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Abe Zhao Baker McKenzie FenXun (FTZ) Joint Operation, China
Abe Zhao is International Tax Director at Baker McKenzie FenXun (FTZ) Joint Operation, China
Subsidy-related relief measures described in this article play an important role in alleviating the tax burden for foreign expatriates working in China. Chinese employers should take advantage of these measures and develop a tax compliant program to administer qualified fringe benefits to its expatriate employees.
For many years, the most important individual income tax (“IIT”) relief for foreign expatriates working in China has been the IIT exemption on qualified employer fringe benefits. Under tax regulations issued in the 1990s ( Caishuizi 1994-20; Guoshuifa 1997-54), foreign expatriates (non-Chinese citizens) working in China may be exempt from IIT for qualified subsidies that are received in association with their employment in China, to the extent that the amounts of the benefits are reasonable as determined by the Chinese tax authorities. The prescribed categories of qualified expatriate subsidies are generally apartment and house rental, meals, relocation, laundry, home visit travels, linguistic training, and children's education. To qualify for IIT exemption, the regulations provide two mechanisms for granting the benefits. One is for the employers to directly incur expenses on behalf of the expatriates in the qualified categories aforementioned and hence benefits are provided to the expatriates in non-cash form. Direct cash subsidies to the foreign expatriates would not qualify. The other is for the expatriates to incur expenses in the prescribed categories first, gather and submit the supporting documents such as tax invoices and contracts as evidence, and seek reimbursements from the employers based on actual amounts incurred.
Although the national rules on IIT exemption are relatively simple, the devil lies in the detail. Issues such as whether a particular type of expense falls within the qualified categories, what amounts are considered reasonable, and what supporting documents are needed, are subject to the interpretation of the tax authorities in each location. The qualification standards and enforcement practices often vary across the country.
As IIT withholding agents of the expatriates, Chinese employers will be held responsible if they fail to withhold IIT on subsidies that do not qualify for exemption. It is important for employers to understand the exact local requirements and implement them internally with consistency. Some recent IIT audit cases, as represented by the one described in the next section, indicate a significantly stepped-up effort by the Chinese local tax authorities to scrutinize subsidy-related IIT exemption for foreign expatriates. These cases illustrate the necessity for Chinese employers to review and refine their internal control procedures to mitigate tax risks.
It was reported in the media that a Chinese subsidiary of a Fortune 500 company was recently audited by the Local Tax Investigation Bureau (“LTIB”) in Beijing. Besides distribution functions, the Chinese entity serves as a regional headquarters for the Southeast Asia operation of the multinational group and therefore employs about 100 foreign expatriates in Beijing. During the audit the Chinese tax officials discovered that some foreign expatriates of the Chinese company derived more than 50 percent of their employment compensation in the form of IIT exempt subsidies. Internal benchmarking data of the LTIB suggested that the normal percentages for similar foreign invested enterprises in Beijing were around 20 percent. Therefore the tax officials expanded their audit efforts and examined more than 90 boxes of supporting documents. The following issues were discovered:
At the end of the tax audit, the Beijing tax investigation bureau issued an adjustment notice to the Chinese taxpayer, and collected an additional 16 million renminbi of underpaid IIT and 12 million renminbi of penalty.
The Chinese IIT system has a top marginal tax rate of 45 percent for salary income. The subsidy related relief measures described above play an important role in alleviating the tax burden for foreign expatriates working in China. Therefore, Chinese employers should take advantage of this tax relief measure and develop a tax compliant program to administer qualified fringe benefits to its expatriate employees.
However, the purpose of the incentives is to facilitate the foreign expatriates to acclimate into the working and living environment in China. Therefore, the regulations have very tight rules on the types of expenses that may qualify for this incentive as well as the procedures that must be followed to claim the incentive. When administering the program, it's important that Chinese employers follow the rules closely and do not adopt overly liberal interpretations that are not supported by the regulatory language.
As the withholding agent for the expatriate employees' salary income, the Chinese employer will bear the primary responsibility for management of its expatriate subsidy program according to the requirements of the Chinese regulations and will incur tax costs and penalties if it is discovered not to follow the government rules and procedures during audit. The heightened enforcement efforts on IIT exemption is not just witnessed in Beijing and has been seen in some other cities of China in recent months. Multinational companies with the pre-existing programs of the granting IIT exempt subsidies to expatriates are encouraged to review their internal procedures and rectify any areas that may create tax compliance risks.
Abe Zhao is International Tax Director at Baker McKenzie FenXun (FTZ) Joint Operation, China. He can be contacted at Abe.Zhao@bakermckenziefenxun.com.Baker & McKenzie FenXun (FTZ) Joint Operation Office is a joint operation between Baker & McKenzie LLP, an Illinois limited liability partnership, and FenXun Partners, a Chinese law firm. The Joint Operation has been approved by the Shanghai Justice Bureau.
Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.
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