When the United Kingdom negotiated the return of sovereignty over Hong Kong to the People’s Republic of China, the ultimate agreement, known as the Sino-British Joint Declaration, included special arrangements to allow life in Hong Kong to continue as it had developed under UK rule rather than impose China’s communist system on the territory. Now 21 years since the 1997 transition of sovereignty, it’s important to note the key differences between China and Hong Kong as they relate to payroll.
“One Country, Two Systems”
The slogan used to summarize the deal between the UK and the PRC describes the payroll landscape perfectly. Although Hong Kong is part of China, the Joint Declaration guarantees that for 50 years after the handover, the economic system in Hong Kong shall remain separate from its parent, including having its own currency, taxation, and social insurance system. The payroll function is, therefore, the perfect place to observe “One County, Two Systems” in action.
The distinctions between payroll in China and Hong Kong start with the fiscal year: China uses January 1 to December 31, whereas Hong Kong uses April 1 to March 31. The administration of income tax is undertaken in China by the State Administration of Taxation (SAT) via municipal tax bureaus based in all the major cities. There are more than 48,000 tax offices of all descriptions across the country. Just tracking down the relevant office for your needs could be a challenge, although general information can be found on the general SAT website. The size of both the department and also of China itself means that local practice on the ground when administering Individual Income Tax (IIT) can vary considerably between individual tax bureaus. By contrast, Hong Kong maintains its own Inland Revenue Department (IRD) in Revenue Tower on Gloucester Road, where 2,800 staff work on all aspects of taxation within the territory.
Income Tax in China
China requires all employers to calculate individual income tax, deduct the amounts owed from employee salaries, and pay the local tax bureau. The system used is a straightforward monthly calculation that focuses on earnings for the current period rather than taxable income for the fiscal year. The basic order for the calculation is as follows:
- Calculate total cash gross pay adding together basic pay and any other cash element paid to the employee
- Plus the cash value of any fringe benefits provided to the employee, such as a company car
- Minus the employee’s social insurance contributions
- Minus the employee’s mandatory housing fund contribution
- Minus a standard monthly tax allowance of 3,500 renminbi (RMB; or RMB 4,800 for foreign expatriates)
- Equals taxable pay
Rates of IIT have remained unchanged for several years; however, change is on the way. The personal allowance is due to be standardized at RMB 5,000 per month for both Chinese nationals and foreigners with effect from October 1, 2018. And while the current progressive seven rates of IIT will remain unchanged, there will be an adjustment to the income bands for some of the rates, effective January 1, 2019.
proposed tax Rates and income bands for 2019
|Current Monthly Income Bracket (RMB)||New Income Bracket (RMB)||Rate of IIT|
|1,500 – 4,500||3,000 – 12,000||10%|
|4,500 – 9,000||12,000 – 25,000||20%|
|9,000 – 35,000||25,000 – 35,000||25%|
|35,000 – 55,000||35,000 – 55,000||30%|
|55,000 – 80,000||55,000 – 80,000||35%|
|80,001 +||80,001 +||45%|
With the current exchange rate sitting around RMB 6.83 per US dollar, this means employees earning over $140,000 per annum will face a marginal rate of tax of 45%. The system is straightforward to calculate, and China does not require all employees to submit a tax return. Only those with annual income in excess of RMB 120,000 (approx $17,600), or who receive salary from two or more employers in China, or who receive income from abroad must submit an annual return.
Employers are required to send a monthly report to the local tax bureau showing earnings and deduction of IIT for each employee. This return might be sent electronically, be passed to the bureau by memory stick, or printed out and delivered as a manual document — the process varies considerably among different offices. Both the return and payment of the IIT deducted should be made broadly by the 15th of the month following deduction, but again, the actual practice on the ground can vary by a few days between cities and provinces.
While China does not require an annual return for IIT purposes, many employers have reported that local tax bureaus have been known to send employees’ annual tax returns to the employer for completion. Although this is not a legislative requirement, local practice may vary considerably on the ground. The best advice is to be guided by what your local staff think prudent in the circumstances.
Income Tax in Hong Kong
By contrast, Hong Kong doesn’t require employers to withhold Salaries Tax from employees’ pay. Instead, employer obligations center on reporting employee details through a system of forms which can be filed electronically and are issued in the following circumstances:
|Employment Condition||Form to Complete||Statutory Period for Notification||Reference in Inland Revenue Ordinance|
|Commencement of employment||IR56E||Within 3 months||Section 52(4)|
|Still under employment at March 31 (employer’s return of renumeration and pensions)||IR56B||Within 1 month||Section 52(2)|
|Cessation of employment||IR56F||Minimum 1 month before cessation||Section 52(5)|
|Employee about to depart from Hong Kong||IR56G||Minimum 1 month before departure and withhold money for tax clearance||Sections 52(6) and 52(7)|
Note that while the deadline for reporting a new hire allows a generous three months after the start date, the deadlines for notifying IRD of a leaver are much tighter, with notification filing required one month before an individual leaves the company or Hong Kong, and stipulating the withholding of final payment until tax clearance is received from IRD. This ensures that people don’t skip the territory without first settling any outstanding taxes.
Tax returns and payment present another significant contrast between Hong Kong and China. Each Hong Kong employee will need to file a tax return and compute their own Salaries Tax bill. That bill is likely to be much lower than it would in China, as indicated by the Salaries Tax rates below:
|Net Taxable Income||Rate of Salaries Tax|
|Up to HK$50,000||2%|
|HK$50,001 – 100,000||6%|
|HK$100,001 – 150,000||10%|
|HK$150,001 – 200,000||14%|
|HK$200,001 and above||17%|
With the current exchange rate around HK$7.85 for every US dollar, the executive earning over $140,000 annually faces a marginal tax rate of only 17% in Hong Kong compared with 45% in the PRC — just one of the reasons why a posting to the territory is a popular option for expatriate employees!
