Tax deductions

Income tax deductions in China for pensions and children’s education expenses

As China introduces personal income tax (IIT) deductions for child-raising expenses, businesses should be aware that many people may choose to access this deduction through their employer. To facilitate this, companies should modify their policies and procedures for collecting tax and HR information.

Meanwhile, the Chinese government is encouraging its citizens to invest in private pensions. A scheme similar to IIT’s existing pilot deduction for commercial endowment insurance schemes may soon follow for private pensions to encourage adoption.

The government encourages private pensions

China’s aging population is leading to increased demands on China’s state pension system. Accordingly, the government is seeking to encourage investment in private pensions. In due course, IIT deductions may be provided for private pensions, although no announcement on this has yet been made.

China’s national pension framework is based on three pillars. These are:

  • The state pension scheme, financed by social security contributions;

  • A so-called “company annuity” scheme under which companies can choose to fund the retirement benefits of their employees. Corporate income tax (IRS) deductions are available for this purpose, although the scheme is little used in practice; and

  • Private pensions financed by individuals.

Previously, the government had not provided many details on the third pillar, but recently the Council of State (i.e. the national cabinet) announced a framework for the design of private pension schemes to be offered by private insurers.

The State Council is considering voluntary participation by individuals (who continue to pay their social security contributions), with annual contributions of up to 12,000 RMB ($1,800).

Premiums can be invested in qualified financial products, such as wealth management banking products, savings deposits and trade capitalization insurance. The Council of State’s framework details the circumstances under which contributions can be withdrawn and how they should be treated for inheritance purposes.

In 2018, a pilot program of IIT deductions for pensions was implemented in Shanghai, Fujian and Suzhou. This applied an exemption-exempt-tax (EET) scheme, similar to the US 401K plan, for a special retirement product called the “Commercial Endowment Insurance Plan”.

It is expected that something similar to this IIT deduction will eventually be rolled out nationally, to bolster the Council of State’s drive to make greater use of private pensions.

IIT deduction for children’s education expenses

On March 19, 2022, the State Council announced the new IIT deduction in Guofa Circular No. 8 (2022), and the State Tax Administration (STA) followed on March 25 with detailed rules. This provides that from January 1, 2022, guardians of children under the age of three can receive an IIT deduction of RMB 1,000 per child per month.

This is the latest step in China’s process of adjusting its IIT regime so that tax burdens reflect the personal circumstances of individual taxpayers. Beginning with the 2018 IIT reform, China has sought to tax IIT based on taxpayers’ aggregate income, rather than separate tax calculations for each income category. However, the schedular tax system remains for types of investment income.

The move towards comprehensive income taxation has been accompanied by the introduction of deductions from IIT for children’s education and continuing education for adults, medical expenses in the event of serious illness, mortgage interest and housing rental costs, as well as expenses associated with supporting elderly parents.

The introduction of a deduction for the costs of raising children reflects the resulting increase in expenses, as well as the government’s desire to increase the national birth rate.

From an administrative point of view, the natural person taxpayer can access the new deduction by providing supporting documents to his employer (as a withholding agent) or by filing the annual post-year-end reconciliation file (March- June).

Because many employees may choose to claim the deduction through their employer, companies will need to modify their tax information collection and HR policies and procedures.