Introduction
For Japanese companies expanding into China, the treatment of travel allowances under individual income tax is one of the frequently discussed issues. In Japan, it is common for certain travel allowances and expenses to be treated as non-taxable, but in China, the individual income tax system and tax practices differ, which may lead to tax risks if the system is designed with the same sensibility as in Japan.
Particularly, due to the long-standing preferential system for foreign expatriates, there may be differences in tax relationships between Chinese employees and foreign employees, making an understanding of the system essential. This article organizes the tax relationships regarding travel allowances in China from both legal and practical perspectives.
1. The Concept of Travel Allowances under Chinese Individual Income Tax Law
Under Chinese individual income tax law, the economic benefits received by employees from their employers are generally included in salary income. However, if employees incur necessary expenses for the execution of corporate activities and subsequently receive reimbursement for actual costs, these are typically not subject to individual income tax.
Therefore, for travel-related expenses in China, it is important to determine whether they are classified as "salary income" or "reimbursement of actual expenses incurred in the course of business execution." While expenses such as transportation and accommodation that are settled based on invoices are generally not subject to tax, there is a higher risk that fixed payment methods with little relation to actual costs may be treated as salary income by tax authorities.
In practice, many companies establish travel expense regulations and build a system that can explain that the expenses are for business execution by keeping travel orders, travel reports, and invoices.
2. Preferential Individual Income Tax System for Foreign Personnel
In China, a special individual income tax preferential system has been established for foreign residents to promote the acceptance of foreign specialized personnel.
Based on the financial and tax document No. 020 of 1994 and National Tax Announcement No. 54 of 1997, housing costs, meal expenses, laundry costs, moving expenses, home leave costs, language education expenses, and children's education expenses provided to foreign personnel are recognized as not included in salary income if certain conditions are met.
Similarly, reasonable travel expenses are also recognized for the same treatment, making them an important element in the salary package design for foreign expatriates.
However, these are not recognized unconditionally, and it is a prerequisite that they have the nature of non-cash benefits or actual expense reimbursements.
3. 2019 Individual Income Tax Reform and Extension of the System until 2027
With the reform of the individual income tax system in 2019, a specific additional deduction system was introduced in China. This system allows for a certain amount of income deduction for children's education expenses, housing rent, housing loan interest, and elderly support expenses, applicable to both Chinese and foreign nationals.
Initially, foreign personnel were to choose between the traditional preferential system and the specific additional deduction system. Subsequently, the abolition of the preferential system for foreigners was planned, but according to the Ministry of Finance and the State Taxation Administration Announcement No. 29 of 2023, the traditional preferential system has been extended until December 31, 2027.
As a result, at this point, foreign personnel can continue to utilize a certain actual expense reimbursement-based welfare system.
4. Points Likely to be Problematic in Tax Audits
In tax audits, what the tax authorities focus on is the substance, not the name.
Even if it is provided under the name "travel allowance," if it essentially has the nature of salary supplementation, it may be recalculated as salary income.
In particular, if the relationship with travel performance is unclear, if a certain amount is paid monthly regardless of the number of travel days, if invoices or internal documents are not retained, or if the basis for applying the preferential system for foreign personnel cannot be explained, the tax risk tends to increase.
Therefore, from a tax perspective, the rationality of actual expense reimbursement and the establishment of a document management system are more important than the method of payment itself.
5. Conclusion
The taxation relationship of travel allowances in China is more complex compared to Japan, and it is an area where misunderstandings are likely to arise, especially in relation to the preferential system for foreign expatriates.
However, the practical criteria for judgment are relatively clear, and whether it has the nature of actual expense reimbursement necessary for business execution is an important point. Additionally, since a certain preferential system will continue for foreign personnel until the end of 2027, it is desirable to consider the potential for utilizing this system when examining salary design and expatriate policies.
In Chinese tax audits, there is a tendency to emphasize substance and document management over the system itself, so it is important to properly establish and continuously operate travel expense regulations, approval flows, and invoice management systems.
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