From 2022 expatriates in China will no longer be entitled to additional tax-free benefits, which in turn will result in higher tax liabilities and likely increased costs for employers. Therefore, preparations for possible increased costs and tax burdens should be held as early as possible to ensure a smooth transition and renegotiation of foreign employees’ packages.

Currently, expatriates who work in China can enjoy a number of tax-exempt benefits, namely:

-          Education expenses for children;

-          Language training expenses;

-          Housing expense;

-          Meal expense;

-          Laundry expense;

-          Relocation expense.

Prior to 2022, these benefits are exempt from individual income tax (IIT). Foreign employees are required to provide the invoice for each expense and such expense has to be of a reasonable amount. However, the new IIT Law of China no longer provides additional tax exempted benefits for foreign workers and attempts to equalize the benefits available to local and foreign tax residents of the country.

Starting from January 1, 2019 the new IIT Law of China became effective. Nevertheless, at the end of 2018, the authorities issued a statement where they outlined a period of 3 years of transition to the new rules. According to the Notice, for the period from January 1, 2019 to December 31, 2021, expatriates in China were given a choice to either continue to enjoy the tax-exempt benefits or apply for six alternative itemized deductions, which are:

-          Ulterior education expenses;

-          Children’s education expenses;

-          Housing mortgage interest;

-          Housing rent;

-          Costs for taking care of elderly parents;

-          Healthcare costs for serious illness.

However, from January 1, 2022, foreign employees can no longer enjoy the former tax-exempt benefits, in particular language training expense, housing expense, and children’s education expense; instead, these categories will be replaced by the corresponding itemized deductions which are listed previously. As for the remaining tax-exempt categories, no additional information was released from the officials.

Most of the alternative itemized deductions are applied using the standard rate, unlike the previous tax-exempt benefits which are applied based on the actual cost of the expense, as long as the invoice is provided, and the amount is reasonable and in alignment with the local standards of living.

Thus, for the higher income foreign employees, the transition from the tax-exempt benefits to itemized deductions is anticipated to be costly. This is especially relevant in the category “children’s education expenses”, whereas using the itemized deduction, the pretax income can only be reduced by RMB 1,000 per child per month. Given that foreign children who are living in China cannot join Chinese public schools, the only available option for them are private schools, which cost an average of EUR 30,000 per academic year. This cost is exempt from IIT before January 1, 2022.

As a result of this transition, the salary expense for companies is expected to increase significantly, or else expats are going to take a significantly lower net salary. In case of multinational companies, this may not be a serious issue; however, small- and medium- sized enterprises employing foreign individuals will have to face additional costs or even be forced to reduce their foreign staff in China. For companies in general, it is advisable to discuss the agreements and labor contracts in advance with their foreign employees, to ensure smooth and seamless transition in the course of their operations. If you would like to know more about the most recent financial policy and tax developments in China, please contact us at info@phcadvisory.com.