Expatriates that live and work in China continue to enjoy certain privileges when it comes to individual income tax (IIT) on their income:
The Chinese government has created these benefits to establish a favourable work environment for foreigners, which has contributed significantly to the Chinese economy’s growth in recent decades. These benefits may lose effect at the end of 2021, but for now they remain an important part of an expatriate’s package in China.
Most foreign employees and their employers generally know which benefits are tax-deductible but are not always aware of the significant tax risks if some of these benefits are challenged. Failing to comply with the specific State Administration of Tax (SAT) regulations can lead to severe penalties and even legal prosecution.
In practice, misunderstandings often arise on how to apply the tax deductions correctly. The policies regarding the rental tax-deductions cause the most confusion; for example, we often read that the maximum deductible tax amount is 50% of the total salary, as long as the employee can provide a rental fapiao to their employer.
In fact, Chinese law does not actually set any limitation on the proportion of income that can be spent on tax-deductible rental; it only emphasises the need for reasonableness. Under the Notice of the State Administration of Taxation on Issues concerning the Implementation of an Individual Income Tax Levy or Exemption on Allowances of Foreign Individuals (Cai Shui Fa  No. 054), expatriates may declare rental expenses not subject to IIT on the following conditions:
Nowadays, an employer is left to make its own judgment on whether or not certain income should be subject to IIT, and to complete tax filings on time, and afterward the tax bureau can conduct random spot checks to confirm that all has been done correctly. If the tax bureau determines that the IIT filing for tax-free items does not comply with the law, then this is regarded as tax evasion and can have serious consequences.
The tax bureau will recover the unpaid tax from the employee and will usually charge a late fee of 0.05% per day. Moreover, the employee can be fined at between 50% and 500% of the unpaid tax; and as the withholding agent, the employer can be penalised at between 50% and 300% of the tax that it should have withheld. Moreover, if the employee has already left China or if the employer is deemed to have actively assisted the employee to avoid taxes, then the tax bureau may decided to charge the avoided tax, late fee and penalties directly to the employer.
As the law states that tax-free rental income should be “reasonable”, the tax office has a lot of discretion to determine whether the employee and the company have acted so. As guidance, Shanghai tax bureaus will usually focus on the following when completing spot checks:
Companies and individuals should always make sure that they comply with the requirements of their local tax bureau, and should always keep the above materials on file so that they can immediately respond to a tax bureau’s inspection. Moreover, where international companies outsource their IIT tax filing work to an external agent or corporate service provider, they should double-check that the service provider is familiar with the requirements for deductions and is able to stay up-to-date with all policy changes.