With the extensive media coverage in Hong Kong and elsewhere, Readers should already be well aware that the revised draft Detailed Implementation Rules of the Individual Income Tax (“IIT”) Law of China (“Draft DIR”) released by the Chinese Ministry of Finance and the State Administration of Taxation on 20 October 2018 for public consultation has provided a generous relaxation on the IIT for non-domicile tax resident (please refer our Tax Tips (14) for background).
According to Article 4 of the Draft DIR, IIT would be imposed on China-sourced income only, provided that the non-domicile resident individual does not stay in China for 183 Days for 5 consecutive years, or, in case the individual has spent 5 consecutive years, he has made a single trip outside of China for more than 30 days during the said 5 years. In other words, the “5 Year Rule” of the existing DIR has been retained with a large degree of relaxation in the Draft DIR, such that the fear that foreign individuals (including Hong Kong individuals) would be subject to IIT on worldwide income for spending 183 days in China has been swept away.
However, when one looks closer at the provisions, there is an important issue that foreign individuals should pay serious attention to.
You Become A Chinese Tax Resident by Spending 183 Days in China!
Under Article 1 of the new IIT Law effective 1 January 2019, a tax resident is defined to include a non-domiciled individual who resides in China for 183 days in a fiscal year (there is no tax resident concept in the existing IIT Law). Article 4 of the Draft DIR mentioned above applies to such an individual. Therefore, a foreign individual who does not have a domicile in China but resides in China for 183 days would still be regarded as a Chinese tax resident under the IIT Law, and, upon meeting the requirements under Article 4 of the Draft DIR, he can be exempt from IIT on foreign-sourced income. [Update] The Public Notice 2019 No.34 issued on 14 March 2019 has an impact here. Please refer to Tax Tips (21) – No Tax Even if Stay in China for Over 183 Days? for details.
Accordingly, while the concern of IIT on worldwide income for foreign individuals has been eliminated, as they are regarded as Chinese tax residents, they will likely be considered tax resident of both their home jurisdiction and China. This dual-residency status creates two important issues:
1. Foreign Tax Credit Claim
The foreigner, as tax resident at his home jurisdiction, may be subject to home tax on the China-sourced income. In order to eliminate double taxation, the foreigner has to lodge a tax credit claim. However, unless domestic rules allow for other tax credit claim mechanisms, the tax credit shall be claimed on the basis of the relevant Double Tax Arrangement (“DTA”) signed with the Other Side for which the tax is suffered, which in this case is China.
For Hong Kong individuals, in the past, most would rely on the salaries tax income exclusion claim under Section 8(1A)(c) of the Hong Kong Inland Revenue Ordinance (“IRO”) to eliminate double taxation, instead of filing a tax credit claim. Unfortunately, the rule has just been changed. Claims under Section 8(1A)(c) of the IRO would no longer be accepted from 1 April 2018 (Year of Assessment 2018/19) onwards for Hong Kong taxpayers who have paid foreign tax of similar nature in other jurisdictions that have signed DTA with HK, which includes Mainland China. Instead, they have to claim relief of double taxation by tax credit under Section 50 of the IRO. Please note that Section 8(1A)(c) is still available in respect of tax suffered in jurisdictions that have not signed DTA with Hong Kong.
Technically, to claim a foreign tax credit under a DTA the individual shall be a tax resident of Hong Kong. If the individual is also a tax resident of Mainland China, the place of tax residency should first be established before a tax credit claim can be lodged in Hong Kong. How to determine the place of tax residency? According to Article 4(2) of the DTA between Hong Kong and Mainland China, when an individual is a resident of both Sides, his status shall be determined by the tie-breaker rules with reference to his “Permanent Home”, “Centre of Vital Interests” and “Habitual Abode”.
Details of the above tie-breaker rules have been discussed extensively in Tax Tips (14) so they will not be repeated here.
On the other hand, if a US tax resident is sent by his US employer to work in China for a period of time which exceeded 183 days in a year so that he has become a dual-resident for both the US and China, regardless of the dual-residency status, he would still be able to claim the foreign tax credit under the US domestic rules. The impact of dual-residency on double taxation for individuals from different home jurisdictions would therefore have to be determined on a case-by-case basis.
2. CRS Automatic Exchange of Information
If a foreign individual becomes a Chinese tax resident, he needs to be very careful in declaring his tax residency for anything related to the Common Reporting Standard (“CRS”). Under CRS, financial information of individuals will be automatically exchanged to the jurisdiction of the individual’s tax residency. As it may take time to confirm oneself as non-resident of China under the tie-breaker rules in the relevant DTA, individuals who do not want their information to be made available to Chinese tax authorities may want to avoid becoming Chinese tax residents, which could happen on 2 July 2019 the earliest, by leaving China, thereby potentially creating a talent drain.
What Can You Do?
Ideally, the Draft DIR should be amended such that individuals meeting the conditions under Article 4 of the Draft DIR would not be regarded as Chinese tax residents. They should file IIT as non-residents under Article 6(2) of the new IIT Law without the various new deductions available to resident individuals and at the same time, be entitled to the various IIT exemption on allowances currently available to foreigners for child education, language training, housing, meals, laundry, home visits, removal and deduction on Mainland social security contributions. This way, the transition to the new IIT Law would be stable and the stated policy objective of attracting foreign talents would be achieved.
If Article 4 of Draft DIR remains unchanged in the final version, in order to avoid the foreign tax credit and CRS issues mentioned above, many foreign individuals working in China will need to prepare for the determination of tax resident status as soon as reaching 183 days of stay. As mentioned in Tax Tips (14), it is likely that the Chinese tax offices have handled very few cases of resident determination in the past and when such cases begin to surface next year, the volume and technicality of the cases could be very challenging for the Chinese tax officers. The competent authorities may need to be involved too. One possible way of reducing the magnitude of the problem is to amend the DTA between Hong Kong and China to make it easier for Hong Kong individuals to be recognised as Hong Kong tax residents.
The other option is, of course, avoid residing in China for 183 days each year.
[Update on 23 Dec 2018] The new IIT DIR has been released. There is no change to the rules regarding tax residency so the concerns expressed above have, unfortunately, become real.
Companies and individuals are recommended to closely follow the development of the Draft DIR in order to ensure that human resources issues are managed well and the employees’ concerns are addressed. For Hong Kong individuals who ordinarily reside in Hong Kong, they should consider applying for the Certificate of Resident Status with the Hong Kong Inland Revenue Department as supporting of tax resident status. Affected individual and companies should talk to knowledgeable tax consultants as soon as possible for advice on managing tax exposure.
The Author would like to thank US Individual Tax expert Ms. Virginia La Torre Jeker J.D. for her comments on the US tax implications in the example mentioned in this article. Please visit https://us-tax.org/ for more information about Virginia.
(This is an English translation of the Chinese article published in the Hong Kong Economic Journal Forum on 5 November 2018: https://manageyourtax.com/HKEJ Forum 17)
New IIT Law: https://baike.baidu.com/item/%E4%B8%AD%E5%8D%8E%E4%BA%BA%E6%B0%91%E5%85%B1%E5%92%8C%E5%9B%BD%E4%B8%AA%E4%BA%BA%E6%89%80%E5%BE%97%E7%A8%8E%E6%B3%95/1289974?fromtitle=%E4%B8%AA%E4%BA%BA%E6%89%80%E5%BE%97%E7%A8%8E%E6%B3%95&fromid=4307817
Public consultation: http://yjzj.chinatax.gov.cn/hudong/noticedetail.do?noticeid=1701567 (this link may not work after 4 November 2018)