11 October, 2018
Foreign national employees may see higher taxes under new law
Income taxes for many foreign national employees are expected to increase as a result of amendments to the Individual Income Tax (IIT) Law approved on August 31, 2018. The amendments, which will come into force on January 1, 2019, will also likely result in decreased taxes for most Chinese national employees.
The amendments approved by the Standing Committee of National People Congress generally reflect the proposed revisions in a draft that was circulated this summer.
Some of the key changes include:
The standard monthly personal deduction is a uniform RMB 5,000, an increase from the current RMB 3,500 that applies to PRC nationals and from the RMB 4,800 for foreign nationals. The RMB 5,000 monthly personal deduction will become effective on October 1, 2018, three months prior to the other changes.
Chinese nationals and foreign nationals, who are deemed to be PRC tax residents, will be entitled to deductions including children’s tuition, medical expenses, housing rental, and expenses for “elder care”, which are expected to be limited to care for parents and other relatives.
The top marginal IIT rates of 45%, 35%, and 30% remain unchanged, but the previous marginal rate of 25% will decrease to 20% or 10%, depending on an individual’s annual taxable income.
The previous marginal rate of 20% has been reduced to 10%, and the previous lowest marginal rate of 10% will fall to 3%.
Salaries, wages, service income and royalty fees are aggregated as “comprehensive income” and will all be taxed at the same rates. This represents a major change from the earlier arrangements for taxation of service income, such as fees paid to independent contractors, which had previously been subject to a flat rate of 20%.
A uniform 20% expense deduction applies to calculate taxable income derived from service income and royalty fees.
The catch-all category of “other income” has been deleted from the amended IIT law, which may produce uncertainty in the classification of some types of income.
The period for determining PRC resident taxpayer status of foreign nationals—as well as residents of Hong Kong, Taiwan and Macao— is reduced from the previous threshold of one-year of presence in China to 183 days, thereby more closely aligning with international practice. This change may result in more foreign nationals being subject to PRC tax on salaries and other income paid for services provided outside of China. The new amended IIT law also signals a possible overhaul of the IIT policies applicable to foreign nationals, such as the elimination of the“5-year rule”, meaning that more foreign nationals in China would become subject to income tax on their worldwide income.
Anti-tax avoidance rules will be introduced in order to provide legal grounds for the Chinese tax authorities to combat tax avoidance. More generally, the tax authorities are expected to tighten their supervision in the future, especially on high net income individuals and their transactions and business structure arrangements.
By introducing the updated IIT rates, a new deduction system, stringent tax resident recognition, anti-tax measures, and a new tax withholding/reporting mechanism, the new IIT law will have significant impact not only on employees, including PRC nationals and foreign nationals, but also on employers.
Standardize social insurance collection may mean increased costs
Employers and employees may face higher social insurance costs as a result of changes in the way that social insurance contributions are collected, beginning on January 1, 2019.
According to a reform announced by national authorities on July 20, 2018, local tax bureaus will have sole responsibility for the collection of the contributions. Previously, there was no clear ruling on where responsibility lay, leading to a situation where collection was made by social insurance authorities in some jurisdictions, such as in Shanghai and Beijing, and by tax bureaus in others, for example in Guangdong and Jiangsu.
Social insurance contributions are made by employers and employees to fund statutory pension programs, and medical, work injury, unemployment and maternity insurance programs. Funding of social insurance programs has come under increased pressure due to China’s rapidly aging population and shrinking workforce. The reform does not affect the collection of housing fund contributions, which remains the responsibility of housing fund authorities.
With their additional powers to undertake audits and to enforce the law and with greater resources at their disposal, the tax authorities are likely to be more aggressive in collecting contributions than social insurance authorities. In particular, given that they are likely to have more information on employee income and taxation, tax authorities are well placed to prevent the underpayment of contributions by any employer that attempts to use lower employee income as the basis for calculating contributions.
In a related development, on September 19, 2018, the State Council instructed local governments and authorities that they should not initiate unauthorized audits or inspections of employers for historical social insurance underpayments and that they are to maintain their current social insurance contribution arrangements until January 1, 2019. This instruction appears to have come in response to complaints from employers facing audits and inspections during the transitional period in such places as Heilongjiang province, and Changzhou, Jiangsu.
