Written by Delilah Li
Tax residency status for individuals without domicile in China is assessed by the period of stay in China. Counting an expatriate’s period of stay in China is quite a convoluted process. Thus, the assessment of an expatriate’s tax residency status and tax liabilities in China can be a tricky task.
On 31 August 2018, China approved the draft amendments to the Individual Income Tax Law (IIT Law), which will be fully enforced from 1 January 2019. The amended IIT Law revises the definition for tax residence and this has imposed a direct impact on the taxation basis of expatriates working in China.
Tax Residence Under The Current IIT Law
Based on the current IIT Law, individuals who are not China-domiciled but have lived in China for one full year[i], are subject to individual income tax on their worldwide income derived from sources within and outside China.
As a concession, the administrative regulations of IIT Law provides that non-China domiciled individuals who have stayed in China for more than one full year, but less than five years may be taxed only on the portion of their income derived from services rendered in China. This is commonly known as the “5 Year Rule”.
Therefore, to avoid being taxed on worldwide income, an expatriate would normally leave China for a period of more than 30 full days consecutively in one trip or a total of 90 full days within a tax year (in the fiscal calendar year from 31st December to 1st January) to break the five-full-year period at any point and reset tax residency.
Tax Residence under the New IIT Law
The new IIT Law defines that an individual without domicile in China who has spent 183 days or more in China during the relevant tax year would be considered a “China Tax Resident’, with income sourced within or outside the country subject to IIT. In comparison with the current IIT Law, the physical presence threshold is shortened from “one full year” to “183 days”.
The new definition of tax residence has indeed induced some degree of misinterpretation, for many believe that it has abolished the “5 Year Rule”.
To clarify, only the National People’s Congress (NPC) and its Standing Committee, China’s top legislature, can make laws. However, it is the State Council, being the country’s highest executive authority, shall make administrative regulations.
It is important to note that no provision under the current IIT Law stipulates the “5 Year Rule”. It is the administrative regulations that set out the “5 Year Rule”. Therefore, no one should dwell on whether the “5 Year Rule” is changed merely by reading the relevant provisions of the new IIT Law.
What To Do Next?
On 6 September 2018, a State Council executive meeting was held to decide on making supporting measures for implementing a newly revised law on individual income tax. Since the new IIT Law will be fully enforced starting from 1 January 2019, we expect that the administrative regulations be rolled out very soon.
As a result, expatriates who once had their compensation package structured under the existing IIT Law should stay tuned to what’s coming next and get prepared for a comprehensive revision of his/her China assignment or employment contract.
Should you wish to go through a full list of amendments to the IIT Law, please click here
[i] Individuals who have resided in China for 365 days in a calendar year are deemed to have lived in China for one full year. Temporary absences from China for no more than 30 days per single trip, or for no more than 90 days cumulatively during the calendar year, are disregarded for the purpose of calculating the days of residence.