Forgot your password?
Please enter your email & we will send your password to you:
My Account:
Copyright © International Chamber of Commerce (ICC). All rights reserved. ( Source of the document: ICC Digital Library )
by Edward ROWE and Jinyan LI
[Page1018:]
[Page1019:]
The Individual Income Tax Law (IIT Law)1 introduced a unified personal tax regime for Chinese and foreign taxpayers. Previously, there were separate tax regimes for Chinese taxpayers and foreigners. The new regime was introduced to make the tax system more equitable and easier to administer, and to broaden the tax base.
Compared to the income taxes imposed by most developed countries, the individual income tax regime has some unusual features as described below.
The tax is essentially schedular. Only certain listed types of income are liable to tax, each category of income is computed separately, and there is no aggregation of the different categories. Some categories of income are taxed at progressive rates, while others are taxed at a flat rate.
There is no system of personal deductions, though a standard monthly deduction is allowed for some income (such as employment income) and specified deductions may be made against some types of income. Each individual is considered to be a separate taxable person and there is no aggregation of the income of, or joint taxation of, spouses.
Income is taxed at different rates depending on its nature. Whereas wage income, business income and management fees are subject to progressive taxation, some other types of income, such as remuneration for professional services and rent, royalties, interest and dividends are taxed at a flat rate.
[Page1020:]
Article 1 of the IIT Law provides that individuals are liable to tax in China:
An individual domiciled in China is liable to tax on his or her worldwide income. “Individuals domiciled in China” are defined in article 2 of the Detailed Rules for Implementation of the Individual Income Tax Law (the ITT Rules)2 as “individuals who, as a result of household registration, family or economic interests, habitually reside in China”. The concept of “domicile” therefore refers to the habitual abode or permanent place of residence. The person’s intention or reason for keeping a domicile in China also seems to be relevant in determining whether a person is domiciled in China.
Citizenship or nationality is an important factor in determining whether a person is “domiciled” for the purposes of the IIT Law. Chinese citizens are generally required by law to maintain a household registration in China and are consequently domiciled in China by reason of the place of household registration. However, since the concept of “domicile” requires that the person domiciled in China “habitually reside” in China, citizens who live permanently outside China are not considered to be “domiciled” in China.
A person who is living or working in a foreign country for a period of time while maintaining economic and family connections in China, and who lives in China from time to time, may be considered to be “domiciled” in China, depending on whether the person “habitually resides” in China. The State Administration of Taxation (SAT) notice of March 31, 19943 considered the term “habitually resides” in China. The criteria for determining whether a person habitually resides in China are: registration with the foreign police bureau, family relationships and economic ties with China.
Foreigners may be considered to be domiciled in China if they make China their permanent home, rather than a place of work or temporary stay. Permanent residence status has not to date been granted to many individuals by the Chinese government. Foreigners are normally issued a visa or residence permit to visit or stay in China, and are generally taxed on the basis of residence rather than “domicile”.
Individuals are also liable to tax on the basis of residence. The IIT Law and ITT Rules do not, however, define the concept of “residence”. The term has been interpreted, for the purposes of the previous personal tax law as meaning “physical stay”. The period of residence is calculated by counting the number of days of actual presence in China. Where a stay in China straddles two tax years, the stay for each year is calculated separately.
[Page1021:]
The tax liability of foreign individuals depends on the length of their stay in China. Foreigners who live for one year or more in China are generally subject to Chinese tax on their worldwide income. Non-residents and individuals who reside in China for less than one year are taxed only on Chinese source income (the one-year rule).
2.2.1. One-year rule4
An individual is considered to have stayed in China for one year only if he or she has stayed in China for a full calendar year. For the purpose of the one-year rule, temporary absences (absences not exceeding 30 days at a time, or an aggregate not exceeding 90 days in a tax year) are not subtracted in computing the period of stay.
Individuals staying in China for one year or more are taxable on their worldwide income, whether or not they remit non-Chinese source income to China. However, persons who stay in China for more than one year but not more than five years may, upon approval by the tax authorities, pay Chinese tax only on non-Chinese source income when such income is paid by a company, enterprise or individual in China. Under the one-year rule, income received from companies or institutions outside China, not remitted to China, is not taxable.
Foreigners who stay in China for more than five years are taxable on their worldwide income without any exceptions and irrespective of the reason for their long-term residence.5
2.2.2. 90-day rule6
Individuals who reside in China less than one year are liable to tax only on Chinese source income.
Individuals who are resident in China for 90 days or less during the year are taxed on their Chinese source income, but are exempt from tax on any compensation paid by an employer outside China for services performed within China as long as the compensation is not borne by the employer’s Chinese establishment.
The 90-day rule applies only to wages and salary income earned during an individual’s stay in China, and does not apply to other types of income that are considered to be Chinese source income.
It should be noted that the 90-day rule is commonly modified by double taxation treaties. In such a case, if the employer is a non-resident enterprise and the taxpayer is not present in China for more than 183 days in a calendar year, his or her employment income is not taxable in China. Therefore, the 90-day rule will only apply to residents of countries or regions that have not concluded tax treaties with China, such as Hong Kong, Macao and Taiwan.
Individuals who reside in China for more than 90 days, but less than one year, are taxable on income from Chinese sources, regardless of where the income is paid. [Page1022:]
2.2.3. Five-year rule
A notice issued jointly by the SAT and the Ministry of Finance on September 16, 19957 clarifies the five-year residence rule for the purposes of the IIT Law. The five-year residence period is now defined as five full consecutive years of residence, and any absence from China for 30 days or more during a temporary trip or for a cumulative period of 90 days within the same tax year does not constitute a full year.
2.2.4. 183-day rule
All tax treaties contain the 183-day rule. The 183-day rule means that employment income is taxable in China if an individual of a contracting state is present more than 183 days in China, and the employment income is paid by a resident of, or is deductible in, China. In the event that no treaty exists between China and the taxpayer’s country of residence, the 30-day rule as described above is applicable. The Chinese authorities have issued guidance on the tax treatment of employment income derived by individuals sent to work in China by international employment agencies.
2.2.5. Dual residence
Where individuals reside in China for more than one year and are therefore taxable on their worldwide income, a double taxation problem will arise if their home country levies tax on the same income. This problem is normally solved by the “tiebreaker” rules in the relevant double tax treaty, under which the individual is deemed to be resident in the country in which he or she has a permanent home or maintains closer residential ties.
[Page1023:]
Under article 2 of the IIT Law, ten categories of income are specified as taxable. The most common categories include wages and salaries, income from personal services, management and contractual fees, and income from production and business.
“Wages and salaries” are defined under article 8 of the IIT Rules as “wages, salaries, bonuses, year-end extras, labour dividends, benefits, allowances, and other income earned by an individual from an office or employment”.
Wages and salaries are normally paid on a monthly basis and individual income taxes are also computed and levied on a monthly basis. An exception is provided for wages and salaries derived from industries such as mining, ocean shipping and fishing. Taxes on salaries and wages from these industries may be levied on an annual basis and paid by monthly instalments. Since wage income is taxed monthly at progressive rates, income averaging during a tax year is permitted in computing the monthly tax liability.
No further interpretation of the terms “labour dividends”, “benefits” and “allowances” is provided in the IIT Regulations.
Since bonuses are included in the definition of “wages and salaries”, this could result in a year-end or other occasional bonus frequently being taxed more heavily than if the same amount had instead been spread over 12 monthly payments. The SAT issued a notice in June 1996 that allows an averaging of annual salaries including bonuses, so that each month’s taxable income of an individual is computed to be the same throughout the year and the applicable tax rate is therefore also the same. The tax rates applicable to wages and salaries (net of the RMB 800 deduction and any other deductions, discussed below) are as follows:
[Page1024:]
Under article 8 of the IIT Rules, “remuneration for personal services” refers to remuneration received for providing designing, decorating, installation, drafting, testing, medical treatment, legal consulting, accounting, consulting, lecturing, news reporting, broadcasting, interpretation, editing, calligraphy and painting, sculpture, cinema, audio recording, video recording, performance, advertising, exhibitions, technical services, intermediary services, agency, brokerage and other services. Remuneration for personal services performed in China is taxable irrespective of the place of payment and is taxable on a per payment basis.
The following statutory deductions are allowed:
A “single payment of remuneration for professional services” is defined as income in the form of a lump-sum payment or income earned from performing a single piece of work. Payments of a continuing nature relating to the same item of income that cannot be divided into separate payments may be aggregated with respect to all such payments received within a month and counted as a single payment.
Income from professional services is taxed at a flat rate of 20%, with a surtax that is imposed when a payment is “abnormally high” (exceeding RMB 20,000). Additionally, for non-residents, withholding tax at a rate of 20% is applied to net income from personal services.
The third category of income specified in article 2 of the IIT Law is “income from contractual operations or leasing of enterprises and institutions”. This refers to “compensation received by an individual for contracting or sub-contracting with an enterprise or institution to manage or operate the business of the enterprise or institution, including remuneration received in the form of salaries or wages”. Under Chinese law, it is quite common for a State-owned or collectively owned enterprise to negotiate with an individual a contract for the management of the enterprise without a change of ownership. The individual concerned expects to receive management or contractual fees (which may include payments described as a fixed salary).
Income from management or contractual fees is taxed on an annual basis net of related expenses.9 This sort of income is treated as business income rather than employment income and taxed annually at rates ranging from 5% to 35%, similar to the tax rate for income from production and business described below. [Page1025:]
Article 8 of the IIT Rules defines “income from production and business earned by individual households” as “income derived from activities in industry, handicrafts, construction, transportation, commerce, catering, services, repair and maintenance, and other businesses such as education, health care, consulting and other income-earning activities”.
Under article 6(B) of the IIT Law, costs and expenses are deductible in computing taxable income where costs and expenses relate to production and business (marketing, management and financial control). Although this article provides that “losses” are deductible, the term “losses” is defined in article 17 of the IIT Rules to mean “all non-operating expenditures incurred by taxpayers in the course of production and business”. There is no provision for loss carry-forward for individuals.
The tax rates applicable to individual industrial and commercial households on income from business and production are as follows:
Directors’ fees are taxed as employment income. Individuals serving as directors of enterprises, including foreign invested enterprises (FIEs), are subject to different tax rules on their income.
A 1994 SAT notice determined the tax obligations of directors and senior management personnel of enterprises in China. Under the notice, the 90-day rule and the one-year rule do not apply to directors and senior managers of enterprises in China. A director is liable for Chinese income tax during the period from the date on which he or she assumed the post of director or senior manager to the date on which his or her post is terminated, regardless of whether the services are performed in China. This affects the treatment of Chinese source income and fees that would otherwise not be considered as being of Chinese source.
However, a problem as to how to treat directors’ fees arises when an individual holds dual posts within an enterprise. The SAT notice issued on November 21, 1996 resolves this problem. Pursuant to the notice, in the case of an individual holding a post as a director or receiving income as consideration for undertaking managerial responsibilities, as well as being a “non-director” of an FIE, wages or salaries received from the “non director” posts are taxed separately from directors’ fees (except income received from transfers or sales of shares that qualify for tax exemption).
[Page1026:]
There are no statutory rules on the taxation of benefits and allowances, except that wages and salaries do not include allowances and subsidies received by taxpayers from their employers if the allowances and subsidies are paid in accordance with State regulations.
By contrast, where an employee receives a cash “allowance” on a per diem or monthly basis, the allowance will normally be treated as part of salary.
Generally, employers are required to incorporate the value of a benefit into the calculation of the tax deduction from the employees’ wages or salaries during the month in which the benefit is received. If the benefit received is in the form of a physical asset (car, dwelling, etc.), the amount of taxable income is calculated according to the price specified in the purchase documentation, or as determined by the tax authorities.
As entitlements to these high-value benefits are obtained by the employees over a period of time, their taxable value may be incorporated into the taxation of employees’ wages on an average monthly basis over the employees’ required service period.
Under the IIT Law, the contingent income of individuals is taxable. “Contingent income” is defined as “income received by individuals from awards, lotteries and other incidental income”.10 Article 2(k) of the IIT Law also states that “other income” is taxable, but this expression is not defined in the IIT Rules.
Where the exact nature of an item of income is not clear, the tax authorities are empowered to make a determination.11 In a case where income is received in kind or in the form of marketable securities, the amount of taxable income is generally the market value of the property or securities.
If two or more individuals jointly receive a payment, each individual is taxed on his or her share of the amount net of statutory deductions.
[Page1027:]
Article 4 of the IIT Law provides that the following personal income is exempt from individual income taxes:
Personal income tax may be reduced for the handicapped, the elderly and members of martyrs’ families as well as for taxpayers that have incurred heavy losses due to severe natural disasters. Other tax deductions may be approved by the State Council’s financial departments.12
[Page1028:]
In the case of individuals, income taxes are levied on a schedular basis. Aggregation of income occurs to a limited extent. The amount of income from each category, i.e. from labour, investment or property is calculated separately, as are the taxes due.
Income is calculated and taxed on a monthly basis or on a single payment basis.
The first method applies to income from wages and salaries for which a monthly deduction is allowed. For Chinese citizens, this method also applies to income from personal services or contractual fees and income from leases of property. The single payment method applies to all other types of income.
With respect to individuals, expenses incurred for the purpose of earning income are generally not deductible. However, the tax laws permit monthly lump sum deductions for residents in the case of income from labour and deductions of a fixed amount or of a fixed percentage of gross income in the case of investment income. Non-residents are not allowed any deductions from income subject to withholding tax.
Individuals may not carry forward losses.
