Tax Compliance Points for Cross-Border Asset Allocation By HNWIs
In recent years, the number of high net worth people in China has shown a fluctuating growth trend. In order to diversify market risks and seek investment opportunities, HNWIs tend to invest their assets overseas, and their overseas investment objectives are becoming more diverse.
Some HNWIs also choose to invest or purchase real estate abroad to develop their businesses or secure their family’s inheritance. Investment inevitably involves the flow of assets, and the flow of assets inevitably leads to tax issues.
Combined with practical observations, this article analyzes the current Chinese tax laws and regulations governing the transfer of assets, as well as the general tax treatment at the point of inflow of assets, with the aim of providing guidance on tax compliance for Chinese residents’ cross-border asset allocation.
China’s tax laws related to the transfer of assets
Overseas investment is usually accompanied by the disposal of domestic assets. In practice, when a natural person sells and realizes the assets in China and then remits the funds out of China, the proceeds from the realization of the relevant assets need to be cleared for tax purposes in China.
However, some natural persons, in order to avoid the tax obligations corresponding to the transfer of assets, adopt illegal means to transfer assets, which constitutes tax violations such as tax evasion as clearly stipulated in China’s laws (not discussed in this article for the time being).
In addition, there are also natural persons who transfer assets abroad in disguise in order to “avoid tax”. The reason why various kinds of disguised asset transfers can realize the so-called “tax avoidance” purpose is often realized by exploiting the “loopholes” in laws and tax collection and management.
In this regard, our country mainly regulates this through the anti-avoidance legislation, and at the same time, actively responds to and joins the anti-avoidance action of global tax governance. At the same time, China actively responds to and joins the anti-avoidance action of global tax governance to comprehensively deal with cross-border tax avoidance behavior.
01 Provisions on Taxation of
Migrant Transfers
In order to regulate and standardize the transfer of property by natural persons, the People’s Bank of China (PBOC) issued the Interim Measures for the Administration of Sale and Payment of Remittances for the Transfer of Personal Property to Foreign Countries in 2004 to regulate the realization and remittance of natural person’s property out of the country in the form of migration transfer and inheritance transfer. [1]
According to the regulations, applicants applying for immigration transfer or inheritance transfer are required to submit tax certificates or tax payment vouchers issued by the competent tax authorities of the place where the property to be transferred is located or the place where the income comes from to the local foreign exchange bureau.
In order to effectively cooperate with the tax collection and management requirements for the disposal of assets in the process of immigration transfer or inheritance transfer by natural persons, the State Administration of Taxation (SAT) and the State Administration of Foreign Exchange (SAFE) jointly issued the Circular on Issues Relating to the Submission of Tax Certificates or Tax Completion Vouchers for the Foreign Transfer of Individual Property in 2005, which stipulates the requirements for the duty of the tax authorities to conduct strict examination of the applicants of immigration transfer in respect of the tax completion of the liquidation of the assets, including the following.
The following aspects:
if the tax authorities have grounds to believe that the applicant has committed tax evasion or tax fraud, and need tofile an audit, they shall issue a tax certificate after the audit is completed and the tax has been paid;
if the applicant has realized his/her property, he/she shall provide the information such as the transaction contract and invoice, etc. If necessary, the tax authorities shall submit the above information to the applicant for examination and approval. When necessary, the tax authorities shall verify the above information;
for taxable acts in which the applicant has not paid the tax, the taxpayer shall be instructed to pay the tax and deal with it in accordance with the provisions of the Law on the Administration of Taxes and issue the tax certificate;
the tax authorities must issue the certificate truthfully in accordance with the applicant’s actual amount of tax paid into the tax account and examine whether there is any tax arrears, and it is strictly prohibited to issue false certificates;
the applicant fabricates a false basis for calculation of taxes If the applicant fabricates false tax calculation basis and fraudulently obtains the tax certificate, and if the applicant forges, alters or modifies the tax certificate, the applicant shall be dealt with in accordance with the provisions of the Tax Administration Law and its implementation rules. At the same time, the tax authorities shall strengthen communication and collaboration with the local foreign exchange management department, and shall establish a regular coordination mechanism to jointly prevent the loss of national tax revenue. The tax authorities shall inform the foreign exchange management department of taxpayers who have tax violations and may transfer property, in order to prevent the applicant from illegally transferring property to foreign countries. In the process of examination and approval, the foreign exchange management department shall promptly inform the corresponding tax authorities if it finds that the applicant is suspected of tax evasion.
