The New IIT Law - Part 1: Chinese Tax Resident & Overseas Income
Looking back on 2018, one of the most influential tax issues is undoubtedly a major revision of China's IIT laws. We decided to compose brief explanations for 8 major questions that our clients and readers might be most concerned with in China's new era of tax laws. We hope to help you better understand the impact of the tax reform and make informed financial decisions. This series will be divided into 4 parts in the form of 2 questions answered per article. This is a preview of what's to come:
Q1. What is a Chinese tax resident?
Q2. Does the overseas income of high-net-worth individuals (HNWIs) need to be taxed in China?
Q3. Can HNWIs earn income through offshore companies to defer tax payment?
Q4. Can overseas trusts still play a role in tax optimization?
Q5. What tax compliance obligations do HNWIs have under the new tax laws?
Q6. How does the new IIT laws affect foreign executives?
Q7. What are the impacts of the departure declaration system before the cancellation ofhousehold registration?
Q8. Will the short-lived "Equivalent Sale Rules" repeat itself?
Question 1: What is a Chinese tax resident?
The new IIT law has revised the definition of Chinese tax residents to a certain extent, but still retains two types of standards that constitute Chinese tax residents. The first is "individual with domicile", in other words "the standard of domicile". The second is "individual without domicile who has accumulatively lived in China for 183 days", also known as the "standard of residence time". Only when the first criterion is not satisfied, will the second criterion be applicable.
For HNWIs with overseas status (including foreign nationals or permanent residents) whose main focus of life is still in China, they are identified as domiciled individuals according to the first criterion and will still be considered as Chinese tax residents even if they strictly control their residence time in China (less than 183 days a year). Therefore, the key question is under what circumstances will HNWIs be considered as "domiciled individuals"?
According to Article 2 of the Implementation Regulations of the New Individual Income Tax Law, domicile in China refers to habitual residence in China due to household registration, family and economic interests. According to Article 089 issued by the State Tax , habitual residence is a legal criterion to determine whether the taxpayer is a resident or a non-resident. It does not mean the actual residence or the place of residence in a particular period of time. If an individual who resides outside China for study, work, family visits, tourism and so on, must return to live in China after the intended purpose has been fulfilled, then China is the habitual residence of the taxpayer.
That is to say, if a HNWI has acquired overseas status, but habitually resides in China for a long time because of China's household registration, family or economic interests, the person will probably be identified as a "person wit domicile". Once it meets the criteria of "domiciled individuals", even if the individual lives in China for less than 183 days a year, he or she will still be recognized as a Chinese tax resident, so his or her global income will subject to IIT in China.
It should be noted that the aforementioned household registration, family and economic interests should be judged comprehensively in light of personal circumstances, and cannot be directly recognized as "domiciled individuals" jus because he or she has a household registration or real estate in China. Generally speaking, if the HNWI's spouse and children live abroad, and his or her property, work and social relations are mainly located outside China, even if the HNWI still retains Chinese nationality, the possibility of the person being identified as a "domiciled individual" is very low. In otherwords, the conditions that constitute a non-residential individual (excluding the first criterion of identification) usually refer to reasons such as the family (spouse, children living abroad), work (employed by an overseas company or operating mainly abroad). It is not enough to hold only a foreign identity to be deemed to have habitual residence abroad.
Question 2: Does the overseas income of HNWIs need to be taxed in China?
The answer to this question depends on whether a HNWI constitutes as a tax resident in China and by which criterion (please refer back to Question 1) is judged to be a tax resident in China. There are generally 2 scenarios:
For an "individual with domicile", the individual's global income (including overseas income) is subjected to IIT in China. If the HNWI comes from countries with relatively high tax rate, such as the United States, then the IIT paid in China can generally be used to offset the income tax in these countries, so it generally does not lead to double taxation. But for individuals from low tax rate countries or regions such as Singapore or Hong Kong, their tax burden willincrease.
If an individual is considered a "non-residential individual", but meets the "living time standard" (accumulatively resides in China for more than 183 days in a year) and thus that individual constitutes as a Chinese tax resident, then the "6-Year Safe Harbor Rule" of Article 4 of the new IIT Law might be able to play a role. According to the “6-Year Safe Harbor Rule”, an individual without a residence who has lived in China for 6 consecutive years for 183 days and has not left China for more than 30 days in a single year is required to pay IIT on his or her global income in China. Otherwise, they only need to pay IIT in China on their income from China and on the part of the income from abroad but paid from China, including the wages and salaries paid by domestic employers and those paid by overseas employers corresponding to their wages and salaries obtained during their working period in China. The overseas part of the income paid by overseas employers, including the wages and salaries paid by overseas employers corresponding to the overseas part of work, overseas stocks, income from investment in financial assets, income from the transfer of overseas real estate, and so on, do not need to be taxed in China. It should be emphasized again that the "6-Year Safe Harbor Rules" only apply to individuals without domicile, not to individuals with domicile.
Although the individuals in both cases constitute as tax residents in China, their tax burdens are different.
In the 2nd installment, we will be discussing offshore companies and overseas trusts.
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