On August 31, 2018, the Decision of the Standing Committee of the National People’s Congress on Amending the Personal Income Tax Law of the People’s Republic of China (which is relevant to China’s hundreds of millions of taxpayers) was officially passed, and later implemented on January 1, 2019.
Let’s review the development track of China’s personal income tax law:
In 1980, China announced its Personal Income Tax Law of the People’s Republic of China, and the personal tax law officially came into being. In the past 38 years, the law has been amended six times with the most recent revision made in 2011, when the taxation threshold was raised to 3,500 yuan per month. Seven years later, the seventh amendment took only three months from the initial review by the Standing Committee of the National People’s Congress on June 18 to its final approval and implementation, and was called “an unprecedented tax reform”.
There are 17 amendments to the new personal income tax law. Who will be affected by these amendments? In fact, most of the provisions mainly affect the working class. The quick-sighted media has also underlined the key ways in which this will affect us. For example, the four labor incomes – including wages, salaries, and labor remunerations – are subject to comprehensive income taxation for the first time, and the threshold has been raised to 5,000 yuan per month. Special expense deductions for education, medical care, housing, and others have been introduced for the first time, with the tax rate structure being optimized to expand the low-level tax rate brackets.
Personal income tax, known as the “Robin Hood tax” in the West, is a type of tax that robs the rich and assists the poor. Every country is striving to play a role in raising fiscal revenues through taxes and regulating income distribution. China is no exception. Two important goals of this amendment are to reduce the burden on low- and middle-income populations and to practice taxation on a fairer basis and adjust the distribution by means of a personal income tax. From a macro perspective, significantly reducing the tax burden of the working class is conducive to increasing income and enhancing spending power, and has a positive impact on the upgrading of consumption structures and on economic restructuring. For the ever-growing high-net-worth (HNW) population, the four provisions in the tax adjustments are closely linked, and have far-reaching implications that cannot be ignored.
The new personal income tax law amends the first article as: “An individual who has a domicile in China or has no domicile and has lived in China for 183 days in a tax year is a residential individual. His income obtained from within and outside China shall be subject to personal income tax pursuant to this law.”
Before the amendment, having a domicile in China and “living in China for one year” were the two selective criteria to determine whether a person was a Chinese tax resident. As long as one of the two conditions was satisfied, they became a Chinese tax resident. After the amendment, the concept of tax residents and non-tax residents was introduced by drawing on international standards. Under the new personal income tax law, “time of residence in China” becomes the standard for determining whether someone is a residential individual. To put it simply, as long as a person lives in China for 183 days in a tax year, he/she is deemed a tax resident and shall pay China’s personal income tax on incomes acquired inside and outside China.
In the past, for foreigners, the tax law only required those who had lived in China for five years to pay income tax on his or her global income from the sixth year onwards, which gave some foreigners a lot of tax planning space. As long as they arranged an overseas “holiday” of more than 30 consecutive days (or 90 days cumulatively within five years) they would satisfy the provision of “living in China for less than one year” and therefore would be exempted from paying taxes to China on their global income.
Redefining tax residency has far-reaching implications. First of all, countries or regions with thriving private bank industries that are popular among the wealthy will re-examine individuals who hold Chinese passports and claim to be tax residents in low-tax jurisdictions such as Hong Kong and Singapore, or those who hold passports from non-CRS countries and prove themselves to be non-CRS country tax residents. These banks’ tax compliance will be severely challenged.
It is expected that overseas private banks will inevitably adopt more prudent and pragmatic standards and re-examine the tax resident status of Chinese customers. At this point, CRS will be able to play its role to the fullest extent. It is expected that in the near future, banks with situations that are similar to those in New Zealand, Australia and other countries will freeze a large number of their bank accounts and spread to other countries and regions. Secondly, with the comprehensive checking-up on dual nationality, the “super national treatment” of foreigners will no longer apply to those who choose to renounce Chinese nationality but continue to live in China, and the tax planning space will tighten up.
Controlled Foreign Corporation (CFC) regulations for resident enterprises have been implemented as early as 2009, while the personal version of CFC has long remained absent, providing individuals with enormous room for tax evasion. In order to plug the tax loophole, Article 8 of the new personal income tax amendments stipulates that in any of the following circumstances, the tax authorities have the right to make tax adjustments in accordance with reasonable methods:
This provision was introduced in accordance with the relevant provisions for corporate income tax, which extends the CFC to individuals, and authorizes the tax authorities to make tax adjustments against tax avoidance, such as individuals not transferring property in accordance with the principle of independent transactions, tax avoidance in overseas tax havens, and indirect equity transfers.
The new rules will have an immediate and far-reaching impact on HNW Chinese tax residents holding offshore company accounts or holding offshore listed companies’ equity in offshore companies. To give a simple example, Mr. Wang, a Chinese tax resident, holds an offshore company (usually a negative non-financial institution, which needs to disclose the controller’s information under CRS), and has an account with an overseas bank. The profits of that account for that year have accumulated in the past years and have not been distributed as dividends to individuals. According to the new personal income tax law, if the profits of the company accounts that belong to individual residents are not distributed or reduced in distribution, the tax authorities can make tax adjustment to the income within the account (20% personal income tax paid by Chinese tax residents) according to CRS regulations and individual-specific CRS provisions.
Back in early 2018, China established the National Immigration Administration through constitutional amendments. Viewed from another perspective, this actually paved the way for the new personal income tax law to comprehensively check up on dual nationality.
The current nationality cancellation procedures do not reflect the requirements for tax settlement, but the drafted new individual tax law amendments stipulate that “taxpayers who cancel their Chinese household registration due to emigration should apply for tax settlement before doing so.” Such a regulation is only a matter of principle, and it is necessary to further clarify how it will be implemented in detail. The implementation of this regulation is relatively late in China, but there are precedents to follow in other countries before tax settlement is carried out. Referring to other country’s practices, assets are generally disposed of at a fair market rate on the day that household registration is cancelled, and personal income tax is paid accordingly.
Article 14 of the new personal income tax law stipulates: “Public security agencies, the People’s Bank of China, financial supervision and management administrations, and other relevant organs shall assist the tax authorities to confirm the identity of the taxpayers and bank account information.” This provision clarifies that all financial institutions have clear legal obligations to cooperate in collecting taxpayer’s information against tax avoidance.
After the implementation of the new personal income tax law, HNW individuals with Chinese tax resident status must review the following issues:
These personal income tax law amendments are actually in line with international standards. Strict tax compliance is an irreversible international trend. Relevant persons affected by the tax law should promptly adjust and change their fluky attitude towards tax avoidance, and consider their own needs in a comprehensive and cautious manner to develop an appropriate financial plan.