02″Departure Tax Clearance” Tax
Collection Regulations
For natural persons with immigration arrangements, in addition to the tax requirements related to the realization of assets and immigration transfer, there are also provisions on “departure tax clearance”.
Prior to the promulgation and implementation of the new Individual Income Tax Law (“IIT Law”) in 2018, the IIT Law did not provide for the tax-related administration of taxpayers losing their Chinese nationality. The new Individual Income Tax Law stipulates that if a taxpayer cancels his or her Chinese household registration due to moving abroad, he or she should settle the tax before canceling his or her Chinese household registration.
However, the Regulations for the Implementation of the Individual Income Tax Law do not further explain the requirements for the implementation of this provision, and no specific rules have been issued in different regions, and thus the departure tax clearance system is not strictly implemented in practice.
03 General anti-avoidance provisions for individual income tax
Prior to 2018, due to the absence of the law, the tax authorities lacked effective regulatory measures and enforcement basis for the transfer of assets and tax avoidance by natural persons using connected transactions and controlled foreign companies, resulting in the loss of tax revenue from individual income tax.
The 2018 Individual Income Tax Law added general anti-avoidance provisions, which made up for the gap in China’s Individual Income Tax Law in the area of anti-avoidance. Specifically, the Individual Income Tax Law adds the principle of independent transactions, controlled foreign companies and general anti-avoidance rules.
business transactions between an individual and his/her related parties do not comply with the independent transaction principle and reduce the tax payable by the individual or his/her related parties without justifiable reasons;
enterprises controlled by a resident individual, or jointly controlled by a resident individual and a resident enterprise, which are set up in a country (region) where the effective tax burden is obviously low, do not distribute or reduce the profit attributable to the resident individual without reasonable business needs;
an individual commits an act of tax avoidance;
the individual implements other arrangements that do not have a reasonable business purpose and obtains improper tax benefits, the tax authorities have the right to make tax adjustments in accordance with reasonable methods. If the tax authorities make tax adjustments and need to pay back taxes, they shall impose back taxes and add interest in accordance with the law.
04 Anti-Tax Avoidance Provisions for Enterprise Income Tax
In addition to direct asset transfer, some HNWIs also transfer assets by setting up enterprises for cross-border transactions and transferring profits. In this regard, China has gradually established a complete set of anti-avoidance system in the field of enterprise income tax.
Specifically, the Enterprise Income Tax Law and its implementing regulations, which have been implemented since 2008, provide for special tax adjustments in the form of special chapters, and for the first time, introduce the cost-sharing agreement, capital weakening, controlled foreign enterprises, general anti-avoidance, and interest on tax avoidance adjustments; and the Implementing Measures for Special Tax Adjustments (2009) provide for the implementation of the special tax adjustments.
In 2009, the Implementation Measures for Special Tax Adjustments (for Trial Implementation) was formally promulgated, which comprehensively standardized the operation and management of anti-avoidance; meanwhile, the SAT also issued a series of normative documents covering pre-tax deduction of interest expenses of related parties, determination of the actual tax burden of the country in which the foreign enterprise is controlled by a Chinese resident shareholder, management of EIT on equity transfer of non-resident enterprises, and tracking and management of transfer pricing, which comprehensively laid the groundwork for China’s EIT, and provided the basis for China’s EIT. This has comprehensively laid down the anti-avoidance legislative framework for China’s EIT.