Guangdong: employees may not be fired for violating family planning rules
Reflecting the recent relaxation on national family planning requirements, the Guangdong High People’s Court and the Guangdong Labor Arbitration Committee announced that employees may not be fired for violating family planning. The conclusion, which was included in opinions published on August 8, 2018, reversed guidelines issued in July 2017 by the Guangdong High People’s Court that employers could dismiss an employee on such grounds if the right was included in the employee’s labor contract, a collective contract, or company policies.
The August 2018 opinions also instruct Guangdong courts and labor arbitration tribunals on the following issues:
An employee’s salary during maternity leave should be based on the employee’s average monthly compensation of the preceding 12-months, including salary, bonuses, allowances, and subsidies, but not overtime pay. If employees comply with family planning requirements and are entitled to additional maternity leave or paternity leave, their salaries, benefits, and any attendance bonuses shall not be affected by taking leave.
A labor dispatch provider must enter into an open-term employment contract with its dispatched employees if the employees have completed two consecutive fixed-term contracts or have 10 years of service. This requirement provides dispatch workers with the same rights to open-term contracts as are given to directly-hired employees under the Labor Contract Law. It is expected that labor dispatch providers will pass on these obligations to those companies that use their dispatched employees.
The right of employers to terminate employees on the grounds of redundancy is expanded to include the situation where an employer suspends operations due to serious financial difficulties and is unable to repay its debts. In this situation, the employer may also enter into an agreement with the employees on a period of suspension during which the employees will not work, but must be paid full salary for the first month and at least 80% starting from the second month of the suspension. If the agreed period of suspension expires or a “reasonable” time period has passed, the employees may unilaterally terminate their employment and claim severance pay.
Severance pay for service periods prior to January 1, 2008 should be calculated on the same basis as under the Labor Contract Law.
Labor arbitration tribunals may apply to courts for orders to collect evidence from third parties, including individuals. An example of such an order would be to require a bank to provide transaction records of salaries paid to employees.
Hong Kong, Macao, and Taiwan employees no longer need work permits
Following the State Council’s abolishment of work permits for residents of Hong Kong, Macao, and Taiwan (“HMT Residents”) on July 28, 2018, the Ministry of Human Resources and Social Security on August 23, 2018 issued implementation measures for the employment of HMT Residents in mainland China. Of particular importance, the August 23 measures repealed the Administrative Regulations on Employment of Taiwan, Hong Kong and Macau Residents in Mainland China.
The State Council also issued rules effective September 1 governing how HMT Residents can acquire residence permits in mainland China. Specifically, HMT Residents may apply to local public security authorities for residence permits after staying in the mainland for more than six months and meeting at least one of three conditions: having employment, a stable residence, or being in continuous study in a school. In terms of the documentation required, an employment agreement or a certificate from the employer can be used to prove a HMT Resident’s employment in the mainland; a housing lease or purchasing contract is proof of a resident’s stable residence address; while a student card or a certificate from a school demonstrates the resident’s continuous study. Work permits with unexpired terms may still serve as the documentation of employment in the mainland until December 31, 2018.
HMT Residents employed in the mainland can now use their residence permit or their mainland travel permits to enroll in social insurance and housing fund programs. Pursuant to the Social Insurance Law, HMT employees should be enrolled in social insurance programs. (Shanghai, however, has yet to implement this requirement.) HMT employees in all jurisdictions are not as yet required to participate in a housing fund, but may do so on a voluntary basis.
The rules clarify that HMT residents do not include Chinese nationals who reside in Taiwan, Hong Kong, or Macao, and who have a hukou (household registration) in mainland China.
Zhejiang allows interns, older workers to join occupational injury insurance
Zhejiang issued rules on July 31, 2018 allowing certain interns and individuals that continue working past the statutory retirement ages to participate in occupational injury insurance. In the past, these persons had not been able to participate because they are not considered to be employees.
The interns eligible to participate in occupational injury insurance are limited to vocational school students aged 16 years and older and only for work they undertake while their school is in session. The conditions for the older workers are that they have not yet started to draw statutory pension benefits, nor have reached the age of 65 for men and 60 for women.
Enrollment in occupational injury insurance, which is solely funded by employers, is optional for employers in Zhejiang under the new rules. Many Zhejiang employers are expected to enroll interns and the older workers in order to minimize their financial exposure in the event of workplace illnesses and injuries. Employers throughout China who are unable to include interns and older workers under occupational injury insurance often had to resort to purchasing commercial insurance or face claims from the interns, the older workers, and their relatives.
