Tax Alert: Extension of Three Major Individual Income Tax Preferential Policies

The extension of the individual income tax (“IIT”) preferential policies, which received much attention, have finally been confirmed as the New Year's bell is soon to ring. On December 29th, 2021, Premier Li Keqiang hosted an executive meeting of the State Council, where three important resolutions have been passed：

• The IIT policy of not including annual one-off bonus in the current month's salary income and implementing the monthly progressive tax rate for separate taxation will be extended until the end of 2023；
• The exemption of IIT repayment by those whose annual income does not exceed RMB 120,000 and who are required to repay tax not exceeding RMB 400 in annual tax reconciliation will be extended until the end of 2023；and
• The IIT policy to separately count the equity incentive income for listed companies will be extended till the end of 2022.

The extension of the above-mentioned policies is expected to bring tax savings of RMB 110 billion a year for taxpayers.

We hereby provide our comments on the extension of the above tax policies for your reference.

l. RSM Comments

#1: Preferential IIT treatment for annual one-off bonus

On January 1st, 2019, China officially implemented comprehensive income tax mechanism, which means the income from wages and salaries, remuneration for labor, author’s remuneration and royalties are included in annual comprehensive income. However, to achieve a smooth transition, the annual one-off bonus, as wages and salaries, is still eligible under the previous preferential policy until December 31st, 2021 (i.e., dividing the annual one-off bonus by 12 months, using the derived amount to determine the IIT rate and quick deduction according to the monthly IIT rate table and calculating the IIT separately without consolidating it into the annual comprehensive income). The formula is as followings:

Tax payable = Annual one-off bonus x applicable tax rate - quick deduction.

If the policy is not extended, starting from January 1st, 2022, annual one-off bonus will be taxed as part of the annual comprehensive income. The impact of such change will be extensive, particularly for taxpayers who receive the majority of their income through annual one-off bonus, which will result in a significant reduction in after-tax income.

We have provided two scenarios below to illustrate the difference between IIT liabilities with or without the policy extension.

Scenario 1: Assume the individual is a PRC resident taxpayer with total annual employment income of RMB 672,000, including monthly salary of RMB 50,000 and an annual one-off bonus of RMB 72,000. He only has income from China. His total annual tax payable (without taking into account special deductions and special additional deductions) is calculated as follows：

Scenario 2: Assume the individual is a PRC resident taxpayer with total annual employment income of RMB 672,000, including a monthly salary of RMB 35,000 and an annual one-off bonus of RMB 252,000. He only has income from China. His total annual tax payable (without taking into account special deductions and special additional deductions) is calculated as follows：

According to the above, the individual in Scenario 1 by receiving annual one-off bonus of RMB 72,000 would be subject to the same tax rate of 30% as the monthly salary income if the policy is not extended, while his annual IIT payable will be reduced by RMB 14,610 with the extension of the policy. In Scenario 2, the total annual remuneration remains unchanged. If the monthly salary is reduced to RMB 35,000 and the difference is paid through annual one-off bonus (i.e., the annual one-off bonus is increased to RMB 252,000), the extension of the policy will reduce his IIT payable by RMB 23,610.

Apparently, the group of taxpayers who will benefit the most from the extension of the year-end bonus policy are specific sectors (e.g., finance, real estate) and specific positions (e.g., sales personnel) whose compensation is more structured towards annual one-off bonus.

#2:  Exemption of tax repayment

In addition to the extension of the preferential tax policy for annual one-off bonus, a second decision made at the State Council meeting on the 29th clarified the two conditions of the exemption of tax supplementation in tax reconciliation：

• Annual income not exceeding RMB 120,000；and
• Annual tax to be supplemented in annual tax reconciliation not exceeding RMB 400

Considering that taxpayers fall into the above circumstances are mainly being low- and middle-income groups, the extension of such exemption will have a direct and effective effect on reducing the tax burden of low- and middle-income groups.

#3:  Preferential IIT treatment for Equity Incentive Program

The third IIT policy to be extended is mainly related to the middle and senior management groups of listed companies. Under the current tax legislation, equity incentive income obtained by the individual from listed companies is subject to the tax rate table of comprehensive income separately. According to the provisions of Circular 164, equity incentives obtained by resident individuals, which satisfy the provisions of the Circular of the Ministry of Finance and State Administration of Taxation on the Taxation of Individuals' Income from Stock Options (Cai Shui [2005] No. 35), will not be consolidated into the comprehensive income of the year and the full amount will be applied separately to the comprehensive income tax rate table for tax calculation until December 31, 2021. The formula for calculating individual income tax on equity incentive income is as followings:

Tax payable = equity incentive income x applicable tax rate - quick deduction.

If a resident individual acquires more than two (including two) equity incentives in one tax year, the tax shall be calculated by combining the equity incentive income.

If the policy is not extended, equity incentives in listed companies shall be taxed as part of the annual comprehensive income from January 1, 2022. Below example is to illustrate the difference between IIT liabilities with or without the policy extension.

Example：The individual is a PRC resident taxpayer, receiving monthly salary is RMB 50,000.  In the year, he also obtained RMB 500,000 of equity income from the employer who is a listed company. Assuming he has income from China only, his annual tax payable, without taking into account of special deductions and special additional deductions, is calculated as below：

It is showing that with the extension of the policy, the individual's IIT liability will be reduced by RMB 79,920. Considering that equity incentive scheme is a commonly adopted by listed companies, the extension of such IIT preferential policy demonstrates that the authorities is willing to further promote the development of capital market and help enterprises to optimize the cash flow of employment spending.

l.RSM Observation

The above three extensions of IIT policies are of great significance to reduce IIT burden for individual taxpayers.

• The first of them is the extension of the preferential tax policy for annual one-off bonus, subjected to much attention, is in line with the country's current policy of encouraging domestic demand and consumption.
• The second decision on individual income tax reconciliation is also of great significance to relieve the pressure on the middle- and low-income groups.
• The third extension of the preferential tax policy for equity incentives shows the determination of the state to further promote the development of the capital market.

In the context of the enduring fight against the pandemic, this offered "tax bonus" is particularly important and meaningful. We suggest that the Finance and HR departments of enterprises keep an eye on the relevant tax policies and prepare relevant plans in advance (e.g., review and optimize the remuneration system of employees, perform record filings for equity incentives in time to enjoy the IIT benefits) in order to effectively communicate with employees and bring in effective motivation.

Meanwhile, there are still other policies of the individual income tax reform that will expire on December 31st , 2021 (e.g., tax-exemption for benefits-in-kind items for foreign employees) and we will continue to monitor whether they will also be renewed in the current background and keep you updated with our comments.

Should you have any question, please feel free to contact us: [email protected]