“Transforming from the Old IIT Regime to a New One” Series ...

News Flash China Tax and Business Advisory

"Transforming from the Old IIT Regime to a New One" Series IV Continuation of the preferential policies for bonuses and equity incentives for a transitional period of 3 years to facilitate the smooth implementation of the new IIT law

December 2018 Issue 39

In brief

The new individual income tax (IIT) law requires a comprehensive review of the previous tax policies, including the current IIT preferential policies to ensure its smooth implementation. As one of the major changes to this IIT reform, employment income, remuneration for personal services, remuneration for manuscripts and royalty income received by resident individuals are combined as comprehensive income and taxed on an annual basis, which would impact the continued applicability of certain preferential policies for wages and salaries, among which, the future of the preferential calculation methods for annual one-off bonus and equity incentives have attracted a lot of concern. In addition, as the new IIT law incorporated the specific additional deductions rules, the transition and continuation of the non-taxable allowances for foreign individuals have also received much attention.

On 27 December 2018, the Ministry of Finance (MOF) and the State Administration of Taxation (SAT) jointly issued the (Caishui [2018] No. 164, hereinafter referred to as "Circular No. 164"), clarifying the issues regarding the transitional treatment of the IIT preferential policies.

In this issue of China Tax and Business News Flash, we will briefly introduce the treatment of the IIT preferential policies drawing the most widely concern and analyze their impacts.

In detail

Preferential policies for annual one-off bonus, equity incentives, and partial one-off compensation income

Under the previous scheduler IIT system, tax on individual income is calculated based on the income category and on a

monthly or transaction basis. In order to avoid a substantial increase in tax burden as a result of combining wages and salaries into an one-off nature, especially income spanning over a number of tax periods, with the regular wages and salaries in the current month, the fiscal and tax authorities have formulated a series of preferential tax policies regarding the tax calculation

method for one-off bonus, equity incentives and partial one-off compensation income.

For the above-mentioned preferential tax policies that are closely related to taxpayers, Circular No.164 has continued the prevailing preferential tax calculation methods, some of which will continue to be applicable over a three-year transitional period.



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Annual one-off bonus

Resident individuals may elect not to include the annual one-off bonus in their comprehensive income received in the current year and calculate the IIT separately based on the calculation method provided in Guoshuifa [2005] No. 9 (hereafter referred to as "Circular No.9").

Bonuses applicable to use this calculation method still have to satisfy the relevant criteria of Circular No. 9;

Divide the annual one-off bonus by 12 months and, based on the monthly converted comprehensive IIT rate table, determine the applicable tax rates and quick deductions on the quotient, and then calculate the IIT separately;

Applicable to annual one-off bonus derived from 1 January 2019 to 31 December 2021; thereafter, the annual one-off bonus will have to be included in the comprehensive income of that year for IIT calculation purpose;

During the transitional period, taxpayers may also elect to include the annual one-off bonuses in the comprehensive income of that year for IIT calculation purpose.

Assuming that an employee received the same amount of annual one-off bonus in February 2018 and February 2019 respectively, a comparison of the IIT liability calculated separately under the previous and new IIT laws is attached in Appendix 1.

It can be seen that due to the continued adoption of the IIT preferential policies for annual one-off bonus as well as the adjusted IIT rate structure and the expanded income band of each tax rate bracket in the comprehensive IIT rate table under the new IIT law, the 2019 IIT liability for the same amount of bonus calculated under separate calculation method is lower than the 2018 IIT liability for all the different amounts of bonus shown in the table. However, as the income bands of the three lower tax rate brackets of 3%, 10% and 20% have been expanded significantly, bonuses of relatively smaller amount that are applicable to the lower tax rates will benefit the most in terms of reduction in IIT liability.

Meanwhile, it should be noted that Circular No.164 provides resident individuals with the option to include the annual one-off bonus in the comprehensive income of the year for

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IIT calculation purpose or not. Taxpayers should make a judgement based on their comprehensive income and deductible items for the year. If the comprehensive income other than the bonus is relatively small and the amount of basic deductions, specific deductions, specific additional deductions and other deductions for that year is relatively large, choosing to include bonuses in the comprehensive income for IIT calculation purpose may be a better way to optimise taxpayers' overall tax burdens.

Income from equity incentives of listed companies

According to Circular No.164, income from equity incentives including stock options, stock appreciation rights, restricted shares and equity rewards (hereinafter referred to as "equity incentives") derived by resident individuals will not have to be included in the comprehensive income of that year if they qualify for the preferential calculation methods under Caishui [2005] No. 35 and other relevant circulars, which basically means adopting the previous methods of Circular No. 35.

The full-amount taxable income is subject to IIT separately based on the annual comprehensive IIT rate table;

Applicable to income from equity incentives derived from 1 January 2019 to 31 December 2021, while the policy for income from equity incentives derived thereafter remains to be clarified;

Multiple income from equity incentives derived within one tax year shall be combined to calculate IIT separately according to the above-mentioned method.