With no general requirement to complete a tax return in the PRC and the operation of a simple monthly tax system, it is possible for those who receive a once-off payment in salary to pay too much tax through the standard calculation of IIT. Consider the case of an employee who is usually paid taxable wages of RMB 30,000 per month and whose marginal rate of tax is 25%. Paying a one-time bonus of RMB 50,000 would push them to the top 45% bracket in the bonus month. To address this, the system allows a special pro rata calculation to be performed on the bonus, but only on one occasion each year. It is therefore important to take this into consideration when designing remuneration packages in China: it is much better to have any additional pay on top of regular pay elements paid once a year to maximize this treatment. Hong Kong by contrast, because Salaries Tax is calculated on the basis of total annual income, does not need such a system.
What Hong Kong requires employers to do, which the PRC does not, is to complete a formal annual return: the BIR56B with accompanying individual IR56B form. Returns may be made electronically and must be received by the end of April, with a copy of the IR56B given to the employee. These forms report pay for the tax year for all employees on March 31. Pay for individuals who have left employment during the year is reported using the leaver IR56 F or G return. Each return shows not only total pay but the full detail of the employment package, including:
- Basic pay and allowances
- Leave pay
- Directors fees
- Tips and gratuities
- Salaries tax payments made on the employee’s behalf by the employer
- Share options
- Benefits in Kind
- Accommodation benefits and allowances
Social Systems in China
When it comes to social insurance, China and Hong Kong take a very different approach, although both require some mandatory form of contribution to be deducted from an employee’s salary. China has adopted the German model of mandatory insurances aimed at specific life event risks, which are:
The employee contributes 8% and the employer around 20% on capped monthly income. Employee contributions accrue in a named fund, with the employer contributions accruing in a public fund. Provided an employee has at least 15 years’ worth of contributions, at retirement age (60) a pension is initially paid from the employee’s fund. Once this is exhausted, a pension is provided from the public fund.
The employee pays around 2%, and the employer contributes anything from 7% to 12%, depending on their location and capped monthly income. The funds provide a pool of money from which a portion of the cost of medical treatment is provided. The exact portion depends on the illness or condition.
The employee contributes up to 1% and the employer 0.4% to 2%, depending on their location and capped monthly income. Once an employee has contributed for a year, an unemployment benefit of up to 24 months is available.
Work-Related Injury Insurance
The employer only contributes 0.4% to 3% depending on the location of the business and the risk of the industry.
Only the employer contributes between 0.5% and 1%, depending on the location of the business. The insurance funds maternity benefits of between 3 and 5 months of pay, dependent on the employee meeting China’s birth control policy.
The above illustrates just how decentralized China’s social security system is. Whilst the central government in Beijing have decreed that the insurance systems must be in place, the schemes are administered locally, leading to the wide difference in contribution rates and monthly income caps applied. To further complicate matters, the rates and ceilings are not all reviewed on the same date: they will vary across the country. Plus, the system is not even arranged on a province level, meaning different cities within the same province can set differing rates on contribution and earnings ceilings.
Social Systems in Hong Kong
The Hong Kong system, by contrast, sits as one standard contribution regime that is focused on one life event: retirement. The Mandatory Provident Fund Scheme Ordinance requires all employees to be enrolled within a Provident Fund. The funds are provided by private insurance companies (known as master trust schemes), and the employer is free to choose which fund they appoint. Regardless of which company is selected, the contribution rate is uniform, with the employee and employer each contributing 5% of pay, capped to a monthly salary of HK$30,000. This makes the maximum contribution from both employer and employee HK$1,500. However, where the employee earns less than HK$7,100, they are not required to pay a contribution, but the employer must still make their requisite 5% contribution.
The employer in Hong Kong has additional options to consider. As an alternative to the MPF arrangements, the employer may offer an Occupational Retirement Scheme pension scheme, which must be at least as good as the MPF system but could provide for greater contributions and benefits. Whichever scheme is chosen, contributions must be remitted to the fund by the 10th of the month following deduction, together with a comprehensive schedule of pay and deductions. Pension provision is policed in Hong Kong by the Mandatory Provident Fund Authority.
MPF arrangements only cover retirement, so the other life events typically covered by social security schemes are managed differently in Hong Kong. A level of public funding is available for medical services for Hong Kong residents, which is funded from general taxation, but approximately 36% of the cost is charged directly to users. Holding private medical insurance is therefore highly recommended.
Sickness, maternity, and paternity leave is all outsourced — to employers! Under the basic employment legislation in Hong Kong (the Employment Ordinance), employers must make compulsory payments to employees to cover sickness, maternity, and paternity leave, using an average salary calculation and paying 80% of average pay. The length of payment for sick leave varies depending on the condition but could be as much as 120 sick days (which is similar to the requirement in China).
Two Systems, Many Distinctions
The payroll landscape really does reflect the nature of each jurisdiction. China has a central vision dictated from Beijing that involves control but pragmatically allows a great deal of interpretation locally. Hong Kong by contrast has a more laissez faire attitude that sees no need to involve employers in the tedium of tax administration and provides great choice in how to meet the limited pension savings obligation. Will the next 21 years see Hong Kong pulled closer to China’s way of doing things, or will it really remain one country with two systems? Only time will tell.