In his 2018 Government Work Report, Premier Li Keqiang vowed to “raise the [individual] income tax threshold and create expense deductions for items like children’s education and treatment for serious diseases.” Fulfillment of this promise primarily falls on the Ministry of Finance (MOF) and the State Administration of Taxation (SAT), which managed to draft an amendment to the Individual Income Tax Law and submitted it to the NPC Standing Committee (NPCSC) in under three months. But the bill did not fare particularly well in the NPCSC. According to reports by Caixin and the Legal Daily, legislators questioned certain main provisions of the draft amendment during group deliberations. Before turning to their opinions, we will first introduce the main content of the draft amendment below.
Highlights of Draft Amendment
New Tax Residence Rules
Among its more minor changes, the draft amendment explicitly labels the two types of taxpayers under the current Law as “resident individuals” (居民个人) and “nonresident individuals” (非居民个人) and lowers the threshold for tax residency from one year to 183 days, in line with other major tax jurisdictions (art. 1; all citations are to the Law as amended by the draft amendment). In other words, an individual would be deemed a resident for individual income tax (IIT) purposes if he or she resides in mainland China for 183 days or more within one tax year (the same as a calendar year).
“Comprehensive Income” and Adjusted Tax Brackets
The current Law provides for different tax rates on eleven categories of income, including income from salaries and wages (工资、薪金), labor service payment (劳务报酬), author’s remuneration (稿酬), and royalties (特许权使用费). Among these four categories, salaries and wages are subject to seven-bracket progressive rates (from 3% to 45%; see chart below) while the other three are subject to a proportional rate of 20% (plus a few category-specific rules).
The draft amendment would subject these four categories of income—collectively termed “comprehensive income” (综合收入)—to the same seven-bracket progressive rates, still from 3% to 45%, but with the income ranges in several brackets adjusted (art. 2, ¶ 2 & art. 3, item 1). The current and proposed tax brackets are as follows:
(range of monthly taxable income, ¥)
(range of monthly taxable income, ¥)
In addition, for resident individuals, IIT on comprehensive income would be calculated annually (as opposed to monthly under the current Law) based on the total comprehensive income earned during a tax year, minus any applicable deductions (art. 6, item 1). (Resident individuals with a withholding agent would still have their IIT on comprehensive income withheld and prepaid on a monthly basis (art. 11, ¶ 2). They would have the opportunity to settlement tax payments with the tax authorities after a tax year ends, paying any additional tax owed and claiming any available tax refund (id. & art. 12, ¶ 2).) For nonresident individuals, IIT on comprehensive income would be paid on a monthly or per payment basis and would be separately calculated for each category of comprehensive income.
Higher Minimum Threshold
Under the current Law, individuals are allowed a standard ¥3,500 deduction on their monthly income from salaries and wages only (popularly known as the “minimum threshold” (起征点) for IIT). The draft amendment would raise the threshold to ¥5,000 per month (or ¥60,000 per year) and apply it to all comprehensive income of a single tax year (art. 6, ¶ 1, item 1). This higher threshold, claims the MOF in its explanation of the draft amendment, “takes into account the increase in consumer spending and various other factors and is forward-looking.” According to its estimates, the overall tax burden on taxpayers who earn comprehensive income would “decline to varying degrees”—in particular, the burden on middle- to lower-income groups would drop “significantly.”
Special Expense Deductions
In addition to “special deductions” (专项扣除) for social insurance contributions that are now available, the draft amendment would for the first time allow resident individuals to claim “special expense deductions” (专项附加扣除) for expenses including “children’s education, continuing education, treatment for serious diseases, housing loan interest, and housing rent” (art. 6, ¶ 1, item 1). The draft amendment would also delegate to the MOF and SAT the task of determining the “specific scope, standard, and implementation procedures” for special expense deductions (id. ¶ 4).
Anti-Tax Avoidance Rules
The draft amendment includes a set of new anti-tax avoidance rules that are modeled after some of the anti-avoidance rules in the Enterprise Income Tax Law. It would authorize the tax authorities to make tax adjustments “through a reasonable method” in any one of the following circumstances (art. 8, ¶ 1):
- Where an individual’s business dealings with his related parties do not conform to the arm’s length principle and are without justifications;
- Where an enterprise that is set up in a country (region) where the actual tax burden is obviously low and that is controlled by a resident individual or jointly controlled by a resident individual and a resident enterprise, fails to distribute or decreases the distribution of profits attributable to the resident individual, without any reasonable business needs;
- Where an individual makes other arrangements without any reasonable commercial purposes to obtain improper tax benefits.
Three of the previous six amendments to the Individual Income Tax Law focused on raising the minimum threshold—from the original ¥800 to ¥1,600 in 2005, then to ¥2,000 in 2007, and finally to the current ¥3,500 in 2011. Further underscoring the importance of this provision to the public, the NPCSC held its first—and the only to date—legislative hearing on the minimum threshold when considering the 2005 amendment. (After the hearing, the NPCSC increased the ¥1,500 threshold proposed by the State Council by ¥100.) Much of the legislators’ discussion last month also focused on the new proposed threshold.
