– Is the Six-Year Rule more favourable than the Five-Year Rule?

Individuals who have stayed in China for 183 days or longer (as compared to the old rules of one full year) in any tax year would now be considered as “Tax Resident” in China under the new widening definition of tax residency[1] and could be subject to IIT on their worldwide income.

Based on the newly updated regulations for the implementation of the IIT law published on 18 December 2018, the long-standing “5-year tax exemption rule” has now been extended to 6-years for foreigners who have no domicile in China but have stayed in China for 183 days or longer in any tax year with other modifications.

Is it now more favourable?

Under the old exemption, even if an individual had spent more than one full year in China (i.e., the old rule of the definition of tax residency), provided he or she did not have a domicile in China, his or her foreign income would not be subject to IIT by temporary absences from China in every 5 years by either:-

(1) being absent from China for at least one continuous period of more than 30 days every 5 years; or

(2) being absent from China for more than 90 days in aggregate within one tax year during the 5 year period.

Under the new exemption, the 5-year tax exemption rule has now been extended to 6 years. But the exemption would no longer apply to individuals who have been absent from China for more than 90 days in aggregate within one tax year during the 6 year period. For foreigners who have substantial establishments in China, it could be practically difficult for them to be absent from China for a continuous period of more than 30 days.

– How to determine whether an income will be subject to IIT?

The following handy flowchart illustrates under what circumstances an individual’s non-China sourced income would also be subject to IIT:-

As the changes in the tax exemption rules could have a huge impact to the individual tax liabilities of the expatriates working in China, employers and employees should seek professional advice to prepare for the reform.

OLN provides a full range of tax advisory services. If you have any questions regarding the above or on any tax issues, please contact one of the members of the tax advisory team.

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[1] For a summary of the key changes in IIT please refer to [“China is reforming its individual income tax rules – are you ready?”] and for more details on the impact of the new IIT law on high net-worth individuals please visit [中华人民共和国个人所得税法修改 – 对您的潜在影响及所需的即时行动]

There is no doubt that year 2018 was a busy year for Hong Kong tax advisors with the various new developments in Hong Kong tax laws. Now we are in 2019 – how will these new developments have an impact on you?

(1) The introduction of the 3-tiered standard transfer pricing documentation for Hong Kong entities engaging in cross-border related-party transactions

Who need to prepare for the reports?

You are likely to subject to reporting if you are an entity with presence in two or more jurisdictions and:-
• Having a total revenue exceeding HK$400 million;
• Having a total assets exceeding HK$300 million;
• Having more than 100 employees;
• Having intra-group related party transaction in one of the following scenarios:-
    o transfer of properties (other than financial assets and intangibles): exceeding HK$220 million;
    o transaction of financial assets: exceeding HK$110 million;
    o transfer of intangibles: exceeding HK$110 million;
    o others: (e.g. service income and royalty income): exceeding HK$44 million.

Even if you are subject to Local File and Master File reporting, you may still be exempted from Country-by-Country reporting if your annual consolidated group revenue does not exceed EUR750 million (i.e., approximately HK$6.8 billion).

	Details to be included	Filing due dates
Local File	Detailed transactional transfer pricing information such as details of the transactions, amount involved in the transactions and a transfer pricing analysis.	These filings are required for accounting periods beginning on or after 1 April 2018 and must be prepared within 9 months after the end of each accounting period.
Master File	A high-level overview of the group, including documenting the global business operations, transfer pricing policies and global allocation of income.
Country-by-Country Reporting	• To be filed by the ultimate parent entity of a multinational enterprise (“MNE”) in its tax jurisdiction.• Sets out the amounts of revenue, profits and tax paid as well as certain indicators of economic activity such as number of employees, state capital, retained earnings and tangible assets for each jurisdiction in which a MNE operates.	The filing is required for accounting periods beginning on or after 1 January 2018 and must be prepared within 12 months after the end of each accounting period.