As compared with the calculation method in Circular No.35, the transitional treatment under Circular No.164 provides the IIT calculation method of calculating the IIT liability of income from equity incentives separately in accordance with the annual comprehensive IIT rate table, with no requirements to amortize such income over the actual restrictionlifting period or vesting period of not more than 12 months, which is more favourable to taxpayers deriving this type of income.

In addition, Circular No.164 provides that the policies for equity incentives after the three-year transitional period will be clarified separately. Looking at

China's prevailing policies to drive "start-up and innovation" and to attract talents, it is also worth watching out for how the government will continue to provide relevant tax policies to support equity incentive incomes in the future.

One-off compensation income for termination of labour relations, early retirement and internal retirement

For one-off compensation income obtained due to termination of labour relations, early retirement and internal retirement, etc., Circular No. 164 also makes slight adjustment on basically adopting the previous policy.

Among them, one-off compensation income of termination of labour relations will continue to be exempted from IIT for the amount that is within 3 times the average salary of local employees in that location in the previous year; while the excess amount will be taxed separately in accordance with the comprehensive IIT rate table. As compared with the previous preferential calculation method, Circular No.164 does not require such income to be amortized over the actual working period of not more than 12 years.

It is worth noting that Circular No.164 adjusts the preferential policies for the above-mentioned one-off compensation income, without a transitional period.

Clarification of non-taxable allowances for foreign individuals

Under the new IIT law, certain specific additional deductions overlap with the current non-cash allowance items for foreign individuals that are exempted from IIT, which triggers foreign individuals' concerns about the continuous effectiveness of the nontaxable allowances and the interaction with the specific additional deductions.

Circular No.164 provides that during the three-year transitional period, foreign tax resident individuals may either claim the specific additional deductions, or enjoy the existing nontaxable allowances such as housing allowance, language training allowance, and child education allowance, etc., but not both simultaneously.

Appendix 2 summarized our interpretations based on the spirit of Circular No.164 and the previous administrative measures of specific

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additional deductions (Discussion Draft). It should be noted that there are different understandings on this policy at present, and the detailed rules on the election and application of the two policies are complicated since they cover determination and changes to the status of resident / non-resident of foreign individuals. Therefore in practice, enterprises should pay attention to the above-mentioned issues regarding foreign employees.

In addition, enterprises should also pay attention to the following matters:

Foreign individuals have to be China tax resident individuals to enjoy the specific additional deductions;

Once foreign individuals elect to claim specific additional deductions or enjoy non-taxable allowances, no change is allowed within a tax year;

After the three-year transitional period, the overlapped items in the two policies, i.e. housing allowance, language training allowance and child education allowance, will be replaced by specific additional deductions. Meanwhile, it is worth paying attention to whether other prevailing non-taxable allowances for foreign individuals, such as home-leave allowance, relocation allowance, as well as meal & laundry allowance would be allowed to continue.

We have summarised the transitional treatment for the above preferential policies that are of most concerns to the public in Appendix 3.

Other preferential policies

In addition to the above-mentioned tax preferential policies, Circular No.164 also clarifies the transitional treatment of the preferential policies related to the following incomes:

Annual performance salary and reward for the head of the centrally-administered stateowned enterprises;

Commission income of insurance salespeople and securities brokers;

Enterprise annuities and occupational annuities received by individuals;

Enterprises selling apartments to employees at a low price.

Circular No.164 also clarifies that in addition to the matters provided therein, other IIT preferential treatment shall be implemented in accordance with the prevailing circulars.

The takeaway

Circular No.164 generally adopts the prevailing IIT preferential policies mentioned above, and makes some adjustments and revisions to certain preferential policies pursuant to the new IIT law. Among them, the transitional policies of separate tax calculation for incomes from annual one-off bonus and equity incentives of listed company etc. can avoid the situation of increasing rather than decreasing of tax burdens on some taxpayers due to the IIT reform, reduce the impact on the regular remuneration arrangements of enterprises, and enable as many taxpayers as possible to benefit from the relevant policies. It helps the effective transition from the previous IIT law to the new one as well as the smooth implementation of the IIT reform. The transitional arrangement for foreign individuals from the current non-taxable allowances to the specific additional deductions under the new IIT law is also a good news relating to retaining overseas talents in China.

However, there are still some matters to be noted when applying Circular No.164:

The policy for income from annual one-off bonus and equity incentives of listed companies under Circular No.164 only applies to resident individuals. The calculation method for the above-mentioned income derived by non-resident individuals will be clarified in specific circulars to be issued later;

During the transitional period for the annual one-off bonus policy, taxpayers should evaluate and determine whether to include the annual one-off bonus in the comprehensive income or to calculate the IIT separately according to their own situations. Considering the withholding agent would usually separate the annual one-off bonus from other wages and salaries derived by the taxpayers for IIT calculation purpose at the time of filing of the IIT provisional withholding tax return, if taxpayers want to include their annual one-off bonuses in the comprehensive income for IIT calculation purpose through the annual IIT reconciliation filing, they have to complete the annual filing by 30 June of the following year to ensure a timely tax refund.

