"Net Worth" is a semi-regular column that opens up the world of business and executive leadership here in Shanghai. With China poised to become the world’s largest economy, the world looks to Shanghai as the bellwether city of the mainland as its center for industry, finance, technology, and entrepreneurialism. With a large concentration of senior executives and home to more than 300,000 millionaires, here is SmartShanghai’s megaphone for insight in business, innovation, and leadership across the city.
You probably haven’t heard yet, but there will be some huge changes to China’s tax code that will be affecting foreigners starting in January 2022.
These new tax laws have sparked conversations (and panic) amongst the professional and business community in Shanghai because it seems almost contrary to the city’s aspirations of becoming the world’s international city for finance, logistics, trade, maritime, and economy. We’ve written before about how Shanghai itself aims to increase the laowai population to more than 800,000 (up from its current pop of 163,000). It appears that the national congress of China will also begin looking at ways to actively attract foreign talent to China which puts this new tax law into question, with local provisions also being rolled out in Shenzhen and Shanghai.
We had the chance to sit down with Carlo D’Andrea, founder and Managing Director D’Andrea & Partners Legal Counsel and the former Chairperson of the Shanghai European Chamber of Commerce. His background in law, as well as being part of one of Shanghai’s largest business associations means we get some interesting insights from this fellow. He’s Italian, gregarious, and has a laugh that fills the room.
Read on, for insights into this new tax law.
Explain China’s new tax laws for foreigners, like we are 5 years old.
The current Individual Income Tax Law allows foreigners to enjoy allowances, such as rental, meal, children’s school fees, and so on, which can be deducted from the taxable income; therefore, reducing the individual income tax (IIT) payable.
By doing so, the savings in terms of IIT for each employee, and for the company, are substantial.
From January 1, 2022, the allowances currently available for foreign professionals become fully taxed. This means that the allowances will become part of the gross salary and, as such, be taxed at the related tax bracket.
Considering that especially the school fees are quite high in value, this means likely pushing the applicable tax bracket to the highest one (45%).
The result of this is that, either the employee will receive a much lower net salary (since the allowances will effectively become part of the salary and won’t be separated any longer), or the company cost on the employee will nearly double (given that a 45% IIT will likely apply to the overall salary package).
As the former Chairman of Shanghai European Chamber of Commerce, can you offer any data or insights how the business community feels about these tax changes?
Yes of course. The impact will be substantial. There are 87,300 foreign invested enterprises (FIE) registered companies in Shanghai. This accounts for 25% of the city’s total GDP. Foreign companies contribute around 30% of total taxes, and 11% of total employment. The share of industrial output is 30% and share of Shanghai's import/exports is 66%.
The impact will likely be a substantial renegotiation of packages (unless the company can bear a nearly doubled staff cost). It is entirely possible that many people will be relocated outside of China, especially senior professionals that have higher compensations and more non-taxable benefits. We will probably see more young foreign professionals, who generally enjoy less or lower benefits. For larger companies, especially for highly skilled professionals or senior executives, it makes it cost-prohibitive to bring foreign talent to China.
To give you an idea of how this might affect a small or medium enterprise. Imagine a company has 10 foreign employees with around 6 children split between them at international schools. Once this law goes into effect, for the company to keep these employees at the same compensation levels, this would increase the cost to the company of around $1.8 million RMB. This can be a substantial heavier burden for many companies.
What are some tips and suggestions you have for businesses to prepare for the new tax changes?
There are four concrete suggestions I can give.
1) Plan and discuss the contract renewals and package structures in the coming months, to be prepared before the new IIT Law comes into place. Do not wait until the last quarter of this year.
2) Work with a law firm if you labor contracts are complex, to find the most suitable and effective solution, in compliance with China’s tax regulation, to minimize the increase of IIT, by either modifying the contractual relationship with the company, or by renegotiating the salary packages.
3) Enroll in a business association that can advocate for your business to Chinese authorities (such as the European Chamber). I know that for myself and my participation with EU Cham, IIT reform will be one of our biggest priorities.
4) Consider localizing your workforce early, if you can forecast losses of foreign talent due to this these tax changes.
Why do you think China has introduced these tax changes? Do you think they will introduce other measure to offset the negative cost-effects for the new laws, to stay attractive for foreign talent and international businesses?
China in this way tries to equalize the IIT treatment for local and foreign employees; however, the overall benefits and services that can be enjoyed by Chinese are much better. For example, foreign children living in China are not able to easily join Chinese public schools. This leaves foreign families only the options to attend bilingual or international schools which cost easily upwards 300,000 RMB per year per child. This may also be a way to improve employment prospects for the hundreds of thousands of Chinese talents that return each year.
Do you think this will really go forward?
This Law was promulgated in January 2019, as the New IIT Law, including new tax brackets, the updated 6-years exemption on worldwide taxation for foreigners (from the previous 5-years), and the removal of the preferential tax treatment on annual bonuses. Everything became effective in 2019, except for the removal of allowances for foreigners, which at the time (2019) was decided to be implemented from January 1, 2022.
But COVID-19 has changed many things in the world. For the first time, China received more in foreign direct investment than the US. Interest in investing into China is high, especially considering their successful recovery from the pandemic, and several examples of new foreign business launches in China (even during 2020).
Shanghai especially has been a city that for many years has had aspirations of becoming the number 1 international city in the world. And China believes in globalization as evidenced by their belt & road initiatives.
But if these tax laws come into effect, businesses and individuals moving to this city becomes a difficult choice, especially when there are other international cities such as Singapore not too far away. If you put people from different countries into a city, it improves the spirit and increases innovation. And when people come to a place like Shanghai, they love it. They want to stay. They want to contribute to its success.
With work being done within many business associations in speaking to Chinese authorities to lobby for changes to continue to make China, and Shanghai attractive for international talent, there may yet be some developments in the future.
And at least for Shanghai, one of China’s bellwether cities of progress and positive change, there may be policy at the local level to help offset this new national law.