Introduction to China IIT Law Five-year Exemption Rule
Article 6 of the existing Regulations for Implementation of the Individual Income Tax Law of the People's Republic of China (‘Old Regulations’) offers a Five-year Exemption Rule to foreign individuals and residents of Hong Kong, Macau and Taiwan, that is, foreign individuals who are considered to be China tax residents but has been staying in China for less than 5 consecutive years are exempted from tax on income sourced from outside China.
The Regulations for Implementation of the Individual Income Tax Law of the People's Republic of China (Revised Draft Seeking Opinions) (‘New Regulations’), announced on 20 October 2018 by the Ministry of Finance and the State Administration of Taxation, keeps the Five-year Exemption Rule with a couple of minor changes to the requirements.
The consultation period for the New Regulations had just ended recently on 4 November 2018. It is pending the final revision by the State Tax Administration with the public opinion collected. The revised implementation rule is set to take effect from 1 January 2019.
1. Tax Resident and “Five-year Exemption Rule” under Old IIT Law
(1) Definition of Tax Resident
In accordance with Article 1 of the existing China Individual Income Tax Law (‘Old IIT Law’), expatriates (including residents of Hong Kong, Macau and Taiwan) who live and work in China for a full one year are considered to be China tax resident and should be subject to China individual income tax on their worldwide income.
According to the Old IIT Law, expatriates who do not leave China for a consecutive period of 30 full days or a total of 90 full days throughout the calendar year are considered to be staying for a full one year. Days travelling inbound or outbound from China are classed as days spent inside China. Fox example, Mr Zhang is an American, he is seconded to China to head the China subsidiary of a US corporation. In Year 2018, Mr Zhang left China on 1 May 2018 and returned back to China on 7 May 2018. In this example, the day of departure and day of arrival are counted as live in China and therefore this means that Mr. Zhang only spent 5 days outside of China.
Consequently, in accordance with the old IIT Law, expatriates who do not leave China for a consecutive period of 30 full days or a total of 90 full days throughout the calendar year will be considered as a China tax residents and shall be subject to China individual income tax on their worldwide income.
(2) 5-year Rule Exemption
For the purpose of attracting talented foreign individuals, the Chinese government, in the Old Regulations, provides a Five-year Exemption Rule so as to reduce the tax burden of expatriates. Article 6 of the Old Regulations stipulates that ‘for income derived from sources outside China of individuals not domiciled in China, but resident for more than one year and less than five years, subject to the approval of the tax authorities-in-charge, individual income tax may be paid on only that part which was paid by companies, enterprises or other economic organizations or individuals which are inside China’ (known as ‘Five-year Exemption Rule’). In short, expatriates, who live in China for a full one year are considered as to be China tax residents and are supposed to pay China individual income tax on their worldwide income, are now being exempted from paying China tax on that part of income sourced outside China, until they live in China for more than 5 consecutive years.
2. New Definition of Tax Resident and “Five-year Exemption Rule”
(1) Definition of Tax Resident under the New IIT Law
The new IIT Law, part of which already took effect on 1 October 2018 and the rest will come into effect on 1 January 2019, adopts the widely practiced 183-day test in the defining tax resident and introduces the definitions of “resident” and “non-resident”. Under the new Law, individuals who are non-domiciled and have resided in mainland China for 183 days or more within a calendar year, are considered as China tax residents.
The new IIT Law then further require that individuals who are considered as tax residents should be subject to China individual income tax on their worldwide income.
(2) Revised 5-year Rule
The new draft Implementation Rule keeps the ‘Five-year Exemption Rule’ with a couple of changes to the requirements.
In accordance with the Draft, expatriates as well as Hong Kong, Macau and Taiwan residents who stay in China for less than 5 consecutive years or who stay in China for more than 5 consecutive years but leave China for more than 30 days in a single trip during that five-year period, is only subject to China individual income tax on income received from inside China. Expatriates who stay in China for more than 5 years consecutively and do not leave China for more than 30 days in a single trip during the five-year period will then be subject to China individual income tax on their worldwide income.
In addition, the condition for entitlement to the tax exemption for expatriates who stay in China for less than 5 years consecutively or who stay in China for more than 5 years consecutively but did leave China for more than 30 days in a single trip during that 5-year period also changed from being required to be approval by the tax authority to filing with the tax authority.
3. Break the Revised 5-year Rule
In accordance with the New IIT Law and the New Regulations, when an expatriate lives in China for 5 years continuously, then starting from the 6th year, she or he will be subject to China individual income tax on incomes received from both inside and outside of China. Should this be the case, her or his tax liability is likely to be increased substantially.
To break the five-year period at any point and reset tax residency, an expatriate should leave China for a period of more than 30 full days consecutively in one trip within a ‘Tax Year’, after becoming a China tax resident for four consecutive years. This will in effect reset the clock back to zero in tax years and the following year would become year 1. The process can then be repeated every five years, therefore enabling an expatriate to remain exempt from tax on income sourced outside China.
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