Since 2015, China’s anti-avoidance legislation on EIT has been gradually upgraded and improved, and the main regulations include:
General Anti-Avoidance Administrative Measures (for Trial Implementation), which mainly stipulates the special tax adjustments that may be implemented “in respect of tax avoidance arrangements adopted by enterprises that do not have a reasonable commercial purpose to obtain tax benefits”;
The Announcement of the State Administration of Taxation on Certain Issues Concerning Enterprise Income Tax on Indirect Transfer of Property by Non-Resident Enterprises, which expands the factors related to the determination of reasonable commercial purpose, so that the anti-avoidance measures are particularly targeted at tax avoidance arrangements that do not have a reasonable commercial purpose;
The Announcement of the State Administration of Taxation on Regulating the Administration of Cost-Sharing Agreements, which emphasizes that tax authorities should strengthen the follow-up administration of cost-sharing agreements;
The Announcement on Matters Relating to the Improvement of Connected Declaration and Management of Contemporaneous Information, which redefines the requirements for connected transactions and contemporaneous information reporting;
The Announcement on Measures for the Administration of Special Tax Investigation Adjustment and Mutual Consultation Procedures and the Announcement on Matters Relating to Withholding and Payment at Source of Income Tax for Non-Resident Enterprises, which further detailed the relevant processes and requirements for the implementation of the procedures for special tax adjustments by the tax authorities, and clarified the rules for the implementation of withholding and payment at source for the income derived from China by non-resident enterprises, among other things.
General tax treatment of the place of transfer of assets
1 General treatment in the place of transfer of assets
1. Asset Disposal and Declaration Requirements of Immigrant Receiving Countries
Currently, some countries have asset disposal and declaration requirements for the transferred assets of new immigrants, taking the United States and Canada as examples:
The United States. For natural persons who immigrate to the U.S. and become U.S. tax residents, U.S. federal law requires them to report worldwide income, including income from foreign trusts, foreign bank and securities accounts. Taxpayers are also required to report the existence of foreign bank or securities accounts on a schedule and the country in which the account is located. U.S. tax residents are also required to file an annual Report of Foreign Bank and Financial Accounts (FBAR) with the Treasury Department to report foreign financial accounts owned, such as bank accounts, brokerage accounts, and mutual funds. In addition, such tax resident individuals are required to file a Statement of Foreign Financial Assets with their tax return to report specific foreign financial assets owned if the value of the assets exceeds the statutory limits. [2]
Canada. For natural persons who immigrate to Canada, the Canada Revenue Agency (CRA) will deem that the assets (non-Canadian taxable property) originally owned by the natural person at the time of immigrating were sold at fair value, and will then deem the natural person to have acquired the relevant assets at the aforementioned equivalent cost on the date the natural person became a resident of Canada. Such assets include equity, jewelry, paintings or collectibles. Generally, fair value is the highest price that the natural person could obtain for the assets in an arm’s length commercial transaction. Upon immigrating to Canada, the natural person should properly retain documentation that proves the fair value of the assets and will be used as evidence to calculate the gain or loss in the event that the assets are actually disposed of in the future. [3]
2. Income tax treatment of asset transfers
The main taxes corresponding to the transfer, holding and trading of assets by natural persons are income tax and property behavior tax. Income tax, i.e. a tax levied directly on the taxpayer’s income, can be a tax on capital gains, a tax on labor income, or a tax on incidental income.
Personal income tax. According to the basic principle of income tax, the object of income tax is “taxable income”. Since a general transfer of assets by a natural person does not directly generate net income, under normal circumstances, the transfer of assets itself usually has no personal income tax effect. However, if a natural person makes an asset transfer and the relevant asset generates income and meets the personal income tax rules of the place of transfer, the natural person may have the obligation to file a tax return with the competent tax authorities of the place of transfer.
Capital gains tax. [4] Due to differences in national tax systems, some countries treat one-time appreciation on the disposal of assets as a capital gain and have established a separate capital gains tax. The tax systems of most countries in the world require capital gains to be realized before they can be taxed, and generally require them to be “realized”. As a result, transfers of assets by natural persons do not normally result in a change in value per se and are taxed accordingly.
It should be noted that, while personal income tax and capital gains tax have the basic principle of “realization” on a “cash basis”, many countries also provide for “deemed realization” situations However, many countries also provide for “deemed realization” cases, such as termination of resident status (naturalization), gift of property, death of the taxpayer, withdrawal of property from a corporation, etc. At the same time, in some areas, some countries have begun to adopt the “accrual” basis of taxation for certain income or gains or for certain financial instruments.
3. Property behavior tax treatment of asset transfers
Property behavioral tax is a type of tax that targets certain property owned or disposed of by the taxpayer and certain specific behaviors (e.g., transfers), and can be divided into the following types:
Property retention tax. Property retention tax is further divided into real estate retention tax and movable property retention tax. Among them, real property retention tax includes urban land use tax, property tax, agricultural tax, etc., while movable property retention tax contains vehicle and vessel use tax and vehicle and vessel use license tax, etc. After a natural person transfers his/her assets outside of China, depending on the taxable object of the property retention tax in each country, he/she shall declare the tax on the assets held by him/her to the tax authority in the place where the transfer takes place.
Property transfer tax. Property transfer tax is divided into real estate transfer tax and property transfer tax. Among them, the tax on compensated transfer of real estate includes deed tax, sales tax and stamp duty, etc., while the tax on uncompensated transfer of property includes deed tax, stamp duty, inheritance tax and gift tax. If a natural person transfers assets or conducts asset transactions that are subject to property transfer tax in the place of transfer, he or she shall fulfill his or her tax obligations to the competent tax authorities in the place of transfer for the acts that have taken place.
2 Transformation of tax residency and its implications
Recognition of tax residency of a natural person is one of the bases of whether, and to what extent, a country has tax jurisdiction over a natural person. In order to solve the problem of conflicting tax jurisdictions, countries nowadays generally advocate resident tax jurisdiction, i.e., tax residents of their own countries should bear unlimited tax obligations (usually advocating taxing their worldwide-sourced income), while non-residents should bear only limited tax obligations (usually advocating taxing only their home-sourced income). It is generally recognized that there are several criteria for the determination of tax residents of natural persons:
(1) the nationality criterion, i.e., as long as a natural person has the nationality of a certain country, no matter where he/she resides or where he/she derives his/her income or economic benefits, he/she is a tax resident of that country;
(2) the domicile criterion, i.e., whether a natural person is a tax resident or not is determined by whether or not he/she is domiciled in the country in which he/she is taxed;
(3) the residence criterion, i.e., whether or not a natural person has a the residence criterion, i.e., whether the natural person has a place of residence that is not permanent; (4) the residence time criterion, i.e., whether the natural person actually stays in a certain country for a certain period of time.
Due to the different national conditions of each country, the tax laws of each country formulate and implement different criteria for the determination of tax residency status.
For example, the U.S. considers all U.S. citizens as residents, and judges whether a foreign natural person is a resident of his or her home country based on the “green card standard” and the “number of days of actual stay standard”. Canada considers natural persons residing in Canada as “de facto residents” and natural persons not residing in Canada but with close ties to Canada as “deemed residents”, both of which are tax residents under the Canadian tax law. China’s tax resident determination adopts both domicile and time criteria, i.e., an individual who has a domicile in China, or who does not have a domicile but has resided in China for 183 days in a taxable year, is considered a tax resident of China.
Based on the above, if a natural person in China transfers his/her assets outsideof China through emigration, real estate investment, trust, insurance, etc., he/she may change his/her nationality,change his/her domicile, transfer his/her residence, or stay outside of China for a long period of time, and accordingly, he/she will be recognized as a tax resident of other countries. A tax resident should normally file a tax return on his/her worldwide income with the country under his/her jurisdiction and complete the annual personal income declaration (which varies according to the domestic laws of each country). It should be noted, however, that the aforementioned objective facts do not necessarily result in a natural person losing the status of tax resident of China. In the case of simultaneous tax residency in both countries, the natural person may be exposed to the risk of double taxation.
Current status of cross-border financial asset regulation
1. Current status of international regulation
With the acceleration of the process of global economic integration, it is common for taxpayers to utilize offshore financial institutions for asset management and transfer their assets to offshore financial accounts in order to evade domestic tax liabilities, which requires countries to strengthen tax-related international information exchange to better safeguard their tax interests.
At the international level, in order to improve tax transparency and tax compliance, OECD formulated the Multilateral Convention on Mutual Assistance in Tax Administration (hereinafter referred to as “the Convention”) in 1998 and amended it in 2010 to provide tax administration assistance in order to combat tax avoidance and tax evasion.[6]
Secondly, the OECD initiated a special tax information exchange peer review in 2009, and gradually shifted the focus of the study to the taxation of “beneficiaries”, aiming at lifting the “veil” of the beneficial owners, and cracking down on natural persons’ use of offshore organizational structure and The research focus has gradually shifted to the “beneficial owner” tax issue, and is committed to removing the “veil” of the beneficial owner, and combating natural persons’ tax evasion through offshore organizational structures and holding relationships, fiduciary relationships, fictitious transactions, nominee holdings, and secret ballots. [7]
Again, in terms of automatic exchange of tax-related information, CRS (Common Reporting Standard) and FATCA (Foreign Account Tax Compliance Act) are two financial tax-related information exchange systems that have attracted wide attention. Specifically, CRS, issued by the OECD in 2014, is an international anti-avoidance measure in which tax authorities of various countries exchange information on the accounts of foreign natural persons and enterprises held by financial institutions of that country with other countries in order to cope with the opacity of information across borders. [8]
To carry out the automatic exchange of tax-related information on financial accounts, firstly, the financial institutions of one country (region) identify, through due diligence procedures, the accounts opened by tax resident individuals and enterprises of another country (region) in the institution, and report information on the account holders as well as information on the income from the sale of financial assets, etc., on an annual basis to the competent authorities of the country (region) where the financial institutions are located, and then the competent tax authorities of that country (region) conduct the exchange of information with the account holders’. The tax authorities of the country (region) and the tax authorities of the account holder’s country of residence carry out information exchanges, and ultimately provide information support for cross-border tax source supervision of each country (region); whereas FATCA is a foreign account tax compliance act implemented by the United States since 2010. The U.S. intends to strengthen the taxation of U.S. taxpayers’ worldwide income through unilateral actions aimed at combating the use of offshore accounts to avoid U.S. taxes.
2. Current status of domestic regulation
In recent years, China has actively participated in the aforementioned tax-related information exchange and converted some international tax standards into domestic tax laws. China signed the Convention in 2013 and has been implementing it since 2017. At this stage, the form of tax administration assistance between China’s tax authorities and other parties to the Convention is mainly in the form of exchange of information, which is carried out in accordance with the Circular of the State Administration of Taxation on the Issuance of the Working Procedures for the Exchange of Information on International Taxation (Guo Shui Fa [2006] No. 70).
In addition, in respect of the automatic exchange of tax-related information on financial accounts, China issued the Administrative Measures for Due Diligence Investigation of Tax-Related Information on Non-Resident Financial Accounts (State Administration of Taxation Announcement No. 14 of 2017) in 2017, which provides a legal basis and operational guidelines for the implementation of CRS in China. Our first foreign exchange of information is scheduled for September 2018. [9]
Although China’s tax law does not yet have a mature body of rules on asset transfers, especially at the level of individual income tax law, and there are practical problems that are not strictly enforced in practice, with the construction of China’s smart tax, especially the imminent landing of the “Golden Tax IV”, the accuracy of China’s tax supervision of individuals, especially high net worth individuals, will be greatly improved. The accuracy of China’s tax supervision of individuals, especially high net worth individuals, will be greatly improved.
Meanwhile, although some countries do not participate in the automatic exchange or do not execute the exchange well, it is difficult for HNWIs to get hold of their assets outside of China, especially for the United States, which implements unilateral actions, as it has not joined the CRS, the information on the overseas accounts of China’s tax residents in the United States and their assets can’t be exchanged back to China, which, to a certain extent, increases the number of cases where the competent authorities of our country discover that China’s tax authorities are not aware of their assets through emigration, asset transfer and other means. This, to a certain extent, makes it more difficult for our tax authorities to detect tax evasion by our tax residents through emigration and asset transfer.
However, according to our practical experience, non-automatic exchange of specialized information is also an important source of information for individual income tax evasion and avoidance cases.
When making cross-border asset allocation, natural persons should comprehensively consider the tax environment in which they are located, which includes both the tax substantive law treatment of China and the invested country, as well as the bilateral or even multilateral tax regulatory system, and should involve the judgment of the overall business environment, so as to better control the tax-related risks of cross-border asset allocation and enhance the economic benefits of cross-border investment.