Capital gains tax

Why China’s high-income earners dread the new tax law that will come into effect in January

Concerns grow over policies on bonuses and the 45 per cent levy on high-income individuals

PUBLISHED : Monday, 09 July, 2018, 8:32am
UPDATED : Monday, 09 July, 2018, 9:00am

Frank Gu, a US-educated legal counsel at a multinational company in Shanghai, is closely following the debate over China’s new individual tax code.

Earning 1 million yuan (US$151,100) annually, the 37-year-old is concerned that he may fall foul of China’s most dramatic personal tax code revision in decades, even though the new tax code has a number of tax-cut measures.

The nation’s top lawmakers are reviewing a basket of changes, including shifting toward an annual levy, higher monthly exemptions, introducing more deductibles, and broadening access to low tax brackets. Once passed, the amendment, the seventh since 1980, will take effect from January 1, 2019.

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Accounting firm EY estimates that changes on exemptions and tax brackets – including raising the monthly tax exemption allowance by 40 per cent to 5,000 yuan from 3,500 yuan – means a taxpayer with a gross monthly wage of 60,000 yuan will see his monthly tax burden trimmed by 16 per cent to 11,006 yuan. An individual with a 10,000 yuan monthly salary will see their tax bill cut by 71 per cent to 115 yuan.

But Gu does not see the changes as all good news.

“The devil is in the details,” he said. “For me, the most significant changes are not higher exemptions but a fundamental shift towards levying tax on a number of incomes comprehensively on an annual basis.”

Gu is also worried that benign tax policies on year-end bonuses will be scrapped.

“If scrapped, the change would hit me hard,” said Gu.

Tax experts are awaiting clarification from authorities on how year-end bonuses will be treated in the new tax code. Meanwhile, there are indications that those with multiple sources of income will face an increased tax burden.

China now levies tax on salary progressively in seven brackets, ranging from 3 per cent up to 45 per cent. The state also collects tax on income including property transactions, dividends, and royalties, under a flat 20 per cent rate.

Under the new tax code, remunerations and royalties will be combined with salary under the progressive tax brackets, up to a maximum of 45 per cent. This adds up to a higher taxable income base for some individuals.

Yang Zhiyong, a researcher at the National Academy of Economics Strategy under the state-run policy institute Chinese Academy of Social Sciences (CASS), questioned whether the change would discourage those who work hard.

“It is unreasonable for taxpayers to bear higher or even sharply higher tax from industrious work because of the comprehensive income levy system,” he wrote in an opinion piece published in mainland media

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Liu Xiaobing, dean of the School of Public Economics and Administration, at Shanghai University of Finance and Economics, said the change may have the unintended result of discouraging those who are well-off, yet resourceful.

An unofficial theme in the tax revamp is a less lenient approach to upper-income earners.

While the tax burden faced by lower-income earners will drop, those in the top three tax brackets, or those whose taxable monthly income is at least 35,000 yuan, remain unchanged.

“The gist of the latest amendments is very clear: to alleviate the burden on the middle and low-income groups and grant them more breathing room,” said Freeman Bu, a tax partner at EY. “The better-paid will not benefit so much comparatively speaking.”

He said the 45 per cent tax rate on upper-income earners is too high, making China unattractive for skilled, globally mobile talent.

In comparison, cities such as Hong Kong and Singapore have much lower tax rates, with the upper band capped at 17 per cent and 22 per cent respectively.

Other rules designed to discourage tax evasion are being introduced into the individual tax system for the first time. These include a measure that some believe is targeted towards wealthy individuals who are in a better position to take advantage of loopholes.

“The anti-avoidance rule is one of the significant breakthroughs as it offers solid legal ground for the tax man to fight unreasonable arrangements,” said Jacky Chu, an individual income tax partner at PwC in China.

For instance, tax authorities will have additional powers to track indirect equity transfers involving domestic companies in overseas tax havens, he said.

“It reflects the determination of authorities to strengthen tax collection, especially targeting high-net-worth individuals and their cross-border deals and tax plans,” he said.

China has already enacted anti-avoidance rules for companies, following a global trend to make it more difficult for multinationals to shift profits to affiliates in low-tax havens.

Individual income tax ranks as the third largest source of government revenue, trailing revenue from the value-added tax and corporate income tax.

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China’s tax revenue for 2017 increased 10.7 per cent to 14.4 trillion yuan, resuming double-digit growth for the first time in five years, according to the Finance Ministry. Tax revenue from individuals grew by 18.6 per cent to 1.2 trillion yuan in the period.

In regards to expatriates, policymakers plan to scrap a 1,300 yuan monthly exemption and comprehensively broaden the tax net to include global income.

Gu, who already faces the highest tax bracket of 45 per cent, said if the changes amount to a higher tax burden, he has few options but to accept the situation.

“Just stop calling it a tax-cut package,” Gu said. “To me, it is more like the state is balancing tax revenue, trimming levies on the have-nots but going more strict on the so-called ‘haves’ like me.”