In a mini series of two articles we would like to share some information about a topic we not only deal with in our consulting work on a daily basis, but which also affects everybody living and working in China on a very personal level: individual income tax for expats. We hope to give you a detailed and concise account of current IIT laws in China and point out a few tips for avoiding too costly taxation. In this first part of the series we will now deal with the basics of expat IIT liability.
Main Factors for IIT Liability
To understand when foreigners working in China will be liable to pay IIT in China, it is important to know about several key factors. Whether IIT needs to be paid by an expat in China and how much IIT needs to be paid depends on:
How much the expat earns
How long the expat stays in China
Who bears the expat’s income
What kind of positions the expat is holding in his host country and home country company
Level of Income
First of all, it needs to be clear which portions of the money an expat receives from the employer are deemed to be taxable income by the Chinese authorities. This includes the base salary, incentive compensations like commissions and bonuses, cash allowances and contributions to an overseas insurance scheme.
The tax rate levied on that taxable income then depends on its cumulated amount. China adopts a progressive taxation system where the tax rate for freelancer’s incomes progresses in three levels from 20% to 40% and the tax rate for regular employees in seven levels from 3% to 45%. A tax exemption of 4800 RMB per month for expats and of 3500 RMB per month for locals is granted. Furthermore, for each individual taxation grade there is a quick deduction amount which will be exempted additionally for this level of taxable income.`
The following table gives an overview of IIT taxation grades.
Thus, a quick formula to calculate the IIT burden is:
Furthermore, it has to be determined which part of the worldwide income the expat might receive for various assignments from various sources is deemed taxable in China. The second important factor in determining an expat’s IIT liability is therefore the duration of his/her stay in China. The relevant thresholds for IIT liability are 1 day, 90 (respectively 183) days, 1 year and 5 years. In combination with the third important factor, the source of payment for the expat’s income, we can then determine on which part of his/her worldwide income an expat needs to pay IIT in China.
If the expat is being paid for his assignment in China by a China company – i.e. his income is borne by a Chinese legal entity – then he/she will be liable to pay IIT from his first day on. In contrast, if the expat’s China source income is borne by a Company outside of China – an overseas entity – then he/she will not be liable to pay IIT in China, unless he/she stays in China for more than 90 days. If there is a tax treaty between China and the expat’s home country, this threshold is usually extended to be 183 days.
Furthermore an expat might not only have to pay IIT in China on his income derived from activities in China, but possibly also on additional income derived from outside of China. Again, IIT liability on worldwide income depends on duration of stay and source of payment for that income.
If the expat’s out-of-China income is borne by a Chinese legal entity and the expat stays in China for more than one year, he will have to pay IIT on this income as well. If he stays in China less than a year, he will not have to pay IIT on the income derived outside of China. However, there is one exemption to this, which applies, should the expat hold a dual senior management role in China and another country and should the payment for his work outside of China be borne by a Chinese entity. In this case the expat will have to pay IIT on the income derived from out of China from the very first day.
In the final and most tax-intensive case the expat will be liable to pay Chinese IIT on his worldwide income. This case is referred to as the “Five-Year-Rule” as it applies when the expat has been staying in China continuously for a period of more than five years, i.e. has been a tax resident for more than five years. Then, all income derived from overseas and borne by overseas entities will also fall under the Chinese IIT regime.
The following table gives an overview of the discussed scenarios.
In a nutshell
As we have seen individual income tax liability for expats in China depends on a – sometimes very complex – combination of factors. An expat planning to keep his personal tax burden at a reasonable level should plan accordingly and carefully assess the structure of his taxable income, his income-generating activities in and out of China, the sources of his income and the duration of his stay in China.
In the next part of our mini-series on Chinese IIT for expats we will deal with some tips regarding the 5-year-rule and the structure of the salary/employment contract, which can help to keep the expat’s IIT burden at a reasonable level.
with contributions by Claudia Foecking
Richard Hoffmann Lawyer in Heidelberg Phone: +49 6221 9985 639 E-Mail