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Dear Members and Friends,
The China-Italy Chamber of Commerce is glad to share with you a new article published by Hawksford.
When the calendar year or the Chinese lunar year draws near, many companies in the Mainland pay an annual bonus to their workforce as a way of rewarding them before the official holiday schedule and workers go on trips back to their hometowns.
Given the cultural and social importance attached to this corporate benefit in Chinese jurisdictions, the calculation of individual income tax (IIT) for these amounts differs from the usual monthly instalments companies deduct on behalf of their employees.
The Hawksford HR Service Team has drafted the ultimate guide to analysing the formulas used to calculate IIT on annual bonuses, maximising your employees' net income, and presenting practical examples of applying these principles.
In 2018, the Ministry of Finance and the State Administration of Taxation issued the so-called Notice Concerning the Connection of Preferential Policies After the Individual Income Tax Law Is Amended (No. 164 [2018] MOF). According to the notice, a resident individual’s one-time annual bonus shall not be included in the yearly comprehensive income calculation until 31 December 2021.
However, this prescription can be ignored if the actual tax payable resulting from a complete analysis is lower than what it could be under the new rules. The tax rate is defined by dividing the employee’s one-time annual bonus into 12 months and using the applicable tax rate and a quick deduction related to the corresponding range defined by the tax laws.
The formula is as follows:
Tax payable on year-end bonus＝One-time annual bonus taxable income × Applicable tax rate - Quick deduction
From 1 January 2022, the one-time annual bonus obtained by a resident individual has to be included in the yearly comprehensive income for IIT calculation and declaration.
Methods of Calculating IIT on One-Time Annual Bonuses
The notice mentioned above implies two ways of calculating IIT on gross one-time annual bonuses before 31 December 2021:
1. Combining the one-time annual bonuses with yearly comprehensive income
2. Considering the one-time annual bonuses as an independent source of income
It is hard to say which one is more tax-efficient because the reality varies from each case. However, the rules summarised below may give you some tips.
1. If the total amount of taxable yearly comprehensive income is lower than zero (*), then the one-time year-end bonus tax impact shall be determined from its inclusion into the employee’s annual comprehensive income to enjoy a more favourable payment in terms of IIT.
2. If the total amount of taxable annual comprehensive income is higher than zero, and, after adding the annual bonus, the total is even higher than CNY 36,000, then the tax impact shall be calculated using both methods to compare the results and choose the more reasonable scenario.
(*) This may happen when the yearly comprehensive income is lower than the yearly total deductions
We shall list two examples below to facilitate understanding.
Example 1:
Employee A
Annual income: CNY 180,000
Monthly social insurance and housing fund paid by Employee A: CNY 4,900
Monthly fixed deduction: CNY 5,000
Monthly special deduction: CNY 2,200
Year-end bonus: CNY 150,000
Option 1: Combine the bonus with yearly comprehensive income
Amount of annual accumulated taxable income:
(180,000/12 months - 5,000 - 4,900 - 2,200) x 12 months + 150,000 = CNY 184,800
Total annual IIT: 184,800 x 20% - 16,920 = CNY 20,040
Option 2: Consider the one-time annual bonus as an independent source of income
Amount of monthly accumulated taxable income:
150,000/12 months = CNY 12,500
Annual bonus IIT: 150,000 x 20% - 1,410 = CNY 28,590
Amount of annual accumulated salary taxable income:
[(180,000/12-5,000-4,900-2,200)] x 12 months = CNY 34,800
Annual salary IIT: 34,800 x 3%-0 = CNY 1,044
Total annual IIT: 28,590 (annual bonus IIT) + 1,044 (annual salary IIT) = CNY 29,634
Conclusion:
The difference between the two tax payables is CNY 9,594, resulting in a clear incentive to include Employee A’s year-end bonus into their cumulative income for the year.
Example 2:
Employee B
Annual income: CNY 240,000
Monthly social insurance and housing fund paid by Employee B: CNY 4,900
Monthly special deduction: CNY 0
Year-end bonus: CNY 144,000
(240,000/12 months - 5,000 - 4,900) x 12 months + 144,000 = CNY 265,200
Total annual IIT: 265,000 x 20% - 16,920 = CNY 36,120
Option 2: Consider the annual bonus as an independent source of income
144,000/12 months = CNY 12,000
Annual bonus IIT: 144,000 x 10% - 210 = CNY 14,190
(240,000/12 months - 5,000 - 4,900) x 12 months = CNY 121,200
Annual salary IIT: (121,200 x 10% - 2,520) = CNY 9,600
Total annual IIT: 14,190 (annual bonus IIT) + 9,600 (annual salary IIT) = CNY 23,790
The difference between the two tax payables is CNY 12,330, so in this case, Employee B clearly benefits if their year-end bonus is considered as an independent source of income.
Tax Payables Gaps Caused by a Difference of Just One Yuan
Sometimes, a discrepancy in wages of just one yuan can cause a huge difference in terms of IIT payable as the applicable tax rate could fall under a higher bracket defined by the tax laws. Employers and HR staff should pay close attention to numbers hovering around each progressive tax bracket threshold if they want their employees to enjoy the highest net income after IIT deduction.
For example:
Employee C receives CNY 36,000 for a one-time year-end bonus while Employee D receives CNY 36,001.
Employee C:
CNY 36,000/12 months = CNY 3,000
Applicable tax rate: 3%
IIT payable on year-end bonus: CNY 36,000 × 3% = CNY 1,080
Employee D:
CNY 36,001/12 months = CNY 3,000.08
Applicable tax rate: 10%
IIT payable on year-end bonus after quick deduction: CNY 36,001 × 10% - 210 = CNY 3,390.10
In this case, although there is only one yuan difference in the year-end bonus between the two colleagues, Employee D will end up paying CNY 2,309.10 more in income tax than Employee C and will receive a lower net amount while the company cost remains the same.
Conclusion
From the examples listed above, we can see that calculating the year-end bonus can be challenging and complicated, especially for foreign companies in China. Not only should your HR team aim to maximise your employees’ net income through their year-end bonuses, but they should also ensure that the balance between monthly salary and year-end payments remains consistent and reasonable with regard to tax.
How Can Hawksford Help?
Hawksford has over ten years’ experience in providing HR and payroll management services and solutions. Our skilled team of experts based in five locations (Shanghai, Beijing, Guangzhou, Suzhou and Shenzhen) in mainland China can provide international companies, SMEs and other types of businesses with professional outsourced services including year-end bonus calculation. We also provide the following compensation and benefits services:
With local knowledge, a robust administration framework and international client experience, we are confident we can guide our clients through the steps to successfully operate their businesses in China.
For more details about this article, please click on the following link: How to Calculate IIT on End-of-Year Bonuses in China | Hawksford
Kind Regards,
CICC Team
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