China Individual Income Tax by jcw46606

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   Individual Income Tax
Janssen Chan
Tax Partner
China Tax & Business Advisory Services
Palo Alto, July 2007
Global Tax Network Hong Kong
Overview on

•   Tax law & regulations
•   Tax computation and collection
•   Tax filing and administration
•   Taxable and non-taxable income
•   Tax planning
•   Compensation date gathering for IIT filing purposes
•   PRC IIT update

Tax Law and Regulations
Source rule and the right to tax

China’s right to tax

      Tax resident
            Taxed on world-wide income

      Non-tax resident
              Taxed on China source income

Tax Law and Regulations
Source rule and the right to tax
China source income includes

     Income attributable to employment inside China or personal
     services rendered in China
     Income from lease of property located in China
     Income from transfer of land use right and real estate located
     in China or transfer of other property in China
     Income from licensing of patents used in China
     Interest and dividend derived from entities or individuals in

Tax Law and Regulations
Domicile/Residency Rule
Tax Resident

     China-domiciled individual
     Non-China-domiciled individual having resided in China
     for a full year or more

Non-Tax Resident

     Non-China-domiciled individual not residing in China
     Non-China-domiciled individual having resided in China
     for less than 1 full year

Tax Law and Regulations
Domicile/Residency Rule

    Definition of Domicile
      Habitually resides in China because of
        − household registration
        − Family / economic ties
      including individuals who have to return to China
      after completion of study, work or visit overseas

    Taxed on world-wide income

Tax Law and Regulations
Domicile/Residency Rule

Residents in China for a full year

     Stay in China for 365 days in a calendar year

     Temporary absence from China ignored

         Single absence not exceeding 30 days

         Multiple absences not exceeding 90 days in aggregate

Tax Law and Regulations
Domicile/Residency Rule

China source income

     Income attributable to working period inside China
     (includes public holiday, personal leave and training days
     in China or overseas)

Overseas source income

     Income attributable to working period outside China
     (includes working days overseas and public holiday during
     that period)

Tax Law and Regulations
US/China Tax Treaty

Physical stay in China < 90/183 days

     Under Tax Treaty, exemption applies if:-
        accumulative days of presence in the PRC in a calendar year (or
        any consecutive 12 months) not exceeding 183 days
        remuneration paid by, or on behalf of, an employer who is not a
        resident of PRC
        remuneration not borne by a permanent establishment or a fixed
        base that the employer has in the PRC

     Threshold for expatriates from tax-treaty countries is 183 days

Tax Law and Regulations

90/183 days < physical stay in China < 1 full year

      Taxable on China source income irrespective of whether the
      cost is recharged to China or not

1 full year < Physical stay in China < 5 years

      Taxable on China source income; and
      Overseas source income paid/borne by Chinese entity

Tax Law and Regulations
5 year Rule

Physical stay in China > 5 years
     Taxable on world-wide income if residing in China for a full
     year in the 6th year and onwards

Tax Law and Regulations
5 year Rule

Avoid being taxed on world-wide income by
     breaking the 5 year chain
        leaving China for 31 days consecutively or 91 days cumulatively by the
        5th year
     restarting the 5 year clock
     leaving China for 31 days consecutively or 91 days
     cumulatively in the 6th year and each year thereafter
        Only China source income for those years is subject to IIT

Tax Law and Regulations
Special Case

Expatriates working in an establishment in China (e.g.
representative offices, permanent establishments)
    Employment income deemed to be borne by Chinese
     90/183 day rule does not apply
     Taxable from day one

Tax Computation & Collection
Tax Table
 Non-Gross-up        Gross-up
Taxable Income    Taxable Income         Tax Rate   Quick Deduction
     0-500             0-475                5%             0
   501-2,000          476-1,825            10%            25
   2,001-5,000       1,826-4,375           15%            125
  5,001-20,000      4,376-16,375           20%            375
  20,001-40,000     16,376-31,375          25%           1,375
  40,001-60,000     31,376-45,375          30%           3,375
  60,001-80,000     45,376-58,375          35%           6,375
 80,001-100,000     58,376-70,375          40%          10,375
 Above 100,000      Above 70,375           45%          15,375

