On 31 August 2018, the Standing Committee of the National People’s Congress of the People’s Republic of China passed an amendment to reform the Individual Income Tax (“IIT”) Law. The Amendment was subsequently passed by Presidential Decree no. 9 with full implementation set for 1 January 2019.
While much of the focus has been dedicated to the worldwide tax levied on expats residing in China, the reform is also celebrated for drawing clearer definitions on tax residence and granting generous deduction allowance to the working class.
Art. 1of the new IIT Law stipulates differentiation between “resident” and “non-resident” for tax purposes. The key differences would be:
The definition of domicile is determined by a multitude of factors, namely:
- Residence, whether by virtue of home ownership or long-term rental, or household (“hukou”) registration
- Commercial interest, being income generation whether by employment or investment in local companies
- Centre of life consideration, whether the family members or association memberships are closely tied to China
It is imperative to acknowledge the lack of quantifiable parameter to govern what constitutes “domicile”. According to Notice 89  of the SAT 國家稅務總局關於印發《徵收個人所得稅若干問題的規定》的通知, however, it provides a key decision criterion: If a person resides outside China due to work, study, travel or family visits, must the person return to China? If that is the case, the person shall be deemed as a Chinese resident.
The exact impact on expatriate workers and Hong Kong citizens residing in China will be further discussed in the Q&A section below.
Art 2 of the IIT Law defines 9 categories of income that are subject to IIT.
- Salary and Wages
- Income from provision of independent personal services（勞務報酬）
- Income from author’s remuneration
- Income from royalties
- Income from (sole proprietorship) operation（經營所得）
- Income from interest, dividend and extra dividend（利息、股息、紅利）
- Income from leasing of property
- Income from transfer of property
- Occasional income（偶然所得）
Furthermore, (1) to (4) are now defined as “Comprehensive Income”. Under this construe, tax residents will be taxed on an annual basis whereas non-residents will be taxed on a monthly, or when taxable income arises, as per the rate in Schedule 1 of the new IIT Law. (5), being income from operation, will be taxed as per the rate in Schedule 2.
Taxpayer Identification and Anti-Avoidance
Citizens and non-citizens with the right of abode in China will have an ID. The ID no. would serve as his/her TIN. Those without Chinese residencies will be allocated a TIN by the tax authority for IIT declaration purpose.
Art. 8 of the Law also introduced measures similar to that of the Corporate Income Tax Law to assess if a taxable individual is engaged in:
- Tax avoidance by use of offshore tax heavens, including direct ownership in a foreign entity or participating in a JV by the taxable individual and a (PRC) resident enterprise in a “exceeding low tax rate” country or region for the purpose of unreasonable profit distribution without sound business rationale
- Asset transfer that are not at arms’ length such that it leads to a reduction of taxable income for the taxable individual or his/her counterparty
- Unreasonable commercial arrangement such that it allows the taxable individual to derive inappropriate tax benefits
The tax authority reserves all rights to make adjustment to the taxable base and levy interest on the additional tax payable.
Oft-overlooked is the negative impact of aggressive tax planning under the new Law. The introduction of TIN will facilitate data collection in an increasingly digitised Chinese society.
Art. 15 requires public security bureau and the banking system to “assist” the tax authority to collect and make comparison of such data. The most notable of which is the alignment of records between the MPS Exit and Entry Administration and the State Administration of Tax (“SAT”)
Whilst having less impact on expats, the relevant education, healthcare, social security, human resources, housing and urban-rural development ministries will also connect its system to SAT’s in order to help determine the eligibility of deductible allowance.
Impact on Expatriate Workers Residing in Mainland China
Expatriates who are tax residents in China will now be subject to IIT for their foreign-sourced income.
Expats previously residing in the Guangdong area may consider relocating their residences to Hong Kong, which adopts a territorial tax regime, while taking advantage of the connectivity by the new Express Rail Link and HK-Zhuhai-Macao Bridge to commute for work. So long that these individuals do not reside for 183 days or more in China, they are unlikely to be deemed a Chinese resident for tax purposes.
That being said, it doesn’t relieve them from the obligation to pay IIT for income paid by their Mainland employers. The move to HK merely mitigates the risk of being taxed on a worldwide basis. The individuals must also be careful not to trigger Chinese domicile by (1) owning or engaging in long term rental of properties in China, or (2) marrying Chinese spouses who reside in China, or (3) developing a large social circle, whether by virtue of friends and business connections, such that the centre of life is deemed to be in China.
Expats who live in cities which do allow regular same-day commute to/from HK may consider other compliant solutions. For instance, business owners may consider splitting their income-generating activities between the Mainland and Hong Kong (or equivalent business hubs). Other general anti-avoidance rules such as transfer pricing and substance requirements must be respected throughout the process.
Questions & Answers
Q1: I am an expat. What if my job requires me to live and work in Shanghai? Am I subject to worldwide tax?
A1: According to Art. 4 of the IIT Law of the PRC – Rules for its Implementation《中華人民共和國個人所得稅法實施條例》, the so-called “5-year rule” is still applicable. The following foreign individuals will not be deemed as a Chinese tax resident if:
- Residing for less than 183 days in a calendar year for 5 consecutive years; OR
- Residing for more than 183 days in a calendar year for 5 consecutive years, but he/she leaves China for 30 consecutive days or more in each of the 5 consecutive years
If you fulfill the conditions in (b) and limit any factors that would cause you to be deemed with domicile in China, you are unlikely to be taxed on a worldwide basis.
Q2: I am a Hong Kong permanent resident and HKSAR citizen. I own an apartment in Shenzhen but I commute to work in Hong Kong every day. I pay my Salaries Tax in Hong Kong dutifully since my income is sourced from Hong Kong. Am I deemed a Chinese tax resident?
A2: You have developed a domicile in China and habitually reside in China. Since you return to China after work every day, you are deemed to have a domicile in China as per Notice 89 .
Nevertheless, in an effort to encourage Hong Kong citizens to relocate to the Greater Bay Area, the HKSAR government is in negotiation with the Mainland authorities to grant special tax privileges to this group of individuals. Thus, your tax residency may be deemed differently in the future.
Q3: I am a Hong Kong resident with Canadian passport. My parents live in Hong Kong. I work for an asset management firm in Guangzhou. I bought an apartment in Guangzhou. But I return to Hong Kong every Saturday to check on my parents and hang out with friends. I return to Guangzhou for work on the intercity train every Monday morning. Am I a Chinese tax resident?
A3: Unlikely. You have clearly demonstrated that your centre of life is in Hong Kong. So long that you do this consistently, you may not be deemed to have a domicile in China. However, you must be careful with regards to Canadian tax treatment, which is beyond the scope of this question.
For tailored solutions and consultancies, please contact a Fidinam professional by email.
Uny Chan, Manager of the Swiss Desk of Fidinam Hong Kong Limited