The Amendments to the Individual Income Tax Law of the People’s Republic of China (“the Amendments”) discussed in the last issue of Tax Tips was promulgated by the National People’s Congress on 31 August. Included in the Amendment, as expected, is the adaptation of the tax resident person concept into Article 1 of the law.
Around one week before the Amendments were passed, the topic of Hong Kong people who enters the Mainland for more than 183 days will be subject to Individual Income Tax (“IIT”) liabilities of up to 45% on income earned outside of the Mainland started to heat up in the Hong Kong media.
On 31 August, according to Hong Kong media reports, Mr. Tam Yiu-Chung, member of the Standing Committee of the National People’s Congress, claimed that Hong Kong and Macau residents would have a five-year grace period, such that they would only need to pay IIT on income earned outside of the Mainland after the year 2024.
The introduction of tax residency concept would indeed have a huge impact on Hong Kong and Macau residents due to their close ties with Mainland China. It can be imagined that for residents from countries such as Japan, the United Kingdom and the United States who visit China for 183 days or more, as they would unlikely buy properties in China, they would likely maintain their home and economic ties in their home countries, and their home tax authorities would have much experience in tax residency determination, their tax residency status should be relatively clear-cut. If what Mr. Tam said is implemented, Hong Kong people can put the issue aside for the next five years.
A potential big loser to the Amendments is Taiwanese individuals. The Mainland and Taiwan signed the Cross-Strait Agreement for the Avoidance of Double Taxation and Strengthening of Tax Cooperation in 2015 (contents are similar to a standard double taxation agreement) but the Agreement is not yet in effect. In 2019 when Taiwan individuals become Mainland tax residents by staying in the Mainland for 183 days, they may need to pay IIT on income derived from inside and outside of the Mainland. If the individuals are also subject to Taiwan income tax on the same income, a double taxation situation will arise which cannot be resolved through a double taxation agreement (the tie-breaker discussed in the last Tax Tips). Nevertheless, as tax policies are designed to serve the economic and political needs, it is possible that the five-year grace period may include Taiwan individuals. At this moment, the only thing that can be done is wait-and-see.
Originally, this issue of Tax Tips would discuss how should Hong Kong companies manage the upcoming challenge in IIT. However, as the issue may be put to bed for 5 years, Hong Kong companies may not be interested in it anymore. Readers should watch the development closely in the coming months. This issue would instead discuss the so-called “183 Days Rule”, which has been given a new meaning by the Amendments: Is it true that there is no IIT liability if one stays in the Mainland for not more than 183 days?
The 183 Days Rule
Many Hong Kong people who frequently travel to the Mainland would have heard that IIT would be imposed if one stays in the Mainland for more than 183 days. Is it true? When one reads Article 1 of the IIT Law, whether the existing one or the amended version, it is clear that a non-domicile person who resides in China for less than 183 days are required to pay IIT on income derived from sources within China:
Current version: “Individuals who are neither domiciled nor resident in China, or who are not domiciled and reside for less than one year in China, shall pay individual income tax in accordance with this Law on income derived from sources within China.”
Amended version: “Individuals who are neither domiciled nor resident in China, or who are not domiciled and reside in China for less than 183 days in a tax year, are non-resident individuals. Non-resident individuals shall pay individual income tax in accordance with this Law on income derived from sources within China”.
So, is one liable to IIT if one stays in China for not more than 183 days?
The exemption from IIT for individuals who visit China for not more than 183 days is an effective extension of Article 7 of the Detailed Implementation Rules of the IIT Law (“DIR”, which is also subject to corresponding amendments to be announced). Under Article 7 of the DIR, “Individuals who are not domiciled in China, but stay in China continuously or in aggregate for not more than 90 days in a tax year, would be exemption from IIT on income derived from sources within China that is paid by the foreign employer and is not borne by a place or establishment of the foreign employer located in China”. In principle, when an employee enters China and performs services, the income would be regarded as derived from sources within China. Provided that the employee does not stay in China for more than 90 days in a tax year (continuously or in aggregate), and the income is paid by the foreign employer which is not borne by any place or establishment of the foreign employer, no IIT would be imposed. Under Article 14 <Income from Employment> of the Mainland-Hong Kong Double Taxation Arrangement (“CN-HK DTA”), the period of stay is extended from 90 days to 183 days; the relevant provisions in Para 1 and 2 are as follows:
“1. Subject to the provisions of Articles 15 [Director’s Fees], 17 [Pensions], 18 [Government Service], 19 [Students] and 20 [Other Income], salaries, wages and other similar remuneration derived by a resident of One Side in respect of an employment shall be taxable only in that Side unless the employment is exercised in the Other Side. If the employment is exercised in the Other Side, such remuneration as is derived therefrom may be taxed in that Other Side.
2. Notwithstanding the provisions of paragraph 1 of this Article, remuneration derived by a resident of One Side in respect of an employment exercised in the Other Side shall be taxable only in that One Side if all the following 3 conditions are satisfied:
(1) the recipient is present in the Other Side for a period or periods not exceeding in the aggregate 183 days in any 12-month period commencing or ending in the taxable period concerned;
(2) the remuneration is paid by, or on behalf of, an employer who is not a resident of the Other Side;
(3) the remuneration is not borne by a permanent establishment which the employer has in the Other Side.”
The most important point is that all 3 conditions in Para 2 shall be satisfied in order to enjoy the 183 days exemption, otherwise the individual may fall into Article 1 of the IIT Law and liable to IIT on income derived from sources in China. Although the rules have been in existence for a long time, many people are still unaware of Condition 2 and 3, and they believe that simply avoid staying in China for over 183 days would be good enough to get away from IIT (and they may not even know how the days are counted).