Tax Computation & Collection
Non-Gross-up Method

Tax calculation on gross salary
(where employee is responsible for IIT)

  Non-Gross-up Taxable Income =
  Gross Salary – Monthly Deduction (RMB4,800 for expatriate)

  IIT Payable =
  Non-Grossup Taxable Income x Tax Rate - Quick Deduction

Tax Computation & Collection
Gross-up Method

Tax calculation on net salary
(where employer is responsible for IIT)

  Gross-up Taxable Income =
   Net Salary – Monthly Deduction - Quick Deduction
                       1- Tax Rate
  IIT Payable =
  Gross-up Taxable Income x Tax Rate - Quick Deduction

Tax Computation & Collection
Gross-up Method
Guoshuifa (1996) No.199

  Where the IIT is paid, in part or in full, by employer

  IIT payable will be the higher of:
    − tax on net income (net of hypo tax) under gross up method
    − tax on gross income under non-gross-up method

Tax Filing and Administration

IIT Filing Deadline

     IIT Law - 7th day after end of each filing period/month
     Local practice varies

      Quarterly tax filing required by some local tax bureaux

 Tax Filing and Administration
Statute of Limitation
     Up to 3 years
        Tax underpayment resulted from fault of tax bureaus
        No late payment surcharge

     Up to 3 years, but could be extended to 5 years when underpayment
        Tax underpayment resulted from tax payer/withholding agent
        calculation errors
        Late payment surcharge applies

     Unlimited period
        Tax evasion or fraud
        Late payment surcharge and penalties

 Tax Filing and Administration
Surcharges and Penalties

     Late payment surcharge

        0.05% per day for tax liabilities arising from May 1, 2001
        Late filing penalty
            RMB2,000 to RMB10,000

     Additional penalties

        50% - 500% of tax underpayment/overdue

Taxable and Non-taxable Income
Taxable Income - Wages and salaries

    base salary
    hardship allowance/cost of living allowance
    other allowances/subsidies
    stock option

Taxable and Non-taxable Income
Other taxable income

    Compensation for personal services
    Interest and dividends from investment
       temporarily exempt from IIT for expatriates include
         - dividend & share of profits derived from FIEs
         - gains from disposal of shares traded in Chinese stock exchanges
    Other kinds of income

Taxable and Non-taxable Income

Benefits-in-kind for expatriates
  currently temporarily tax-exempt

     Housing accommodation in the PRC
     Meal and laundry expenses in the PRC
     Relocation and moving expenses
     Business travel expenses

Taxable and Non-taxable Income
Benefits-in-kind for expatriates (cont’d)
  currently temporarily tax-exempt

     Home leave “transportation” expenses (up to 2 trips/year)
     Language training expense and children education costs
     incurred in China

     Non-taxable on reimbursement basis and the amount is
     reasonable and supported by receipts. Cash allowance is
     taxable as income.

Tax Planning

Example:                        Scenario I   Scenario II
                                   US$          US$

Total annual package              150,000      150,000

Restructured to include:
   housing                           -         42,000
   children education                -         20,000
   home leave                        -          4,000
                                  ______       ______
Net amount reported               150,000      84,000

Compensation Data Gathering
• Information required every 27th of each month-end

• Critical to obtain payroll information timely and correctly

• Tight monthly filing due date

• Heavy penalty for late filing and under-report

• Difficult to get refund if over-report

Payroll Period Defined

• Compensation received in the month
• Calendar month is mandated
• Weekly, Bi-weekly, Semi-monthly
• No ruling on pay periods other than monthly
• General practice: all pay cycles covered within one
  particular month

