxable “fringe benefits” (BIK are additional compensation, not included in the salary or wages, but paid on reimbursement and non-cash basis).

However, due to the implementation of the Amended PRC Individual Income Tax (IIT) Law and relevant regulations from January 2019, certain non-taxable BIK will be replaced by additional itemized deductions for some expatriates, while other non-taxable BIK might cease to be exempt from IIT from next year.

The policy change has sparked concerns among foreign individuals and their employers, who may face an increase in tax burdens or labor costs. This article explains the implications of the changed policy and provides suggestions from tax, HR, and legal perspectives.

What are the tax-exempt benefits-in-kind for expatriates in China?

Non-China domiciled individuals working in China can currently enjoy tax-exempt benefits-in-kind, including the below eight categories:

– Housing expense

– Education expense for children

– Language training expense

– Meal fee

– Laundry fee

– Relocation expense

– Business travel expense

– Home leave expense

Such benefits-in-kind could be exempt from PRC IIT provided that the expenses are reasonable in amount and there are corresponding supporting documents, such as invoices (fapiao). In addition, there are some specific requirements for each category. For example, for home leave expenses, only the travel expenses for the expatriate themself from China to their/spouse’s home country for up to two trips per year could be exempt from IIT.

A three-year transition period for non-China domiciled tax residents

However, with the country’s new IIT Law taking effect from January 1, 2019, the government has considered rolling back the tax exemption on special benefits-in-kind for foreigners, partly in a move to equalize benefits between local and foreign tax resident workers.

To ensure a smooth policy transition, at the end of 2018, the Ministry of Finance and the State Tax Administration jointly announced the Notice on the Preferential Policy Convergence Problem (Cai Shui [2018] No.164).

The Notice introduced a three-year transition period. From January 1, 2019, to December 31, 2021, non-China domiciled tax residents (who do not have a domicile in China and live for 183 days or more in China in a given tax year) can choose to enjoy:

1. The tax-exempt benefits-in-kind;

2. The six additional itemized deductions.

To be specific, the six additional itemized deductions include:

– Children’s education expenses;

– Continuing education expenses;

– Housing mortgage interest;

– Housing rent;

– Healthcare costs for serious illness;

– Expenses for taking care of the elderly.

The two policies cannot be simultaneously enjoyed by non-China domiciled tax residents during the transition period. Once decided, non-China domiciled tax residents cannot change their preference within a given tax year.

According to the Notice, after the three-year transition period, starting January 1, 2022, non-China domiciled tax residents will no longer enjoy preferential tax-exemption policies on benefits-in-kind, including housing, language training, and children’s education.

Instead, the three categories of benefits-in-kind will be replaced by the corresponding additional itemized deductions (housing rent, continuing education expenses, and children’s education expenses).

However, as to the remaining five categories of benefits-in-kind (namely meal fee, laundry, relocation expense, business travel expense, and home leave expense), the policy has not clarified whether they may continue to be tax-exempt.

Given the possibility that the government may abolish the tax exemptions on all of the eight benefits-in-kind, or the tax bureau may become more rigorous in approving the tax exemptions on the remaining items, employers should prepare for possible changes as early as possible to avoid concerns from expatriates.

Compared with the six additional itemized deductions, the eight tax-exempt benefits-in-kind are more beneficial to expatriates who have a higher income and level of expense.

The tax-exempt benefits-in-kind are deducted based on the actual cost of each expenditure, although the amount is subject to the limit of a “reasonable” amount, which is based on the local living standard, consumption level, market price, etc., and a proportion of around 30 to 35 percent of the expatriate’s monthly salary is usually acceptable by the tax authority.

However, most additional itemized deductions (except for healthcare costs) are deducted based on a standard basis.

For example, the itemized deduction standard for children’s education fees is RMB 1,000 a child per month – this can be a much smaller amount than the foreigner’s actual expenses for children’s education.

Foreigners with children in international schools can be relatively more affected. The international school tuition can come to tens of thousands of dollars per child per year. Once the children’s education expense loses tax-exempt status, expatriates with children in such schools will face a significantly higher overall tax burden.

Expatriates that earn enough money to put themselves into the 35 or 40 percent incremental tax bracket with a couple of kids at international school would face several thousand dollars of additional taxation.

Nevertheless, the policy transition is not necessarily a bad thing for all foreigners.

Previously, to enjoy the tax-exempt benefit-in-kind, expatriates have been required to provide corresponding invoices or receipts every month for each expense, which is not easy.

For instance, if a foreigner wants to claim rent expenses, it is not enough to simply sign a lease contract with the landlord. To get an invoice for the rent, the expatriate needs to ask the landlord to make record-filing for the lease contract and provide an invoice every month. In practice, some people try to skirt this process by using alternative invoices, which is not advisable in terms of compliance.

In addition, foreigners whose income is not that high and cannot enjoy the tax-exempt benefits-in-kind will be able to access the six itemized deductions as long as they are resident taxpayers. Foreign employees can claim itemized deductions directly through their tax filing or via their employer, once they obtain their tax ID in the tax bureau. The application process will be much easier than submitting a pile of invoices or receipts.

Preparing for a possible transition

As the policy change could result in some expatriate employees facing a reduction of up to 13 percent in their net take-home pay, to ensure staff stability, employers should re-examine the labor contracts with affected employees and consider restructuring the employee’s salary package to lower their tax burden. Early communication and planning can improve transparency and avoid any disputes.

In some circumstances, enterprises may need to compensate foreign employees for their increased tax burden. “For larger multinationals, this will be a big burden. But it could be significant for small and medium-sized enterprises (SMEs), especially those that are already struggling to cover the costs of multiple expatriates in China out of operating profit. These companies might need to adjust their model, considering hiring more “in-pats”.

Large multinational companies (MNCs) may face the increased budget cost of dispatching personnel in China. For the sake of cost control, the headquarters of these companies will need to be more prudent and agile in planning the dispatching of employees to China.

Some regions of China have been introducing preferential IIT policies to reduce the tax burden on foreign talents. For example, relocation to the Greater Bay Area has become a strategy for some multinationals.

Currently, the Guangdong-Hong Kong-Macao Greater Bay Area offers IIT subsidies to “high-end” and “urgently needed” foreign talents (including those from Hong Kong, Macao, and Taiwan), which can substantially lower their IIT rate to 15 percent until the end of 2023. To be eligible, however, the foreign worker has to work in the designated nine cities in Guangdong province and meet the definition of “overseas talent” and “high-end talent” or “talent in short supply”. Moreover, the foreign worker must satisfy some basic conditions and requirements on contract terms and income, as set out by the municipal governments.

Hainan Free Trade Port also introduced a similar IIT preferential policy for “high-end” and “urgently needed” foreign and domestic talents until the end of 2024. Hainan will require foreign individuals to sign a labor contract of more than one year with an enterprise registered and having substantial operations in Hainan FTP, to benefit from the lower IIT rate in certain sectors. From 2025 to 2035, Hainan FTP will continue to reduce IIT rates to 3, 10, and 15 percent (three tax brackets) for eligible talents’ taxable income earned in Hainan, but qualified foreign or Chinese talents have to reside there for no less than 183 days per year.

Other regions may also consider similar policies to stay competent in attracting talents.