China makes changes to the Individual Income Tax Law

The National People’s Congress (NPC) Standing Committee approved, on 31 August 2018, a second draft of the Individual Income Tax Law to amend a number of elements of the calculation and enforcement of individual income tax (IIT) in China.

The aim of the new IIT law is to ease the tax burden for low to mid-income earners while taking a tougher stance on both high-income earners and foreign workers. It includes significant changes to residency rules and the introduction of General Anti Avoidance Rules (GAARs) for individuals.

Article 1 of the IIT law deems that a foreign individual who resides in China for an accumulated 183 days or more in a year will be considered a ‘tax resident’ and therefore subject to Chinese tax on their worldwide income.

This provision will replace the previous five-year-rule, under which a foreign individual was subject to Chinese taxation on worldwide income if they lived in China for more than five years. This rule was easily circumvented because expatriates could ‘reset the clock’ on the five-year threshold by leaving China for an aggregate of 91 days per year or more than 31 consecutive days.

Article 11 of the IIT law also stipulates that, for tax residents, IIT will now be calculated on an annual rather than monthly basis. However, withholding agents will continue to withhold the tax in advance on a monthly basis and non-residents will continue to pay tax on a monthly or subordinate basis.

Article 8 provides additional powers over tax avoidance schemes, particularly in relation to transactions involving non-arm’s length asset transfers and commercial arrangements where inappropriate tax benefits are derived.

With reference to the GAARs under the PRC Corporate Income Tax Law, the new rules empower the PRC tax authorities to assess tax on individuals who are involved in certain transactions – asset transfers that are not at arm’s length, tax avoidance by use of a low tax jurisdiction or deriving inappropriate tax benefits through unreasonable commercial arrangements. Where tax is assessed, late payment surcharges will be collected accordingly.

There are still some areas of the law that are unclear. It is expected that further clarification and implementation guidelines will be released by the end of October. Some changes will take effect as early as 1 October 2018 but the changes to the tax residency rules and the introduction of GAARs are to take effect on 1 January 2019.

Although the new residency rules and anti-tax avoidance provisions appear to mark a radical shift in the tax treatment of foreigners living in China, equivalent or more stringent regulations apply in most, if not all, developed countries worldwide, so the changes are in line with international standards.

China has also started exchanging information on residents’ financial accounts with about 100 other countries from September. The move is part of the Common Reporting Standard (CRS), a global agreement on sharing tax data backed by the OECD, which will give PRC tax officials a better view of Chinese residents’ overseas financial investments and earnings.

Navigating through these new tax reforms will be a challenge. Depending however on the type of overseas asset held and the level of overseas income generated, there are a number of potential solutions that may assist taxpayers to mitigate or defer tax liabilities – particularly through the use of Trusts and/or Family Investment Companies (FICs) to hold assets.

These structures do not change a taxpayers obligations to report under the CRS and their effectiveness in achieving tax or other benefits will vary depending on the taxpayer’s nationality, the type and location of assets, the existence of any relevant double tax treaties and other factors.

Expert advice is essential not just to ensure the correct planning but also to demonstrate that you have taken care to achieve full compliance. Anyone with concerns over their existing arrangements would be advised to contact their nearest Sovereign office to discuss the options available.

The contents of this publication should in no way be read as proposing any arrangement that might constitute aggressive tax planning in respect of either individuals or companies. Sovereign will never recommend any structure that would not be effective if scrutinised by regulators and tax authorities.

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