Zhejiang’s new rules reflect a growing trend to protect workers who do not qualify as employees and are therefore are not normally entitled to statutory benefits. Guizhou requires that vocational students be enrolled in occupational injury insurance when working, while Liaoning and Gansu permit employers to contribute to occupational injury insurance for workers who have exceeded the statutory retirement ages.
Employer obligations on sexual harassment prevention likely to increase
Employers are expected to have increasing responsibility to protect employees from sexual harassment pursuant to the draft Civil Code. Provisions in the draft, which was considered by the National People’s Congress on August 27, 2018, require employers to take “reasonable” measures for the prevention of workplace sexual harassment and to develop procedures for taking and handling complaints.
The draft Civil Code, which in addition to the section on sexual harassment has five other sections addressing issues such as marriage, inheritance and contracts, is set to be approved by the end of 2020. Males may also be protected from harassment, given that the draft language does not limit its protection to females.
The draft amendments are, however, silent on the issue of the potential liability of employers if workplace sexual harassment should occur.
There are already regulations that aim to protect women from sexual harassment, but they lack a clear definition of what constitutes sexual harassment. The possible inclusion of provisions in the Civil Code, which operates at a higher level in China than regulations, indicates that the government is giving greater attention to the issue.
Study finds most Shenzhen labor arbitration awards not challenged
According to a study of labor dispute cases over the five-year period of 2013 to 2017, most awards made in labor arbitration in Shenzhen were not challenged. The study, released on August 22, 2018 by the Shenzhen Intermediate People’s Court and the Shenzhen Labor Dispute Arbitration Committee, found that only in one in five (20%) cases did an employer or employee bring a district court case in an attempt to overturn arbitration awards.
Among the report’s other key findings are that:
Mediated settlements are reached in nearly half (47%) of arbitration proceedings but in only one quarter (25%) of district and intermediate court proceedings.
The vast majority of arbitration awards are upheld in district and intermediate courts, with only 5% of cases being reversals.
Courts may overrule arbitration awards based on differing standards of the evidence that may be considered. The study cites as an example a dispute over the salary of an employee. The arbitration tribunal based its decision on the salary declared by the employee, while the district court ruled that the salary should be based on the amount reflected in banking records.
Employee ordered to pay liquidated damages for competing during employment
The Suzhou Intermediate People’s Court ruled in a July 2018 case that a former employee had violated a contractual non-compete provision when, while still employed, he had registered a company to compete. He was ordered to pay liquidated damages to his former employer. The case clarifies that liquidated damage clauses may also be enforceable when used for non-compete obligations owed during employment.
In the case, Qian Xiaochun joined Tianzhiyue Consulting Service Co. on June 1, 2016 as an advisor in the marketing department at a monthly salary of RMB 3,500. Qian’s employment contract included a provision that he would be required to pay to Tianzhiyue an amount equal to twice his monthly salary if he engaged in competing work during the term of his employment.
On May 10, 2017, while still employed, Qian established a company that had a similar business scope to that of Tianzhiyue. He left Tianzhiyue when his contract expired on May 31, 2017.
An arbitration tribunal refused on jurisdictional grounds to accept a claim filed by Tianzhiyue against Qian for RMB 7,000 in liquidated damages. Tianzhiyue then brought a suit in Zhangjiagang District People’s Court, which accepted the case. Qian argued that he in fact did not breach the non-compete obligation during employment because his new company did not engage in business activities until the month after he left Tianzhiyue. The district court accepted Qian’s argument and rejected Tianzhiyue’s claim, reasoning that the Labor Contract Law related to non-compete obligations only after the end of employment, not during employment.
The intermediate court reversed the district court’s decision and awarded Tianzhiyue RMB 7,000, basing its judgment on the non-compete provision in the employment contract as well as on the principle of the duty of loyalty of employees not to compete with their employers. The intermediate court found that the similar business scopes of the two companies was evidence of competition. The finding indicates that the act of registering a company in itself could be “competitive work” and that it is not necessary for a competing company—or the employee—to have actually engaged in operations in order to have breached a non-compete obligation.
The intermediate court admitted that while the Labor Contract Law specifically authorizes liquidated damages for a breach of a post-termination non-compete obligation, the law is not clear whether liquidated damages are permitted when employees compete during employment. The intermediate court then justified the enforcement of the liquidated damages clause in Qian’s employment contract based on the reasoning that the harm to an employer caused by an employee who competes during employment may be more serious than that caused by a former employee who competes after employment.
For further information, please contact:
Dongpeng Wang, Partner, Jun He
wangdp@junhe.com