Some legislators advocated an even higher threshold because, to them, a mere 43% increase (from ¥3,500 to ¥5,000) would be inadequate to match the much larger increase in per capita disposable income (67% from 2011 to 2017) and consumer price index (“an average of 2% annual increase”) over the last several years. Some thus recommended ¥6,000 or ¥7,000 while others suggested ¥8,000 to ¥10,000 to “boost domestic demand and stimulate consumption.”
One NPCSC member (also serving as a deputy director of the NPCSC Budgetary Affairs Commission) doubted that the modest increase could offset the elimination of deductions now available on each category of income that would be merged into the single category of “comprehensive income.” He cited internal estimates by the Commission that “some people” would see their taxes go up. He also faulted the MOF for not supplying enough data—for example, the new threshold’s impact on fiscal revenue and consumers—for the NPCSC to decide whether ¥5,000 is a reasonable threshold.
NPCSC members also recommended the establishment of mechanisms for “dynamically adjusting” the threshold—tying it to “income, expenditure, and price levels”—so that the Law need not be amended once every few years. And a few others argued that the threshold should be varied geographically across China given the disparity in regional economic development.
Special Expense Deductions
Several legislators argued that eldercare expenses should be included in the special expense deductions given China’s aging population. At the very least the “only children”—those without siblings due to China’s now-abandoned one-child policy—should be allowed to claim deductions on their expenditure on caring for their parents, as a way to make up for “the sacrifices these families have made to the nation.”
Others suggested some limiting rules on special expense deductions. One member, for instance, argued that only “a reasonable amount” of special expenses should be eligible for deductions so that “excessive spending” wouldn’t qualify for deduction. Another suggested that not all housing loan interest should qualify for deductions: Homes purchased for living and investment should be treated differently; so should “affordable housing” and “villas.”
Delegation of Legislative Authority
Multiple NPCSC members—and the NPC Financial and Economic Affairs Committee in an internal report—expressed concern with the draft amendment’s failure to conform to the “law-based taxation” (税收法定) principle—that is, all essential elements of a tax must be prescribed by statute (or “law” (法律) in the narrower sense). Among the Law’s 22 articles (as amended by the draft amendment), they counted five articles that delegate authority to the State Council or MOF/SAT to prescribe (among other matters) the scope of special expense deductions and “other income” on which to levy IIT. Xu Xianming, a four-term NPCSC member and who served briefly as a deputy procurator general of the Supreme People’s Procuratorate, had particularly strong words for the draft amendment’s delegation clauses, warning that they are “a long way from the requirements of the law-based taxation principle.” These legislators urged that more details be written into the Law itself—and, if some degree of delegation is indeed inevitable, at least that the authority be delegated only to the State Council, not the MOF or SAT.
The legislators have also made a range of other comments on the draft amendment. We won’t discuss them here for various reasons, but will note that, according to Caixin, the legislators seemed to have overwhelmingly agreed that the highest possible rate on comprehensive income, 45%, should be lowered (or, in the alternative, the top brackets should cover higher income ranges).
The draft amendment is currently open for public comments and has already received over 80,000 comments only 14 days into the 30-day comment period. (In comparison, the three other bills that were simultaneously released have each received fewer than 700.) Given the sheer volume of comments and the apparent lack of consensus on several important provisions in the draft amendment, we would normally predict that the next reading won’t happen till December and that the amendment won’t be passed till 2019. But several factors could potentially shorten the ordinary timeline.
Under the draft amendment, IIT on most taxpayers’ income would be calculated on an annual basis—a big shift from the current monthly scheme. A January 1 effective date would obviously cause the least disruption. And officials—especially Premier Li who made the promise to reform the IIT in his 2018 work report—would most likely prefer an effective date before the distant January 1, 2020. The drafter of the amendment probably had the same consideration when it, in a rare move, listed “January 1, 2019” as the amendment’s effective date. (Draft laws almost never include a specific effective date.) Assuming this effective date is fixed, the next and final reading of the draft amendment will most likely take place in late October, because the NPCSC’s August session is too soon for consensus building and its late December session is too close to the (presumptive) effective date to allow for adequate preparations for implementing the amendment.
In terms of substantive changes to the draft amendment, our predictions are as follows:
- The minimum threshold will likely be further raised, however slightly, similar to what happened with the 2011 amendment (State Council’s proposed threshold was increased by ¥500).
- The minimum threshold will likely remain uniform across China. Suggestions that the threshold be dynamically adjusted based on price level and other factors may require a more extensive revision to be implemented.
- The highest rate (45%) could be decreased or, alternatively, it could apply to a higher income range.
- Eldercare expenses will likely be made a type of special expense deductions.
- There will most certainly be more detailed rules on special expense deductions.
- The MOF and SAT will likely lose all authority to prescribe rules affecting IIT liabilities (for example, the power to decide to levy IIT on non-statutory types of income). Any such authority will be delegated (if at all) to the State Council, subject to stronger NPCSC oversight (in the form of mandatory NPCSC approval or recording requirement).
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