OLN’s observations

Transfer pricing policy requires holistic review of intra-group transaction and group overhead allocation. Aftermath ratification is usually problematic. It is therefore advisable for multinational corporations to carry out preemptive measures as soon as possible. As this is the first piece of legislation in Hong Kong specifically addressing transfer pricing matters with many uncertainties in the application of the law, it is expected that the Hong Kong Inland Revenue Department (“HKIRD”) would provide further guidance in this area through new or revised Departmental Interpretation and Practice Notes. Taxpayers should continue to monitor the developments in order to assess their transfer pricing documentation obligations.

(2) Other key new developments

Lorem initius…

	Key Features	OLN’s observations/ comments
The implementation of the two-tiered profits tax rates regime	From the year of assessment 2018/2019 onwards (i.e., commencing on or after 1 April 2018), the profits tax rate for the first HK$2 million of profits of corporation will be at 50% of the corporate tax rate of 16.5% (i.e. 8.25%).	Before the implementation of the two-tiered profits tax rates regime, Hong Kong has already provided a 8.25% concessionary profits tax rate to corporates conducting the following activities in order to strengthen Hong Kong’s position as an international asset and wealth management center and drive demand for the related professional services in Hong Kong:- •  Qualifying corporate treasury centre; •  Qualifying professional reinsurance business; •  Authorized captive insurance business; •  Qualifying aircraft lessor; •  Qualifying aircraft leasing manager. The two-tiered profits tax rates regime aims to reduce the tax burden on enterprises especially small and medium enterprises and startup enterprises. Taxpayer should be aware that in case of connected entities, only one enterprise would be eligible for the two-tiered rates.
Automatic exchange of financial information in tax matters (“AEOI”)	HKIRD has already started conducting AEOI with 50 jurisdictions including Mainland China, United Kingdom, France, Singapore and Japan from September 2018. It means that HKIRD would have the obligation to provide information where requested by tax authorities of these jurisdictions.	Currently Hong Kong has activated AEOI with 50 jurisdictions which would soon extend 25 more jurisdictions including Switzerland, Cayman Islands and Cyprus [1]. Hong Kong plans to expand the list of AEOI jurisdictions to 126 jurisdictions by being one of the participants of the Convention on Mutual Administrative in Tax Matters. United States, British Virgin Islands are 2 of the jurisdictions that have already joined the Convention but not currently one of the AEOI jurisdictions.
Stamp duty on residential properties	To address the overheated property market, the Government has employed rounds of demand-side management tax measures including the followings: •  Special Stamp Duty (applying to sellers who sell residential properties within 3 years of purchase); •  Buyer’s Stamp Duty (applying to non Hong Kong Permanent Residents); •  Doubled ad valorem Stamp Duty (of which Hong Kong Permanent Residents (“HKPR”) who do not own any other residential property in Hong Kong at the time of purchasing a residential property are not affected); the recent tax measure is the New Residential Stamp Duty of which the flat rate of 15% would apply to a HKPR who acquires more than one property under a single instrument, even though that HKPR does not own other residential property at the time of purchase.	Notwithstanding the recent cooling down of the market for residential properties, there is currently no indication from the Government of the possible relaxation of the tax measures. However there is no doubt that the Government would continue to monitor the market for residential properties and would introduce tax measures in response to the market.
Tax measures in response to the population ageing	The Government has continuously introduced tax measures in response to the population ageing including the following:- •  Starting from 1 April 2019, taxpayers can claim deductions for purchasing eligible health insurance products for themselves or their specified relatives[2]  under the Voluntary Health Scheme up to HK$8,000 per insured person; •  The Inland Revenue and MPF Schemes Legislation (Tax Deductions for Annuity Premiums and MPF Voluntary Contributions) (Amendment) Bill 2018 has been introduced to seek to introduce tax deductions for deferred annuity premiums and Mandatory Provident Fund Tax Deductible with the maximum tax deductible limit for a taxpayer to be HK$60,000 per year.	It is expected that the Government would continue to introduce tax measures to alleviate the long-term pressure on the public healthcare system and to encourage savings for the retirement.
Continuous expansion of the treaty network	Hong Kong has recently signed a Comprehensive Double Taxation Agreement (“CDTA”) with Finland which is the 40th CDTA signed by Hong Kong and the first one signed with a Nordic country.	Hong Kong has continuously expanding the treaty network to bring a greater degree of certainty on taxation liabilities for those who engage in cross-border business activities and help promote bilateral trade and investment activities. There are currently 13 CDTA negotiation in progress, including Germany and Macao SAR.