How to Count 183 Days
The first important point is how to calculate 183 days. “Any 12-month period commencing or ending in the taxable period concerned” denotes two concepts, namely, that the number of days of presence may straddle over 2 years, i.e. the days of presence can be calculated continuously or in the aggregate irrespective of the year; and that a floating calculation method may be adopted. The 12-month period can commence or end at any day within the taxable period concerned. In counting the actual number of days, one should include all days spent in the Mainland, including days that are not the full day such as the day of arrival and day of departure, as well as weekends, holidays, and vacation etc spent in the Mainland before, during and after the employment.
Who is the Employer
Some may think that Condition 2 “the remuneration is paid by, or on behalf of, an employer who is not a resident of the Other Side” is easy to satisfy, by simply having the Hong Kong employer bears all the employment costs without charge-back to the Mainland entity that the employee works in. It is not that simple. The “employer” is the party who owns the work product of, is responsible for, bears the risk of, and assess the performance of the individual. If the Mainland entity owns the work product of the individual, is responsible for his well-being, bears the risk of his acts, and assess his performance, the tax authority would regard the Mainland entity to be the real employer, and the income of the individual would be subject to IIT on the part performed in the Mainland.
The tax authority would consider the following factors in assessing the employer-in-substance:
(1) Does the Mainland entity direct the work of the individual;
(2) Does the Mainland entity determine and is it responsible for the working location of the individual;
(3) Does the Mainland entity provide the tools and materials to the individual in performing his duties;
(4) Does the Mainland entity determine the quantity and requirement of the position?
The above are common factors considered in determining if the master-servant relationship exists. Hong Kong entities sending employees to the Mainland should pay attention to such details and ensure there is documentary evidence to support the master-servant relationship. Mainland tax authorities will take the substance-over-form approach in assessing the identity of the real employer.
Condition 3 is related to Permanent Establishment (“PE”) which is a relatively complex area. Some basic understanding of what constitutes a PE is required.
When an employee is sent to work in China at a place or establishment that is relatively fixed and lasting, that place or establishment could be regarded as a PE. Conceptually it is like an unregistered branch of a foreign entity. If the employer is a Hong Kong entity, the CN-HK DTA shall be referred to in determining whether a PE exists.
According to Article 5 of the CN-HK DTA, the term “PE” means a fixed place of business through which the business of an enterprise is wholly or partly carried on, including a place of management, a branch, an office, a factory, a workshop, a mine, an oil or gas well, a quarry or any other place of extraction of natural resources, as well as:
(1) a building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only if such site, project or activities last more than 6 months;
(2) the furnishing of services, including consultancy services, by an enterprise of One Side in the Other Side, directly or through employees or other personnel engaged by the enterprise, but only if such activities continue (for the same or a connected project) for a period or periods aggregating more than 183 days [NB] within any 12-month period.
Many people can understand sub-paragraph (1) above but not sub-paragraph (2).
When a Hong Kong entity sends employees to a fixed location in the Mainland to work in a project or connected project within any 12-month period, and from the first day of arrival to the project completion day the period of stay (continuously or in aggregate) exceeds 183 days, the fixed location is a PE of the Hong Kong entity unless exemption under CN-HK DTA applies. The number of days is counted based on all employees of the entity who work in the Mainland at different times for the same project, and each day is only counted once when more than one employee is present at the same time. For example, if a Hong Kong entity (Company A) sends 10 employees to work for the same project at the same time for 3 days, the aggregate days in China is 3 days and not 30 days. However, if another Hong Kong entity (Company B) sends 1 employee to work for a project in the Mainland for 100 consecutive days, and then sends another employee to the Mainland for the same project soon afterwards, PE would be created when the second employee stays more than 83 days, creating Corporate Income Tax liability for Company B.
Condition 3 of Article 14 Para 2 requires that the employee remuneration is not borne by a PE or fixed place of the employer located in the Mainland. If a Hong Kong individual is sent to perform services at a PE of the employer in the Mainland, or the employees themselves have created a PE of the employer through the carrying out of a project or contracted work, their remuneration is deemed to be borne by the PE no matter the length of time of their services and where the remuneration is actually paid. This rule, however, does not apply to individuals who visit the PE for inspection, review or provide temporary assistance for the head office.
In the above example, the two employees of Company B are both liable to IIT even though each of them stays in the Mainland for not more than 183 days.
Lastly, if one of the employees of Company B stayed in the Mainland for more than 183 days, would he be considered a Mainland tax resident and subject to IIT on his worldwide income (assuming that there is no five-year grace period)? What information is needed to make the determination? The answer is for the Readers to work out.
183 days can be the difference between paying or not paying IIT, or the triggering point from paying IIT on China sourced income to worldwide income, and each situation has to be studied on a case-by-case basis to determine how should the rules be applied. The different ways of counting 183 days (less than or not more than 183 days, and over which period) for different purposes can often create confusion. From experience, many Hong Kong enterprises are not aware of the issue, and some of them even print the Mainland address on the name cards of the Hong Kong employees, which becomes a useful clue to the tax authority and create tax risks. Enterprises facing such issues should review the operating structure and staff secondment arrangement to manage their tax exposure.
NB: CN-HK DTA Second Protocol Article 3
(This is an English translation of the Chinese article published in the Hong Kong Economic Journal Forum on 10 September 2018: https://manageyourtax.com/HKEJ Forum 15)
Final version of IIT Law amendments:
HK news report on 5 year grace period:
Current IIT Law Implementation Rules: