As Chinese individuals and companies head overseas in greater numbers, the country's tax authorities are starting to follow.
The Beijing billionaires who set up cryptically named companies in the British Virgin Islands to hold their fortunes are in the cross hairs. So are the Guangdong salesmen living and working in Africa and Latin America. China's tax officials are now demanding that citizens start reporting exactly how much money they earn overseas.
In asking for this information, national and municipal tax agencies in China are quietly beginning to enforce a little-known and widely ignored regulation: Citizens and companies must pay domestic taxes on their entire worldwide incomes, not just on what they earn in China.
The nascent campaign this winter puts China on the same side as the United States in a global debate over whether taxation should be primarily national or global. On the other side of the issue are European nations, Japan, Australia and Canada, all of which tax people within their borders but exempt most expatriates and overseas subsidiaries from paying income taxes in their home countries.
"The newest element is the Chinese tax authorities' deciding to more strictly enforce this worldwide taxation, which has always been required of Chinese individuals," said Edmund Yang, a PricewaterhouseCoopers partner in Beijing for international assignments. "The level of compliance among Chinese nationals overseas has been relatively low."
Economists and accountants have long debated the fairness of taxing citizens and companies overseas. Europeans have argued that expatriates use fewer government services, like state-run health care, while playing a big role in promoting exports.
Advocates of worldwide taxation have contended that such exemptions are regressive and hurt lower-income individuals, as many expatriates are bankers and other high earners in finance. Expatriates may also benefit if their home countries are prosperous, well-run places with solid tax bases to which they can return someday.
The roots of China's decision to embrace worldwide taxation trace to the early 1990s. Still a very poor country then, China sent teams of tax officials to the United States, Britain, Germany and other nations to seek advice on drafting a modern tax code.
One team sent to the United States visited state tax officials in California and New York, said Lili Zheng, a Deloitte accountant who coordinated the visit and is now co-leader of the firm's Asian international investment practice. The team paid a long visit to the Internal Revenue Service and was given a two-volume bound copy of the United States tax code and a five-volume copy of I.R.S. regulations.
Chinese officials chose the American definition of income, with its worldwide scope, in issuing their tax code in 1993. It remains in force today, although with many amendments.
Now, China is taking the first steps to enforce that broad definition.
The government of Guangzhou, the commercial hub of southeastern China, has summoned executives from 150 of the largest corporations based there to a meeting on Jan. 28 to discuss the obligation of their overseas employees to pay Chinese taxes. Municipal governments in Beijing and other big cities are also contacting big companies in their jurisdictions and telling them to provide detailed information on the expatriates’ incomes, tax advisers said.
The State Administration of Taxation in Beijing has begun a separate campaign to curb tax evasion by Chinese companies as they start to make big overseas investments. New rules taking effect on Feb. 1 will ban a wide range of international investments deemed to be tax shelters. The rules could indirectly hit many wealthy Chinese individuals, who commonly make their overseas investments through specially created companies, often located in the Caribbean.
Worldwide tax enforcement could also prove a potent tool as President Xi Jingping seeks to catch corrupt officials who have fled overseas.
Enforcement of the tax regulation and compliance has been low partly because China lacked data on its citizens’ overseas earnings and investments. But the Chinese government has seized on the continuing United States effort to gather more information on the overseas activities of American companies and citizens. China has simultaneously been negotiating with the United States and other countries to share information on overseas bank accounts belonging to Chinese citizens.
The Chinese tax enforcement effort comes as the country’s economy starts to slow. With overseas investments by Chinese individuals and companies surging, national tax officials are looking for ways to collect on that trend. And local governments are seeking to develop a new source of tax revenue to offset dwindling revenue from other sources.
The finances of local governments across China have deteriorated considerably in the last two years. Sales of government-owned land to developers for apartment buildings and office towers have dropped as real estate prices have fallen and housing starts have tumbled. At the same time, Beijing has overhauled its system of business taxation to the disadvantage of local governments.
Local governments used to assess a tax of 5 percent on the revenue of most businesses in service industries and real estate, and shared part of the proceeds with the central government. Beijing is phasing out these taxes in favor of value-added taxes, which go directly to the central government.
That has given municipalities a powerful incentive to step up enforcement of individual and corporate income taxes, which they still collect and then split with the central government. Sam Pang, a tax partner at Ernst & Young, is helping Guangzhou draft a tax enforcement brochure to give companies at the January meeting.
China’s decision could increase pressure for similar action by countries that face sizable budget deficits and have large numbers of affluent expatriates, like Australia, Britain, France and Ireland. Although not one of these countries has shown signs yet of switching to a different model, there has been a broad increase in interest by governments around the world in sharing more information on overseas financial accounts.
While China is taking a page from the United States playbook, Beijing’s tax policies in some ways are even tougher.
The top income tax bracket in China is 45 percent, compared with 39.6 percent in the United States. That top bracket for the Chinese kicks in at $12,900 a month.
The United States also allows expatriates to exempt a slowly rising sum of foreign earned income, which amounted to $99,200 last year. It then taxes the rest. In China, overseas citizens are eligible only for an extra deduction of $210 for each month they are overseas.
Ms. Zheng at Deloitte predicted that China would pursue a few prominent cases to persuade other Chinese companies and individuals to declare their overseas income and pay taxes on it.
“The law has always been there — the enforcement has previously been lacking because of limited resources,” she said. “China is going to enforce some cases to let people know.”
By Courtesy of NY Times