Taxpayers should continue to monitor the development in the various areas of tax laws and take appropriate steps to manage the tax risks.

OLN provides a full range of tax advisory services. If you have any questions regarding the above or on any tax issues, please contact one of the members of the tax advisory team.

[1] On the basis of bilateral competent authority agreements or a multilateral competent authority agreement under the Convention on Mutual Administrative Assistance in Tax Matters.

[2] The taxpayer’s spouse and children, and the taxpayer’s or his/her spouse’s grandparents, parents and siblings.

With Hong Kong being a signatory to the Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information (“MCAA on AEOI”) and the Convention on Mutual Administrative Assistance in Tax Matters (“Convention”) entering into force in Hong Kong, Hong Kong has started exchanging financial account information with 41 jurisdictions commencing from 1 September 2018, including United Kingdom, France, Germany, Australia, Canada, Singapore and Japan.

This means the information of account holders who are subject to taxation as a resident in other jurisdictions other than Hong Kong including interest income, dividend income, gross proceeds from the sale of financial assets would be provided to the tax authorities of the other jurisdictions under the Automatic Exchange of Financial Account Information (“AEOI”) regime. Please refer to our Article “Is your personal data at stake because of the increased transparency in tax administration through Automatic Exchange of Information?” for a detailed discussion of the AEOI regime.

How it works?

(1) The Hong Kong Inland Revenue Department (“IRD”) has established a dedicated platform, i.e., the AEOI Portal, for reporting financial institutions (“FIs”) to electronically submit notifications and furnish Financial Account Information Returns for reporting the required information of reportable accounts.

(2) The IRD will exchange the financial account information collected from the reporting FIs with relevant jurisdictions via the Common Transmission System established by the OECD.

OLN’s observation

In the past Hong Kong had relied on a bilateral approach which involves signing bilateral Competent Authority Agreements (“CAA”) for AEOI with other jurisdictions that already have a comprehensive avoidance of double taxation (“CDTA”) or a tax information exchange agreement (“TIEA”) with Hong Kong. As at 13 September 2018, Hong Kong had 40 CDTAs and 7 TIEA, and signed 16 bilateral CAAs for AEOI. Hong Kong’s move of being a signatories to MCAA on AEOI and having the Convention entering into force in Hong Kong has demonstrated Hong Kong’s commitment to enlarging the scope of the exchange of tax information in the international community and to comply with the OECD’s requirement to have the first exchange of AEOI with a wide network of partners by September 2018.

With the continuous trend of the exchange of tax information between the tax authorities, taxpayers, in particular for the taxpayers that have presence in various jurisdictions, should carefully assess their tax obligations to ensure compliant with the tax laws of the relevant jurisdictions.

OLN is equipped to advise clients on tax issues arising from various jurisdictions. If you have any questions regarding the above or on any tax issues, please contact one of the members of the tax advisory team.

