Working in China can be quite rewarding, as most expats enjoy great cultural experiences and are treated well. Although China is no longer considered a “hardship” post, the average expat can still expect to enjoy an overall compensation package that’s better than if they were in their home country.
Even though China’s top income tax rate for wages and salaries is bracketed at 45 percent, there are several concessions available for expats. Certain benefits are exempt from tax as long as the amounts are reasonable and substantiated by official invoices (fapiaos).
- Accommodation rent
- Meals and laundry
- Moving expenses
- Children’s tuition
- Trips to home country
- Language training
Generally, China’s individual income tax is quite straightforward for foreigners as the taxes are withheld from their pay on a monthly basis. Subsequently, a simple recap of an Annual Individual Income Tax declaration must be filed to tax authorities by March 31 of the following year if the individual’s annual income exceeds RMB120,000.
As most U.S. citizens and residents living abroad decry the burdens of declaring their worldwide income on their U.S. tax returns, unbeknownst to most, China also taxes its citizens/residents (hukou or household registration) on their worldwide income.
Some foreigners in China need to pay taxes on worldwide income
The tax test
Nonresident aliens can be taxed as residents of the United States if they spent too many days in the U.S. by meeting the substantial presence test. The substantial presence test requires the individual to be present in the United States at least 31 days during the current calendar year and 183 days during a three-year period which includes the current year and the two immediately preceding years.
For purpose of the 183-day test, days are counted as all days present in the current year, one third of days present from the first preceding year, and a sixth of days present from the second preceding year.
Unlike the U.S., China has its Five-Year Tax Rule for the expats which is far less confusing than the U.S. substantial presence test. According to the rule, foreigners who have lived in China for more than five years continuously will be subject to individual income tax on their worldwide income from the sixth year onwards for every full year spent in China.
To avoid being subjected to this rule, expats should leave China for a period of 30 consecutive days or 90 days cumulatively during any year within the five-year period. If expats already met the five-year rule; luckily, expats can reset the clock and break the five-year residence in China by spending less than ninety days (or less than 183 days for tax treaty residents) in China in any single tax year starting from the sixth year.
Once an expat has reached the status of resident in China, he or she will be required to include his or her income from sources within and outside China, including income from interests, dividends, capital gains, rental income, and income recognized from the exercise of employee stock options granted and vested while working outside of China. The home country of the expat generally has the first right to tax. After paying the taxes in foreign jurisdictions, the expat may claim the income tax paid outside of China against the amount of the income tax assessed in China. Since the China tax is a pay-as-you-go withholding system and the tax return is generally due merely 30 days after the calendar year, reporting foreign incomes on the Chinese tax return can be quite daunting.
Although China Individual Tax reform is on the horizon, currently there is no foreseeable tax benefit to being treated as a Chinese resident for tax purposes other than receiving a gracious “thank you” note from the State Administration of Taxation (SAT) for paying the taxes. On the contrary, nonresident aliens in the U.S. can elect to be taxed as residents of the United States if certain requirements are met, and thus enjoy more favorable rules as residents. The U.S. tax rules regarding filing status, deductions, and exemptions for nonresident aliens are much more restrictive than those filing as U.S. residents.
Just like the U.S., China is actively pursuing its residents to report their worldwide income. Although enforcement has not been aggressive in the past, China has recently signed an intergovernmental agreement with the United States on cooperation with the Foreign Account Tax Compliance Act (FATCA). FATCA is a reciprocal agreement to combat tax evasion which requires the financial institutions in cooperating nations to share financial information on their citizens which makes hiding income offshore a lot more difficult.
Cross border taxation will undoubtedly add an extra layer of complexity. Familiarity with the Chinese Five-Year-Rule can avoid unwanted tax complications.
David Yen is with U.S. Abroad Tax in Shanghai and he may be reached at firstname.lastname@example.org. This article is not intended as legal or tax advice, and cannot be relied upon for any purpose without the services of a qualified professional.