Talent Retention in China: How to Reduce Individual Income Tax

According to a survey conducted by the China Youth Daily, 36.2% of employees in China consider their annual bonus to be a major factor in whether or not they will change jobs in the next year. So when determining bonuses, it is critical that employers pay close attention to the calculation of individual income tax, as this can considerably diminish employee take-home pay.

In this article, we detail how employers can reduce the overall tax burden of their employees, both local and foreign, through carefully balancing salaries and bonuses, and thereby retaining valuable talent.

For Chinese employees

According to the State Administration of Taxation’s Announcement No. 9, 2005 (Guo Shui Fa [2005] No.9), individual income tax on annual bonuses should be calculated as explained below.

Step 1: Determine the applicable individual income tax rate and quick deduction

The employer should first divide the lump-sum annual bonus by 12 to determine the applicable tax rate and quick deduction amount. The chart below shows the applicable individual income tax rate and quick deduction for each individual income tax bracket.

For example, employee “A” receives a lump-sum annual bonus of RMB120,000. According to the chart, the applicable tax rate should be 25% (120,000 ÷ 12 = 10,000), and the quick deduction amount should be RMB1,005.

Additionally, if employee “B” receives an annual bonus of RMB13,000, with a monthly wage of RMB4,000 and deductible expenses amount of RMB5,000, then monthly taxable income will be calculated as:

[13,000 – (5,000 - 4,000)] ÷ 12 = 12,000 ÷ 12 = 1,000

According to the chart, the applicable tax rate should be 3% and the quick deduction amount will be zero.

If the employee’s monthly wage is less than the deductible expenses amount stipulated in the Tax Law, the tax rate and quick deduction amount should be determined based on the formula:

[annual bonus – (deductible expenses amount – monthly wage)] ÷ 12

The deductible expenses amount is set at the regional level based on local social insurance standards.

Step 2: Determine the applicable formula

There are two basic formulas for calculating individual income tax on annual bonuses. First, if the employee’s monthly wage is more than (or equal to) the deductible expenses amount stipulated in the Tax Law, the applicable formula shall be:

Individual income tax on lump-sum annual bonus = lump-sum annual bonus x applicable tax rate – corresponding quick deduction amount

To illustrate, for employee “A”, whose annual bonus is RMB120,000 (subject to a 25% tax rate and quick deduction amount of RMB1,005), individual income tax should be paid based on:

Individual income tax on the lump-sum annual bonus = RMB120, 000 x 25% – RMB1,005 = RMB28,995

Second, if the employee’s monthly wage is less than the deductible expenses amount stipulated in the Tax Law, the applicable formula shall be:

Individual income tax on lump-sum annual bonus = [lump-sum annual bonus – (deductible expenses amount – monthly wage)] × applicable tax rate – quick deduction amount

For employee “B”, whose annual bonus is RMB13,000 (subject to a 3% tax rate and quick deduction amount of zero), individual income tax should be paid based on:

Individual income tax on the lump-sum annual bonus = [RMB13,000 – (RMB5,000 – RMB4,000)] x 3% – RMB0 = RMB360

Note that the annual bonus here refers to that given to employees prior to tax deductions.

If the employer pays part of the individual income tax on employee annual bonuses, the amount paid will be regarded as part of the employee’s taxable annual bonus according to the State Administration of Taxation’s Announcement No. 28 issued, 2011 (SAT Announcement [2011] No. 28), which further complicates the issue of individual income tax calculation.

For foreign employees with residency in China

If a foreign employee has residency in China, he/she shall be subject to the same individual income tax calculation method as Chinese employees. The employer should first divide the lump-sum annual bonus by 12 to determine the applicable tax rate and quick deduction amount. The applicable formula will be:

Individual income tax on lump-sum annual bonus = lump-sum annual bonus x applicable tax rate – corresponding quick deduction amount

For non-resident foreign employees

According to “Guo Shui Fa [1996] No.183”, a non-resident foreign employee’s annual bonus should be regarded as an additional one-month of his/her wage, meaning that the lump-sum annual bonus should be used directly (rather than the lump-sum annual bonus divided by 12) to determine the applicable tax rate and quick deduction amount.

The Tax Law stipulates that no expenses shall be deducted from this amount.

For example, if non-resident foreign employee “A” receives a lump-sum annual bonus of RMB40,000, according to the chart, the applicable tax rate should be 30%, and the quick deduction amount should be RMB2,755.

The applicable individual income tax should be calculated as follows:

Individual income tax on lump-sum annual bonus = RMB 40,000 x 30% – RMB 2,755 = RMB 9,245

Additionally, if a non-resident foreign employee works both in China and overseas at the same time (e.g., the employee works in a multinational company), the IIT on his/her annual bonus should be calculated based on how many months he/she has resided in China.

Note that the employee should be taxed for a full month even if he/she only works for one day in that month within China. The applicable formula shall be:

Individual income tax on lump-sum annual bonus = (lump-sum annual bonus x months working in China ÷ 12 months) x applicable individual income tax rate – corresponding quick deduction amount

For example, foreign employee “B” receives a lump-sum bonus of RMB60,000 and he works for five months and two days within China. According to the chart, the applicable tax rate should be 25% (RMB6,000 x 6 months ÷ 12 months = RMB30,000), and the quick deduction amount should be RMB1,005.

Individual income tax should be calculated as:

Individual income tax on lump-sum annual bonus = (RMB 60,000 x 6 months ÷ 12 months) x 25% – RMB 1,005 = RMB 30,000 x 25% – RMB 1,005 = RMB 6,495

If a non-resident foreign employee happens to be the director or senior manager of an enterprise registered in China (including a branch, regional headquarters or representative office), the individual income tax on his/her annual bonus should be paid based on his/her tenure as a senior manager, even if he/she also works outside of China.

The employer should use the employee’s lump-sum bonus to directly determine the applicable tax rate and quick deduction amount. The applicable formula will be:

Individual income tax on lump-sum annual bonus = lump-sum annual bonus x applicable tax rate – corresponding quick deduction amount

Reducing overall tax burden

As previously mentioned, employers should be able to reduce the overall tax burden of their employees through careful balancing of salaries and bonuses.

To illustrate, an employee “C” receives an annual bonus of RMB420,000, and another employee “D” receives a total of RMB420,001. We assume their salary income is higher than the deductible amount of expenses stipulated in the Tax Law.

Employee D’s lump-sum annual bonus is actually just one renminbi more than C’s, but D’s take-home pay turns out to be RMB19,250.30 less than C’s. This is the so-called “more is less” phenomenon in China’s annual bonus system (see charts below).

Thus, employers should pay close attention to numbers hovering around the threshold of each progressive tax bracket. The simple deduction of RMB1 from a bonus package could mean a lot more in actual take-home pay.

About the Author

Dezan Shira & Associates, a specialist foreign direct investment practice that provides advisory services to multinationals investing in emerging Asia. This article was first published in China Briefing and was reedited for clarity and conciseness. For further details or to contact the firm, please visit www.dezshira.com 

Photo credit: Shutterstock

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