By Zhou Qian and Rainy Yao

SHANGHAI — According to a survey conducted by China Youth, 36.2 percent of employees considered their annual bonus to be a major factor in whether or not they will change jobs in the next year. When determining bonuses, it is critical that employers pay close attention to the calculation of individual income tax (IIT), as this can considerably diminish employee take-home pay. In this second part of a two-part article, we discuss how to calculate IIT for foreign employees, as well as provide tax planning advice for employers.

IIT on the annual bonuses of foreign employees should be calculated based on their residency status in China, as explained below.

For foreign employees with residency in China

If a foreign employee has residence in China, he/she shall be subject to the same IIT calculation method as Chinese employees (see part one of this article). The employer should first divide the lump-sum annual bonus by 12 to determine the applicable tax rate and quick deduction amount. The applicable formula will be:

IIT on lump-sum annual bonus = lump-sum annual bonus x applicable tax rate – corresponding quick deduction amount

For non-resident foreign employees

According to “Guo Shui Fa [1996] No.183”, a non-resident foreign employee’s annual bonus should be regarded as an additional one-month of his/her wage, meaning that the lump-sum annual bonus should be used directly (rather than the lump-sum annual bonus divided by 12) to determine the applicable tax rate and quick deduction amount. The Tax Law stipulates that no expenses shall be deducted from this amount.

For example, if non-resident foreign employee “A” receives a lump-sum annual bonus of RMB 40,000, according to the chart given in part one of this article, the applicable tax rate should be 30 percent, and the quick deduction amount should be RMB 2,755. The applicable IIT should be calculated as follows:

IIT on lump-sum annual bonus = RMB 40,000 x 30% – RMB 2,755=RMB 9,245

Additionally, if a non-resident foreign employee works both in China and overseas at the same time (e.g., the employee works in a multinational company), the IIT on his/her annual bonus should be calculated based on how many months he/she has resided in China.

NOTE: The employee should be taxed for a full month even if he/she only works for one day in that month within China. The applicable formula shall be:

IIT on lump-sum annual bonus = (lump-sum annual bonus x months working in China / 12 months) x applicable IIT rate – corresponding quick deduction amount

For example, if foreign employee “B” receives a lump-sum bonus of RMB 60,000 and he works for five months and two days within China. According to the chart, the applicable tax rate should be 25 percent (RMB 6000 x 6 months / 12 months = RMB 30,000), and the quick deduction amount should be RMB1,005. IIT should be calculated as:

IIT on lump-sum annual bonus = (RMB 60,000 x 6 months / 12 months) x 25% – RMB 1,005 = RMB 30,000 x 25% – RMB 1,005 = RMB 6,495

Notably, if a non-resident foreign employee happens to be the director or senior manager of an enterprise registered in China (including a branch, regional headquarters or representative office), the IIT on his/her annual bonus should be paid based on his/her tenure as a senior manager, even if he/she also works outside of China. The employer should use the employee’s lump-sum bonus to directly determine the applicable tax rate and quick deduction amount. The applicable formula will be:

IIT on lump-sum annual bonus = lump-sum annual bonus x applicable tax rate – corresponding quick deduction amount

As previously mentioned, employers are able to reduce the overall tax burden of their employees through careful balancing of salaries and bonuses. To illustrate, if an employee “C” receives an annual bonus of RMB 420, 000, and another employee “D” receives a total of RMB 420,001, assuming their salary income is higher than the deductible amount of expenses stipulated in the Tax Law, then:

In the example above, D’s lump-sum annual bonus is actually RMB 1 more than C’s, but D’s take-home pay turns out to be RMB 19,249.30 less than C’s. This is the so-called “more is less” phenomenon in China’s annual bonus system. Thus, employers should pay close attention to numbers hovering around the threshold of each progressive tax bracket (see chart below).

Asia Briefing Ltd. is a subsidiary of Dezan Shira & Associates. Dezan Shira is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in China, Hong Kong, India, Vietnam, Singapore and the rest of ASEAN. For further information, please email china@dezshira.com or visit www.dezshira.com.

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