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China's New Tax Regime - What Clients, Advisors Must Know

Tom Burroughes, Group Editor , 25 February 2019

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At the start of this year China introduced new controls affecting private individuals, such as through offshore holdings of wealth. This news service interviews Withers, the international law firm, about the issues in play.

At the start of the year China introduced sweeping new controls on what citizens can hold in terms of offshore wealth. The change perhaps was overshadowed by the US-China confrontation over trade, but as far as wealth management firms are concerned, the tax law changes were arguably more significant for some practitioners in Asia. 

This publication recently interviewed Joyce He, senior legal and tax manager at Withers

In general, how draconian are the changes that are being made and are high net worth Chinese individuals sufficiently aware of what's at stake, in your view?

The following key changes brought by the recent individual income tax ("IIT") reform in China have a substantial and far-reaching impact on all taxpayers (including local Chinese employees, foreigners working or living in China, as well as HNWIs who possess citizenship of another country while living in Mainland China) and withholding agents:

(1)    change of the tax residence rules;
(2)    consolidation of various categories of income into "comprehensive income";
(3)    introduction of additional special expense deductions;
(4)    adjusting the tax brackets;
(5)    increasing the basic standard deduction for comprehensive income;
(6)    introduction of a new annual tax reporting system;
(7)    introduction of the anti-avoidance rule; and
(8)    introduction of tax clearance mechanism upon expatriation.

Among the above changes, the introduction of the anti-avoidance rules, tax clearance mechanism upon expatriation and change of the tax residence rule are expected to have a notable impact on Chinese HNW individuals. Chinese high net worth individuals have been well aware of such changes and have actively consulted with professionals to determine the impact on their tax resident status and global mobility tax and wealth planning.

1. I understand that the new rules in China mean that owners of offshore companies will not only pay taxes on dividends they receive, but they will also face levies of as much as 20 per cent on corporate profits, rising from as low as zero under previous rules. Is this correct?

In the past, without the anti-avoidance rule in the IIT law, there was no legal ground for tax authorities to attribute offshore companies' undistributed profits to its Chinese individual shareholders and then collect IIT. However, there were a few cases where the local tax authorities attributed the undistributed profits of an offshore company to its Chinese individual shareholder with reference to the controlled foreign corporation rules provided in the Enterprise Income Tax Law and collected PRC IIT on such undistributed profits at the rate of 20 per cent.

The newly-introduced anti-avoidance rules in the revised Individual Income Tax Law give tax authorities the power and solid legal basis to make the relevant tax adjustments and levy IIT accordingly in the case where a company registered in a tax haven abroad and controlled by a Chinese individual or jointly by a Chinese individual or resident enterprise does not distribute or reduce distribution of its profits without reasonable commercial needs. In such cases, IIT will be collected at the rate of 20 per cent.

Please note that detailed implementation rules concerning anti-avoidance rules have not been included in the Implementation Regulations for the Individual Income Tax Law or the supplementary guidance circulars and notes promulgated in December 2018. Such detailed rules are expected to be clarified and released in separate circulars.

2. A 2 January report by Bloomberg noted that in the past, people could avoid tax on overseas earnings by acquiring a foreign passport or green card, while keeping their Chinese citizenship. This method will no longer operate because the government will tax global income from all holders of "hukou" household registrations, whether they have additional nationalities or not. Is this correct?

Even in the past, it might not necessarily have been the case that people acquiring a foreign passport or green card while keeping their Chinese citizenship could claim tax exemption on foreign sourced income as a non-domiciliary for PRC IIT purpose. Other factors, such as the individual's permanent or habitual residence address, family and/or economic connection, and actual number of days residing in China, should also be taken into consideration to determine the individuals' domicile and tax resident status. It is worth noting that in practice, the local tax authorities normally consider an individual with Chinese "hukou" a Chinese tax resident by default.

The above principle does not change in the revised Individual Income Tax law. The scope of taxation for individuals is generally determined by the individuals' residency status, source of income and length of stay in China. Although in most cases an individual with Chinese "houkou" (household registration) is deemed as domiciled in China and a Chinese tax resident and subject to PRC IIT on his/her worldwide income, there are very few situations where such an individual might not be considered a Chinese tax resident depending on factors such as the individual's permanent or habitual residence address, family and economic connection and actual number of days residing in China.

For example, an individual with both Chinese "hukou" and Hong Kong permanent ID card (in practice, such coexistence would only occur for a transitional period), who has permanent residency in Hong Kong but none in Mainland China and has resided in Hong Kong with his/her family for more than 180 days in a tax year, he/she is considered a Hong Kong tax resident. However, it can be anticipated that residence and domicile status will be under greater scrutiny for PRC IIT purpose.

It is worth noting that China does not recognise dual nationality and multiple citizenship and has taken measures to crack down on dual nationality in recent years. The individuals who have acquired a foreign nationality are required to cancel their "hukou" at the local police station.

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