Major amendments to China’s Individual Income Tax Law (“IIT Law”) were proposed by the Standing Committee of the 13th National People’s Congress in June 2018 and after a period of public consultation which ended in July, the Draft Amendment (“Draft”) will likely take effect in October and be fully implemented in January 2019. 
The key reforms include:

• New definition of tax residency with revised criteria for determining tax residency status for foreigners
• Augmenting current system of taxing individual income
• Revised tax rates and reshuffling of taxable income brackets
• Expanding standard basic deduction and introducing additional specific deductions
• Introducing new anti-avoidance rules for individuals
• Implementing a taxpayer identification system

Changes to Tax Residency

The Draft introduces the concept of resident and non-resident for IIT purposes and will reduce the threshold for tax residency from 1 year to 183 days. This means that any foreign individual who has stayed in China for 183 days or longer in any tax year will be considered a resident, with income sourced within or outside China subject to IIT.

This shortened tax residency will, if passed, repeal China’s longstanding “5-year tax rule”. Under the 5-year tax rule, a foreign resident’s worldwide income only becomes subject to IIT after the resident remains in China continuously for five years. Foreign individuals were able to avoid having their overseas income subject to IIT by temporary absences from China prior to the 5-year threshold.

Reclassification of Taxable Income

Under the current IIT Law, all income received by individuals taxable was lumped together for IIT purposes. The Draft designates 4 categories of employment-related income (including income from salary and wages), income from independent personal services, income from author’s remuneration and royalties, as “Comprehensive Income”. These will now be subject to one set of progressive tax rates in determining the IIT payable on them. All tax residents will be taxed on an annual basis for these while non-residents will continue to be taxed on a monthly or as and whenever taxable income arises.

Income from business operations conducted by self-employed taxpayers will now be reclassified as “Business Operations Income”, and all income from contractual/leasing operations will either be treated as Comprehensive Income or Business Operations Income depending on the circumstances.

Income from interest income, dividends, income from property leasing, income from transfer of assets, incidental income and other income will continue to be taxed separately at the rate prescribed for those categories.

Revised IIT Rates & Tax Brackets

In an effort to alleviate the IIT burden on low and middle-income earners, the Draft consolidates certain taxable income categories and revises both the rates of IIT and tax brackets that will apply to these income categories, as illustrated in the 2 tables below:

Under Current IIT Law		Under the Draft
Categories	Tax rates	Categories	Tax rates
Income from wages & salaries	3%-45%	Classified as “Comprehensive Income”	3%-45%
Income from remuneration for personal services	20%-40%
Income from authorship	20%
Income from royalties	20%
Income from operations by individual and commercial households	5%-35%	Classified as “Business Operation Income”	5%-35%
Income derived from contractual or leasing operations	5%-35%	treated as either Comprehensive Income or Business Operation Income
Income from interest, dividends & bonuses	20%	unchanged
Income from lease of property	20%
Income from sale/transfer of assets	20%
Other income	20%

	Comparison of Tax Brackets for IIT
	on Monthly & Annual Taxable Income
Bracket	Amount (RMB) under Current IIT Law	Amount (RMB) under Draft	IIT rate (%)
1	up to 1,500/month	up to 3,000/month	3
	up to 18,000/yr	up to 36,000/yr
2	1,501-4,500/month	3,001-12,000/month	10
	18,001-54,000/yr	36,001-114,000/yr
3	4,501-9,000/month	12,001-25,000/month	20
	54,001-108,000/yr	114,001-300,000/yr
4	9,001-35,000/month	25,001-35,000/month	25
	108,001-420,000/yr	300,001-420,000/yr
5	35,001-55,000/month	35,001-55,000/month	30
	420,001-660,000/yr	420,001-660,000/yr
6	55,001-80,000/month	55,001-80,000/month	35
	660,001-960,000/yr	660,001-960,000/yr
7	over 80,000/month	over 80,000/month	45

IIT payable by lower and middle-income earners will be significantly reduced under the reforms. So, for example, a resident national with a taxable income of RMB 40,000 per month currently paying RMB 8,195 in IIT will see her tax burden fall to RMB 6,090 or less depending on which specific deductions she and her family qualify for.

Augmented Statutory Deductions

The standard basic deduction (i.e. the first part of the salary that is not subject to IIT) is to be increased slightly from RMB 3,500/month for Chinese employees (and RMB 4,800/month for foreigners) to RMB 5,000/month for both.

