Extension of Preferential Individual Income Tax Policies on Benefits Granted to Foreigners and Annual Bonus of PRC Tax Residents

On December 31st, 2021, the Ministry of Finance and the State Administration of Taxation jointly released Announcement No. 42 (“Announcement 42”) and Announcement No. 43 (“Announcement 43”) to extend the expiration date of preferential Individual Income Tax (“IIT”) policies on benefits granted to foreigners and annual bonus of PRC tax residents from December 31st, 2021 to December 31st, 2023. As we mentioned in our newsletter “How Employers can Prepare for the Changes of Individual Income Tax (“IIT”) Policies on Foreigners” in June 2021 (“Newsletter of June 2021”), some Chambers of Commerce in China had been lobbying the Chinese governments on cancellation of the underlying preferential IIT policies from January 1st, 2022 onwards. The extension is the result of such successful lobbying.

Although Announcement 42 and Announcement 43 also extend the expiration dates of the IIT policies on stock incentive schemes of listed companies, incentive schemes for in-charge persons of state government-controlled state-owned enterprises and the qualified exemption for annual filings, the extension of IIT policies on benefits granted to foreigners and annual bonus of PRC tax residents are the most important ones for the foreign-invested enterprises as well as all enterprises granting to their employees annual bonus as significant part of the employees’ remunerations.

Extension of the IIT exemption policies of certain benefits granted to foreigners

According to the circular Caishui [2018] No. 164 (“Circular 164”), the housing allowances, the language training allowances and the children’s education allowances granted to foreigners are exempt from PRC IIT and such policy is valid until December 31st, 2021. The newly issued Announcement 43 extends the expiration date of this policy to December 31st, 2023.

Extension of the preferential IIT policies of annual bonus granted to PRC tax resident individuals

According to Circular 164, the annual bonus granted to PRC tax resident individuals can be excluded from the annual salary incomes and taxed separately and such policy is valid until December 31st, 2021. The “separate taxation” allows that the marginal IIT rate applicable to only 1/12 of the annual bonus amount can be used for calculation of IIT for the entire annual bonus. The newly issued Announcement 42 extends the expiration date of this policy to December 31st, 2023.

What is unclear?

The expiration dates of the underlying preferential IIT policies are, according to Announcement 42 and Announcement 43, extended to December 31st, 2023, but there is no clear treatment after 2023 in this regard. In other words, if no new announcements are issued to further extend the expiration dates of the preferential IIT policies, the policies will be stopped from January 1st, 2024 onwards. The grace period from January 1st, 2022 to December 31st, 2023 effectively gives a buffer for the state government to observe the reactions from the enterprises and to evaluate the economic contributions from foreign direct investments as well as the effect from the general “tax-cut” tendency from a macro-economic angle. The state government will then decide on whether the underlying preferential IIT policies will be further extended after 2023 based on the evaluation during this grace period.

What actions should be taken by the enterprises?

As we mentioned in our Newsletter of June 2021, in order to face the potential cancellation of the underlying preferential IIT policies, the employers should adjust the remuneration structure to reduce the overall tax burden, if necessary, re-visit the company's overall compensation policy and make corresponding adjustments due to the potential changes of IIT policies. Based on our observation of the market practice, many enterprises have already amended the employment contracts with the employees (especially the expatriates) to reallocate the IIT cost bearing between the employer and the employee. Considering that the expiration dates of the underlying preferential IIT policies are extended,

• if the enterprise has not yet concluded the amended employment contract with the employees to factor in the potential change of the IIT policies, no further action is necessary now;
• if the enterprise has already concluded the amended employment contract with the employees to reallocate the IIT cost bearing, the enterprise may consider terminating the amendments and make the original unamended employment contracts prevail.

This topic will be re-visited in 2023.