At the same time, enterprises and employees need to further assess the impacts of these policy adjustments on the tax burden of employees' overall remuneration and specific cases to seek an optimised solution. Furthermore, they should continue to follow up on the development of the policies with transitional arrangements, so to react timely and seek professional advice and assistance when necessary.

Appendix 1: Comparison of the IIT liability for annual one-off bonus under the new IIT law vs old IIT law

Annual oneoff bonus (RMB)

36,000 144,000

300,000

February 2018

Applicable tax rate

Quick deduction

10%

105

25%

1,005

25%

1,005

IIT (RMB) 3,495 34,995

73,995

February 2019

Applicable tax rate

Quick deduction

3%

0

10%

210

20%

1,410

IIT (RMB) 1,080 14,190

58,590

Tax burden difference

(%)

(69%)

(59%)

(21%)

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Annual oneoff bonus (RMB)

420,000

660,000

960,000

1,000,000

February 2018

Applicable tax rate

Quick deduction

25%

1,005

30%

2,755

35%

5,505

45%

13,505

IIT (RMB) 103,995 195,245 330,495 436,495

February 2019

Applicable tax rate

Quick deduction

25%

2,660

30%

4,410

35%

7,160

45%

15,160

IIT (RMB) 102,340 193,590 328,840 434,840

Tax burden difference

(%)

(1.6%)

(0.8%)

(0.5%)

(0.4%)

Appendix 2: Non-taxable allowances for foreign individuals

Non-taxable allowances applicable to foreign individuals

Specific additional deductions

2019 - 2021

From 2022

Children's education allowance Children's education

Housing allowance

Housing mortgage interest or rental

Language training allowance Continued education

Qualified, choose either one

Tax exemption treatment is no longer applicable, while resident individuals can claim specific additional deductions pursuant to the new IIT law

Home-leave allowance Relocation allowance Meal & laundry allowance

Major illness medical treatment Elderly care

Enjoy the non-taxable items pursuant to the new IIT law

Appendix 3: Transitional arrangements for certain preferential tax policies

Transitional arrangements under the new IIT law

Transitional period

Other key points

Annual one-off bonus

Equity incentives of listed companies

One-off economic compensation for the termination of labour relations Non-taxable allowances and specific additional deductions for foreign individuals

Separate tax calculation; or inclusion in the annual comprehensive income

2019 ? 2021;

Thereafter, inclusion in the annual comprehensive income

For separate tax calculation, divide the annual one-off bonus by 12 months and, based on the monthly converted comprehensive IIT rate table, determine the applicable tax rates and quick deductions on the quotient, and then calculate the IIT separately

Separate tax calculation

2019 ? 2021;

Tax policies thereafter remain to be clarified

The IIT is calculated based on the full amount by reference to the annual comprehensive income tax rate table

Separate tax calculation

No transitional period for this adjustment

The IIT is calculated based on full taxable amount by reference to the annual comprehensive income tax rate table

Either one without overlapping

2019 ? 2021;

Thereafter, only specific additional deductions are available under the three overlapped items and no IIT exemption can be enjoyed.

Choose either one during the transitional period, and no changes are allowed in the same tax year

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Let's talk

For a deeper discussion of how this issue might affect your business, please contact a member of PwC's Global Mobility Services Team

Central China

Jacky Chu +86 (21) 2323 5509 jacky.chu@cn.

North China

Edmund Yang +86 (10) 6533 2812 edmund.yang@cn.

South China

Louis CS Lam

+852 2289 5528 +86 (20) 3819 6308 louis.cs.lam@hk.

In the context of this News Flash, China, Mainland China or the PRC refers to the People's Republic of China but excludes Hong Kong Special Administrative Region, Macao Special Administrative Region and Taiwan Region.

The information contained in this publication is for general guidance on matters of interest only and is not meant to be comprehensive. The application and impact of laws can vary widely based on the specific facts involved. Before taking any action, please ensure that you obtain advice specific to your circumstances from your usual PwC's client service team or your other tax advisers. The materials contained in this publication were assembled on 29 December 2018 and were based on the law enforceable and information available at that time.

This China Tax and Business News Flash is issued by the PwC's National Tax Policy Services in China and Hong Kong, which consists of a team of experienced professionals dedicated to monitoring, studying and analysing the existing and evolving policies in taxation and other business regulations in China, Hong Kong and Singapore. They support the PwC's partners and staff in their provision of quality profes sional services to businesses and maintain thought-leadership by sharing knowledge with the relevant tax and other regulatory authorities, academies, business communities, professionals and other interested parties.

For more information, please contact:

Matthew Mui Tel: +86 (10) 6533 3028 matthew.mui@cn.

Please visit PwC's websites at (China Home) or (Hong Kong Home) for practical insights and professional solutions to current and emerging business issues.

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