What Compensation Required?
• Most cash compensations are taxable

• Example: base, bonus, COLA, hardship,
  relocation allowance etc.
• Hypothetical tax can be deducted, if any
• Caution: stock option, discount on ESPP,
  vested restricted stock awards/units if of China
  source are subject to China tax

Illustration for one month

• Base                       US$7,500.00
• COLA                          1,000.00
• Transportation allowance
  (on cash basis)                   500.00
• Less: hypo tax                 (1,800.00)
• Taxable income              US$7,200.00

PRC IIT Update

• Annual Tax Filing

• Employee Stock Options

• Permanent Establishment (“PE”)

Annual Tax Filing

Annual Tax Filing

  Tax Circular (2006) No. 162
  Annual Tax Filing
  Self-Reporting Requirements (two ways reporting)
  For PRC nationals and foreigners
  Deadline : 3 months following the end of fiscal year (i.e.
  from 1 January 2007 to 31 December 2007)
  Deadline : 31 March 2008

Annual Tax Filing

Tax circular 162 applies to the following situations :-

   1. Individual, deriving annual income over RMB120,000;
   2. Individual deriving salary and wages from two or more
      sources within China;
   3. Individuals deriving income from outside China;
   4. Individual deriving taxable income but does not have a
      withholding agent.

Annual Tax Filing

            Exclusion Clause

 (for individual income over RMB120,000)
  If an individual stays in China for less than
  1 full year, such individual is not required
  to file annual tax return.

Annual Tax Filing

    Definition of less than 1 full year

Have been away from China for 31 days or
more in one absence or 91 days
accumulatively during a tax calendar year.

Annual Tax Filing
  For annual income over RBM120,000 would also include the
  following 11 categories taxable income specified under the
  IIT Law :-
1. Wages and Salaries;
2. Production of business operations derived by individual
     industrial and commercial households;
3. Contract and leasing operations of enterprises;
4. Remuneration for personal services;
5. Author’s remuneration;
6. Royalties;
7. Interest, dividends and bonuses;
8. Lease of property located in PRC;
9. Transfer of property located in PRC;
10. Contingent income;
11. Other taxable income determined by the finance authorities of
     the State Council.

Annual Tax Filing

  File annual tax returns continuously for 5 years

Annual Tax Filing

      World-Wide income

Annual Tax Filing


             For normal cases
           less than RMB 2,000


           For serious cases
         RMB 2,000 - RMB 10,000

Employee Stock Options

Employee Stock Options
–   Grant Date
–   Vesting Period
–   Vest Date
–   Exercise Date
–   Stock Option Income

Employee Stock Options

       PRC Tax Implications

Employee Stock Options
                       Any PRC taxes?

• Grant Date                No

• Vest Date                 No

• Exercise Date             Yes

Employee Stock Options
Example :-
• Grant Date = January 1, 2006
• Grant Price = $40
• Vesting Period = One year
• Exercise Price = $100
• No. of Share Exercised = 1,000
• Vest Date = January 1, 2007
• Exercise Date (first time) = March 1, 2007

Employee Stock Options

Example : -
(Grant Price $40)                                   (Exercise Price $100)
  Grant date                       Vest date           Exercise date
     1 Jan 2006   Vesting period     1 Jan 2007          1 Mar 2007
                       (1 year)

Stock Option Income

= ($100 - $40) x 1,000 shares

= $60,000

Employee Stock Options
 Stock option income is subject to China tax only if it is
 China Sourced Income

 Fully vested prior to China:
 No China Tax Implications

Employee Stock Options
                                                        2 months (Arrived in China on
                                                            November 1, 2006)

1 Jan 2006
                                                        1 Nov 2006                  1 Jan 2007

                             12 months

-- PRC source income period
   = November 1, 2006 to January 1, 2007
   = 2 months

-- The PRC source taxable income
   = $60,000 x ------- = $10,000
-- Exercise month: March 2007

