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A shift to global taxation: China individual income tax developments

In late June, while mainland China residents were still busy finishing their first individual income tax reconciliation, the so-called 'Hong Kong drifters' (ie, Chinese citizens working in Hong Kong) were discussing another matter. Since the end of June, some Stated-Owned Enterprises (SOEs) in Hong Kong (including the branches of State-Owned Banks) have been informing their Chinese citizen employees who are not permanent residents of Hong Kong that they are taxable in mainland China. While this has been a long-standing position for the China tax authorities, there has been increased attention on compliance and it could signify a change in approach to oversight of China domiciled individuals working overseas.

To calculate the tax due, they should combine their Hong Kong wages and their income from mainland China, a move towards being taxed on their worldwide income rather than just income from China. For Chinese employees working in China and elsewhere, this development which was not initially accompanied by an official notice from the China tax authorities raises questions and challenges.

Residency and taxation in China

According domestic tax law, China tax residents fall into one of two groups: China domiciled and non-PRC domiciled who stay in China for 183 days or more in a tax year. When either criterion is met, an individual is regarded as a Chinese tax resident and subject to tax on worldwide income. It’s important to note that an individual not domiciled in China can limit income tax to only China-sourced income, if they meet the ‘six-year rule’, spending 30 consecutive days in the country in this period.

In considering whether an individual may be taxed based on China domicile, the concept needs to be clarified. Based on the Implementation Regulations for the Individual Income Tax Law of the People’s Republic of China (Implementation Regulations), Article 2 states: 'Individuals who have a domicile in China shall mean individuals who habitually reside in China due to household registration, family and economic interests'.

This has further been explained as: For an individual who lives abroad due to study, work, home leave, tourism, and other reasons, and still will return to live in China after these reasons are eliminated, he or she shall be the habitually resided in China. Thus, the individual has a domicile in China.

Key to the recent developments for individuals in Hong Kong, is whether the individual 'habitually resides' in mainland China. For 'Hong Kong drifters', they have not obtained permanent residency in Hong Kong and are living in Hong Kong for work purposes. To the extent they will return to live in mainland China at a future date, they will be regarded as domiciled China and regarded as Chinese tax residents. Accordingly, they are subject to taxation on their worldwide income.

Calculating taxes and claiming a foreign tax credit

On 22 January 2020, in response to concerns being raised, the State Administration of Taxation and the Ministry of Finance jointly issued the Announcement on Individual Income Tax Policies Relating to Overseas Income (Announcement No.3), which provides detailed guidance on the definition of overseas income, calculation of taxable income, overseas tax credit, declaration requirements and other compliance considerations.

There are two categories of taxable income that determine how China's income tax is calculated: firstly, domestic and foreign income and foreign income is combined and tax is calculated. Income such as employment income (not including bonuses subject to special taxation rates), business income from both China and overseas is combined. Secondly, income from other foreign sources, such as income from a bonus (subject to beneficial tax treatment), capital gains and dividends, is not combined with China-sourced income. As an individual’s total income tax liability is based on calculations for these two different categories of income, taxpayers will need to understand how tax is determined on their China and foreign income.

Having determined taxable income and potential tax due, a key concern is whether double taxation may arise.

Announcement No. 3 provides clarity on how double taxation can be prevented, allowing tax paid abroad to be claimed as a foreign tax credit, up to a maximum of the China tax due on that income.

For the tax paid in Hong Kong and other countries (where the tax year does not end on 31 December) additional clarification was shared in Announcement No.3 outlining the process for claiming a foreign tax credit.

Importantly for Chinese employees working in Hong Kong or other countries, as income tax rates in mainland China are up to 45%, the foreign tax credit may be considerably lower than the mainland taxes due, resulting in additional tax being due. For China-domiciled individuals who are not employees of SOEs, further compliance scrutiny may be applied in the coming years where compliance with global taxation of residents is pursued. For employees with roles that involve spending some time in China, careful planning will be required to manage scenarios where differing interpretations of double tax treaties and conflicting domestic laws could create issues of double taxation.

Declaration and compliance

A tax resident who derives income outside China is required to complete an annual tax filing during the period from 1 March to 30 June of the following year.

A tax resident who derives overseas income should file their tax declaration with the ‘in-charge’ tax authorities at the location of their employer in China; where there is no employer in China, the tax resident shall complete tax declaration formalities with the in-charge tax authorities at the location of their household or the place of habitual residence in China. Notably, this applies for individuals not employed by SOEs and who are working overseas.

In addition to submitting a Tax Declaration Form for Individual Income Tax (Form B), details should also be provided regarding the form of the overseas tax credit details, annual tax certificate by the overseas tax authorities, tax payment statement, or tax payment records should be provided.

Managing the new developments

The continuous development of the China tax regime combined with recent reforms and clarifications, provide China employees working internationally with clarity on how to meet their compliance obligations. Nonetheless, the introduction of seemingly new regulations, initially targeted only at employees of China SOEs, in addition to potential uncertainty for long-term expats from China, means individuals who are or may be considered China domiciled should review their individual circumstances to determine how the announcements impact them. The Chinese tax authorities have begun to review the large number of people who have received overseas income from employment and investing abroad. Alongside this, the implementation of Common Reporting Standards (CRS) for sharing of information between government tax authorities provides a more effective way for the Chinese tax authorities to obtain information about overseas income.

With the continued expansion and deepening of the ‘Belt and Road; initiative, an increasing number of Chinese companies are expanding international operations. For Chinese employees who work on an assignment or are transferred overseas, managing compliance in China will be critical. For employers, understanding the impact of the clarified tax obligations of China residents and their overseas income is an important first step. Responding to these developments, whether to support employees with compliance or support in the process, management and overall tax burden, for example through a tax equalisation policy and evolved global mobility policies, are steps companies will need to review and take in the coming months.

For questions about this issue, please contact our expert for support with:

  1. Compliance filing and tax consultation of individual income tax on overseas income
  2. Simulation and analysis of individual income tax burden of Chinese assignees
  3. Individual income tax planning service for Chinese assignees.