Arguably the single most important amendment to the IIT Law is the long overdue augmentation of deductible expenses for Chinese taxpayers. Under pre-existing implementing rules, expatriates have long been allowed to deduct 5 categories of expenses from IIT but since the Draft is silent about several of those categories, it is uncertain whether or not all of those expenses can still be claimed after the Draft becomes law. If not, the new IIT rules will significantly increase the tax burden of expatriates working in China。

The new categories of expenses that the Draft does allow as deductions are as follows:

• Children’s education expenses
• Expenses for taxpayer’s own continuing education
• Health care expenses for serious/major illness
• Mortgage interest (on principal residence)
• Rental expense (for principal residence)

These new deductions are in addition to those that Chinese taxpayers can already claim for social insurance and housing fund contributions and commercially-sourced medical insurance.

Those familiar with HR practices in China will know how time-consuming it is to track, account and make filings for employee deductions, many of which vary from month to month. In the coming months, employees will need to work closely with their employer’s finance / HR departments to ensure that all claimable special deductions are taken into account.
 

New Anti-avoidance Rules for Individuals

Under the current IIT Law, the collection and administration of IIT is governed by the Administrative Law of the PRC on Tax Revenue Collection. These are being reinforced by provisions contained in the Draft which address, among other issues, tax evasion/avoidance. In particular, Article 8 of the Draft introduces General Anti-tax Avoidance Rules (“GAAR”) for individuals which gives tax authorities wide latitude for reviewing situations under which individuals are seeking to reduce their IIT burden. Unless a justified business-related purpose can be demonstrated for those arrangements, they may be disallowed.

Art. 8 also outlines specific scenarios which are liable to challenge by China’s tax authorities (e.g.: non-arm’s length transactions; business arrangements channeled through tax havens; arrangements deriving tax benefits but lacking reasonable commercial substance, etc.).

The new GAAR are only the most recent step that China is taking to step up tax enforcement efforts and tax authorities are, no doubt, hoping to rely on the tax agreements that China has put in place with 103 countries including the USA, the UK and Canada.

To avoid expensive tax audits and penalties, resident taxpayers should review their sources of income and obtain whatever professional advice they need to ensure their arrangements comply with the new rules.
 

New Administrative Arrangements 

The Draft outlines new administrative arrangements aimed at, among other things, modernizing the collection process and incentivizing/penalizing taxpayers.

Under the new system, all taxpayers will be allocated unique identification numbers to facilitate IIT collection and internal administration arrangements.

The Draft also includes measures aimed at streamlining the tax refund claim process. In situations where taxpayers have paid too much IIT (e.g.: due to under-reporting of deductions), they can file claims and (hopefully) be paid out after the annual tax reconciliation on March 31st.
 

Final Remarks

These reforms are some of the most important and comprehensive since the passing of the original IIT Law in 1980 and will impact nearly all working age individuals in China.

Expatriate residents should expect to be paying significantly more IIT and their overseas income will be subject to far greater scrutiny. At the same time, the tax burden of millions of local working class and middle-income taxpayers will experience a windfall as their IIT burdens are reduced.

Since employers remain statutory IIT withholding agents for their employees, the reforms will certainly impact the payroll/finance operations of every company in China. Given the scope of the reforms, adapting to them will require complex adjustments that will require months to implement properly.

The new tax rates and brackets will be effective from October 1, 2018. Foreign companies with operations in China will then have only a few months to review their payroll and IIT declaration processes and communicate whatever changes are needed with their expatriate and local employees to ensure a smooth transition. Tax equalisation arrangements with expatriate employees need to be reviewed and to the extent that any of these employees incur additional taxes due to loss of deductions, employers will need to formulate a policy and plans for addressing these.

In the meantime, all taxpayers with outside sources of income and/or expenses to claim should begin gathering together supporting documents and obtaining whatever professional advice they need to prepare for these reforms.