-- Reporting month: April 2007

Employee Stock Options
Before April 7, 2007:-
- Tax borne by employee
- PRC source taxable income = $10,000
PRC IIT payable (First time exercise)
    Taxable income
= [ --------------------- x Tax rate – Quick deduction] x Relevant months
    Relevant month
   (Max: 12 months)
= [ ----------- x 15% - 125 ] x 2
= $1,250

Employee Stock Options

•   Exercise Date (second time): November 1, 2007
•   Exercise 3,000 shares
•   Vesting period in China: 6 months
•   PRC source taxable income = $30,000

Employee Stock Options
                      Taxable stock       Vesting period
                      option income         in China          Total
                           (A)               (B)            (A) x (B)
Stock option              10,000              2             20,000
in March 2007
Stock option             30,000               6             180,000
in November 2007        ________                           ________
                         40,000                             200,000
                        =======                            =======
Relevant month = ---------------- = 5 (max: 12)

Employee Stock Options

March 2007
IIT payable = [ ----------- x 15% - 125 ] x 2 = $1,250

November 2007
IIT payable = [ ( ----------- x 20% - 375) x 5 ] - $1,250 = $4,875

Permanent Establishment
Permanent Establishment
US/China tax treaty:-
• If a foreign company (i.e. US Company)
  furnishing of services, including consultancy
  services, through employees or other engaged
  personnel, continue (for the same project or a
  connected project) for a period or periods
  aggregating more than 6 months within any 12-
  month period in China


Permanent Establishment

• If the employee has and habitually exercise
  authority to enter into contracts for the US


Permanent Establishment
              On April 4, 2007
        Guo Shui Han (2007) No. 403
            (“Tax Circular 403”)

• Provide interpretation on the new “Double
  Tax Arrangement” signed between Hong
  Kong and China on August 21, 2006

Permanent Establishment

Tax circular 403 states:-

• applicable to other tax treaties that China has
  concluded with other countries

Permanent Establishment

Tax circular 403 further defines:-

• Aggregate 6 months in any 12-month period

Permanent Establishment
Tax Circular 403 states:-
First Month
• It should start by counting from the month
  when the first employee arrives in China
Last Month
• It should count the month where the last
  employee leaves China

Permanent Establishment
Tax Circular 403 states:-
             Employees that present in
             China for just ONE day in a
             particular month

               “ A FULL MONTH “

Permanent Establishment
Tax Circular 403 states:-

                Exclusion Period

Permanent Establishment
Tax Circular 403 states:-
         If US Company does not have any
         employees providing services in China for
         a continuous period of 30 days

                      “A MONTH”
                    could be excluded

Permanent Establishment
• First staff into China on February 28, 2007
• Last staff out of China on August 28, 2007


Permanent Establishment
• No employee performing services in China
  for the month of April 2007 (30 consecutive
  days) and period from May 12, 2007 to June
  10, 2007 (30 consecutive days)


Permanent Establishment

             In late 2006

     Guo Shui Han (2006) No. 970

          Tax Case Ruling

Permanent Establishment
Tax Case Ruling
Basic Facts:
• A HK Company was engaged in trading and
  technical services
• No staff and no actual business activities in
• Sales contacts were negotiated and concluded
  by employees/shareholders of their
  subsidiary company in Beijing

Permanent Establishment
State of Administration of Taxation concludes:-
• As the subsidiary company’s
  employees/shareholders in Beijing could
  conclude contracts habitually on behalf of
  their HK Company
• HK Company has created a PE in China
• Income derived inside and outside China
  which relates to the “PE” will be treated as
  China sourced income and subject to foreign
  enterprise income tax (“FEIT”)

Permanent Establishment
Points to Note:
• Services provided by foreign companies in
• Negotiation and Conclusion of contracts by
  employees in China
• Tighten control on enforcement of “PE” in
• Current business operations/arrangements
• Employee’s PRC IIT issue

   Janssen Chan

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