Member Article

The State Administration of Taxation ("SAT") issued the Notice on Relevant Issues in Adjusting the Method for Calculation of Individual Income Tax Annual Lump Sum Bonus Etc. Received by Individuals on 21 January 2005. The Notice, which took effect on 1 January 2005, repeals two SAT Notices issued in 1996 and addresses the issue of the calculation of individual income tax ("IIT") on annual bonuses. Definition The Notice defines annual lump sum bonus ("annual bonus") as a lump sum bonus paid to an employee by an administrative organisation, an enterprise or institution based on the overall financial performance of the employer and the work performance of the employee in that year. Such annual bonus also includes extra salary paid at the end of the year and annual salary and performance-related payment based on evaluation by the employer if the employer implements an annual salary and performance-related remuneration system. Calculation method For IIT calculation purposes, the amount of the annual bonus is treated as a separate month’s salary with its own applicable tax rate and quick calculation deduction factor ("deduction factor"). In other words, the annual bonus is not added to that monthly salary in the month it is paid out. To determine the applicable tax rate and deduction factor, the amount of the annual bonus shall first be divided by 12. The applicable tax rate and deduction factor for this amount is applied to the total amount of the annual bonus to arrive at the IIT payable. For instance, if an employee receives an annual bonus of RMB 96,000, the IIT payable on the annual bonus is calculated as follows: RMB 96,000/12 = RMB 8,000 According to PRC law, for an amount between RMB 5,000 and RMB 20,000 the applicable tax rate is 20% and the deduction factor is RMB 375. The IIT payable in our example is therefore: RMB 96,000 x 20% - RMB 375 = RMB 18,825. If the employee’s monthly salary in the month in which the annual bonus is paid is below the standard monthly deduction of RMB 800, the difference between the monthly salary and the standard monthly deduction i.e. RMB 800 shall be subtracted first from the annual bonus before dividing the amount by 12 months. The Notice specifies that each taxpayer may use the foregoing calculation methods only once in a given tax year. Any other bonuses paid to an employee throughout the year need to be added to the employee’s salary in the month the bonus is paid and IIT will be assessed on the total amount. The Notice provides that the IIT treatment of an individual with no residence in China shall be continued to be handled pursuant to a SAT Notice issued in 1996 (the Notice of the State Administration of Taxation on the Issue of the Levy of Tax on Bonuses Received by Individuals Who Have No Residence Inside China), if the bonus was received in a month during which the individual did not have any IIT payment obligation or did not work a full month in China.