Sep 2009
In brief
On 17 August 2009, the State Administration of Taxation ("SAT") issued Guoshuifa [2009] No.121 ("Circular 121") to clarify various Chinese individual income tax ("IIT") treatments.
Salient points
Circular 121 clarifies, inter alia, that:
- "Double pay" (also widely known as "13th month salary") is no longer taxed as a separate month income;
- Director's fees and salary income received by executives (including those from related companies) need to be combined and taxed as "salary income"; and
- Overseas Chinese ("Huaqiao") undertaking employment in China would be entitled to a monthly allowance of RMB4,800 (similar to foreign individuals) when calculating their IIT liabilities only if certain tests are satisfied.
Double pay / 13th month salary
It is common practice for companies in China to make a 13th month salary payment to their employees but the IIT treatment for such payment has been varied from one location to another. Following a SAT circular Guoshuifa [2005] No. 9 ("Circular 9") which introduced a preferential IIT treatment for a one-time annual bonus, some local-level tax bureaus extended the definition of "annual bonus" to include the 13th month salary payment. As such, where an employee received an annual bonus and a 13th month salary payment in different months, one of them would be regarded as "an additional bonus" and might be added to the monthly salary payment which would likely be falling at higher marginal tax rates.
Some local-level tax bureaus however continued to apply another SAT circular Guoshuihan [2002] No. 629 ("Circular 629") to tax the 13th month salary as a separate month salary. As a result, even if the employee received the annual bonus and the 13th month salary in different months, the 13th month salary would be taxed at lower marginal tax rates and the employees could enjoy a more favourable treatment.
This local "concession" is now withdrawn by Circular 121 and the higher marginal tax rate may therefore be imposed on the 13th month salary payment. Accordingly, we would suggest employers to revisit the remuneration strategies for their employees to ensure these payments are structured and paid tax effectively.
Director's fees
In China, unlike employment income which is taxed at the progressive rates from 5% to 45%, director's fees are taxed as "income from personal services" at the progressive rates from 20% to 40%. If an executive holds a remunerated directorship within the group companies, the director's fees have been taxed separately from the employment income. Also, where a foreign individual holds an overseas directorship, his offshore director's fees should not fall within the ambit of IIT.
However, Circular 121 now stipulates that the director's fees shall be treated as salary income where the executive takes both employment position and directorship from his employer (and including related companies). The executive director will therefore be exposed to a higher IIT liability as the "combined income" will likely be subject to IIT at higher marginal tax rates.
It is generally believed that this change seeks to counteract those executive directors who allocate excessive income from salary income to director's fees in order to have a portion of his income being taxed separately at lower marginal tax rates. Also, the literal reading of Circular 121 may suggest that where the executive director does not receive salary income from the same company or from a related company, the director's fee will continue to be taxed separately as income from "personal services".
It is however not entirely clear as to whether Circular 121 will also bring the offshore director's fees received by a foreign executive from an overseas related company into the Chinese tax net as this may involve the taxing right of a foreign tax jurisdiction and is inconsistent with the international practice on income allocation concerning director's fees. On this uncertain issue, we have contacted some local-level tax bureaus and they tended to take the view that Circular 121 may not apply to offshore director's fees received by foreign executives from overseas companies. We will continue to seek clarifications from the SAT and major local-level tax authorities in this regard.
Monthly allowance for "Overseas Chinese"
Chinese citizens working in China are allowed a monthly deduction of RMB 2,000 in computing their taxable income from employment, while those Chinese citizens qualifying as "Overseas Chinese" are allowed an increased monthly deduction of RMB 2,800, entitling to a total monthly deduction of RMB4,800 (the same level for foreign individuals).
It has not been clear in the past what factors should be considered to determine whether a Chinese citizen qualifies for treatment as "Overseas Chinese". Circular 121 now provides two alternative criteria for this purpose.
- Criterion 1: A Chinese citizen will qualify as "Overseas Chinese" after having obtained a long term or permanent residence permit issued by a foreign country; and having lived in that foreign country for consecutive two years during which cumulative absence outside that country totalled no more than six months.
- Criterion 2: A Chinese citizen will qualify as "Overseas Chinese" after having lived in a foreign country for consecutive five years during which cumulative absence outside that country totalled no more than 30 months, even not having obtained a long term or permanent residence permit.
Circular 121 appears to provide, however, that where the Chinese citizen's stay in the foreign country is merely for purposes of foreign study or overseas secondment by a Chinese employer, that period of overseas stay may not be counted in applying the above two criteria. Based on the clarification as provided by Circular 121, employers should review their current treatment of "Overseas Chinese" employees to ensure that their overseas stay fully satisfies one of the above criteria.
Bottom line
Circular 121 is silent on the effective date of these new changes. It is, however, generally believed that the changes should take effect on or after the date Circular 121 was issued (i.e. 17 August 2009). Companies should therefore observe the important changes as introduced by Circular 121 and immediately revisit their remuneration strategies for 13th month salary in respect of the employees and for remunerated executive directors. They should also consider their Overseas Chinese's foreign residence records as this may affect their monthly IIT filing position.
