Tax Risks for Foreign Expatriates in China

Aug 14, 2024 elitestage No Comment

After the epidemic, as China lifted travel restrictions, many foreigners restarted their plans to return home. Many of them only maintain an employment relationship with a Chinese company, which is also their only source of salary income. They may plan to return to China to continue to perform their duties for their Chinese employers.

Every year, the Chinese government conducts a round of tax clearance for local residents. How foreign workers in China pay taxes and what risks they face are issues that every company attaches great importance to.

01 Obligation of Declaration

As a general rule, resident taxpayers in China are obliged to declare their foreign-sourced income to the Chinese tax authority.While there is still a particular exemption rule for a special group of resident taxpayers:who are not domiciled in China;

who have not physically stayed in China for noless than 183 days for six consecutive years.

The special group is exempted from paying Chinese IIT on their foreign-sourced income which is not paid or borne by a company or an individual in China.

02 Definition of Foreign-Sourced Individual Income

Circular 3 has defined the foreign-sourced individual income according to the location of:activities carried out, e.g. income from labor services rendered outside China, for which time-apportionment method are usually used for quantification;payers, e.g. interest and dividend income paid or borne by an enterprise located outside China or a non-resident taxpayer of China;

transaction targets, e.g. income from transfer of immovable property located outside China and from transfer of equity investment in enterprises located outside China.

03 IIT Calculation

In general, resident taxpayer should calculate their Chinese IIT on both the China-sourced and foreign-sourced income, and foreign income tax paid on their foreign-sourced income, if any, can be offset from the China IIT payable of the current period. The offset limit is the IIT calculated in accordance with the Chinese IIT law on the foreign-sourced income. The portion in excess of the offset limit can be carried forward to the next five years.It is particularly pointed out that only income tax imposed by foreign countries can be offset, which excludes foreign income tax which should not be imposed according to double tax treaty and interests, late payment surcharges or administrative penalties connected with foreign income tax, etc. In view of that, it is recommended that taxpayers should keep solid documentation to support the nature of the tax payments they made outside China, especially to separate the creditable foreign income tax from those uncreditable payment items.

04 Assistance Declaration Obligations of Chinese Enterprise

Circular 3 highlights the declaration assistance obligations of a Chinese enterprise who dispatches resident taxpayers to work outside China, where the relevant remuneration, i.e. the foreign-sourced individual income, is to be paid by a foreign enterprise. In such case, the dispatching Chinese enterprise could:take over the IIT withholding obligation on the foreign-sourced income;report the details of the dispatched employees to the Chinese tax authority by the end of the following February.

The details to be reported include all personal information, income information and tax payment information.

If the dispatching enterprise takes over the withholding obligation, Circular 3 explained that the remuneration payer outside China could withhold the relevant Chinese IIT, pass the tax fund to the dispatching enterprise in China for them to declare and settle it with the Chinese tax authority.Under such arrangement, cross-border tax fund remittance will be processed regularly so that support from the Chinese banks or SAFE will be necessary. In addition, taking the offsetting of foreign income tax payment into consideration, the calculation of the Chinese IIT to be withheld is also relatively complicated.It is noteworthy for the foreign expatriates to review the relevant tax consequences in the above two situations.

According to the current Chinese tax regulations, for foreign expatriates who hold a position with a Chinese employer only, the salary paid by the Chinese employer should anyway be fully subject to Chinese IIT, irrespective of how many days the expatriates stay in China or where the work related to this position is carried out.

Under normal circumstances, foreign expatriates carry out most of the employment related activities in China to contribute to the daily operation of the Chinese employer and to perform professional and management tasks on site. This means that usually such expatriates would not stay in their home country for more than 183 days either in a calendar year or a rolling year. As a result, their salaries should be regarded as China-sourced income, and the home country of the expatriates should give up the taxation right on these salaries, in accordance with most international tax treaties. Therefore, double taxation dispute would not arise.

But when the foreign expatriates stayed in their home countries for more than 183 days in a calendar year before their returning to China, or even continue to base in their home countries, the tax consequences would become complicated and even undesirable.

When a foreign expatriate stays in his/her home country for more than 183 days in a certain calendar year, he/she may be in general not regarded as a Chinese tax resident for that year.

In such case,i) if he/she becomes a tax resident of the home country, he/she may refer to the double tax treaty between China and the home country and apply for avoidance of double taxation at his/her home country. Nevertheless, as mentioned above, China anyway imposes income tax on his/her full salaries according to Chinese domestic tax regulation, based on the understanding that the employment-related activities, wherever they are carried out, contribute fully to the Chinese employer who also fully bears the salary costs.However, such treatment might be interpreted as a violation of double tax treaty, considering that the activities are carried out outside China and should not be regarded as China-sourced income. Also, China, where the expatriate’s tax residency does not belong to, may not have right of taxation on the salary income. From this point of view, the home country may possibly reject the tax exemption treatment/credit treatment on the salary income and ask the expatriate to apply for tax refund from China, which, based on our practical experiences, has rare chance of success.

ii) if he/she would not become a tax resident of the home country even by staying there for more than 183 days, it could happen that the expatriate is tax resident of nowhere for the calendar year. In principal, no double tax treaty could be applied in such case, while the home country could claim for income taxation on salary income (borne by the Chinese employer) according to their domestic law based on the fact that he/she stays there to carry out employment-related activities for a certain period of time. As a result, double taxation could also be triggered if China also claims the full taxation right on the salary income.

Things could look better if the expatriate is considered as domiciled in China, e.g., in cases where he holds a Chinese green card, is settled down with family in China and all the economic interests are closely related to China, etc. In this circumstance, even if the expatriate stays in China for less than 183 days, he is still a Chinese tax resident and could claim for Chinese tax credit on his foreign income tax by referring to the double tax treaty between China and the foreign country. However, in such case, such a status change may lead to his worldwide income being subject to Chinese income tax on a long-term basis.

Even if with the travel restriction in China has been removed, the taxation under cross-border employment or business arrangements is always complicated. Due to the diversification in tax laws as well as the discrepancy in understanding and interpretation on tax treaties in different countries, to solve and avoid double taxation is never an easy topic. It requires detailed case-by-case analysis, and a close cooperation between experienced tax advisors from all involved countries.

Our Recommendation

In general, the declaration of foreign-sourced individual income in Chinese IIT filings demands relatively higher professional expertise, as it requires detailed assessment, and complicated calculation. We recommend concerned taxpayers, especially high net worth individuals who have diversified income categories derived in- and outside China, to seek for professional assistance where necessary, to mitigate their tax compliance risks in China.

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