Tax on employment income is calculated on a monthly basis. A taxpayer may not deduct any losses and outflows incurred in the course of gaining employment income. Instead, monthly deductions are granted to taxpayers regardless of whether or not the taxpayer incurred the expenditure. A standard monthly deduction of RMB 800 is allowed in calculating employment income.13 Where an individual is taxed on salary or wages for less than a full month, for example in the month of entry or the month of termination, the full deduction of RMB 800 is permitted.
In addition, individuals without a domicile in China who earn wages and salariesfrom Chinese sources are allowed an additional deduction of RMB 3,200.14 This additional deduction of RMB 3,200 applies to the following categories of taxpayer:
[Page1029:]
Employers are required to withhold taxes due on employment income. The tax withheld each month must be paid to the Treasury within the first seven days of the following month.
Where a withholding agent fails to pay the tax in due course, the tax authorities may levy a surcharge of 0.5% per day on overdue tax and set a new time for remittance. To encourage compliance, the withholding agents are allowed to retain for their own use 2% of the total amount withheld.15
Taxpayers may take credit for income taxes paid abroad on income earned outside China.16 The credit cannot exceed the Chinese tax otherwise payable on the income earned abroad. The “amount of Chinese tax otherwise payable” is defined as the amount of tax computed under article 32 of the IIT Rules taking into account the following:
A taxpayer must submit a duplicate of the certificate evidencing the payment of taxes to a foreign government.17
When the foreign income tax paid is less than the amount of Chinese tax otherwise payable, the taxpayer may deduct only the amount of foreign tax paid. If the amount of foreign tax paid exceeds the amount of Chinese tax otherwise payable, the excess portion cannot be deducted as a tax credit; however, it can be carried forward for five years.18
[Page1030:]
Chinese law does not define the term “dividend”, but it is used to mean the allocation of profits by an enterprise to its investors. Dividends are generally taxed in the same manner as other types of investment income. Resident individuals pay income tax on dividends received from sources inside and outside of China; non-resident individuals are only taxed on dividends derived from Chinese sources. Dividends received by enterprises from other enterprises are normally excluded from income to avoid double taxation. There is no imputation system to reduce double taxation for individuals on income earned through a corporate entity.
The source of dividends is the place where the company paying the dividends is
located.
Resident shareholders of companies are liable to income tax on all dividends received regardless of whether or not the paying companies are resident in China.
Resident shareholders are not allowed any deduction for expenses incurred in earning dividends.19
The tax on dividends received is generally imposed by way of withholding at the rate of 20%.
Generally, Chinese resident individuals can claim a credit for foreign tax paid on foreign-source dividends.20 A credit may also be available for the underlying foreign tax paid on profits out of which the dividends are paid.
A non-resident individual shareholder is liable to income tax on all dividends paid by companies resident in China.
The tax on dividends paid is generally imposed by way of withholding tax at the rate of 20%,21 which may be reduced by a tax treaty to 10% or 15%.
In addition, there may be an exemption available to non-residents under certain circumstances under the Chinese tax law applicable to the business entity. For example, prior to 2008 dividends received by a non-resident investor from a FIE were exempt from income tax.22
[Page1031:]
“Interest” is not defined in Chinese tax law. For income tax purposes, interest generally includes interest paid on deposits or loans, bonds, payments made provisionally for others and deferred payments.
The source of interest is not clearly defined in Chinese tax law. It is generally the place where the obligation to pay the interest arises. In most cases, the source is the place where the payer of the interest is located.
Residents are subject to tax on interest from all sources at the rate of 20%.23
Resident individuals are not allowed any deductions for expenses incurred to earn interest income.24
The following forms of interest income are exempt from individual income tax:
Taxpayers who receive any of the above interest income should submit to the tax authority an application for exemption together with supporting documents.
A credit is granted for foreign tax paid on foreign-source interest.27
Non-residents are subject to income tax only on interest that has a Chinese source.28 It is generally imposed by way of withholding tax.
The rate of withholding tax on interest paid to non-residents is 20%, which is normally reduced by tax treaties to either 10% or 15%.
[Page1032:]
Article 2 of the IIT Law provides that income tax is levied on “income from royalties”. This term is defined in article 8(F) of the IIT Rules as “income derived by individuals from the provision of the right to use patent rights, trademark rights, copyrights, non-patented technology and other licensing rights”.
Royalties paid to non-residents have a Chinese source if they are paid by a resident or if they are paid by a non-resident and are effectively connected with a business carried on in China through an establishment of the person paying the royalties.29
Residents are liable for tax on royalties arising from all sources.
For individual income tax purposes, a deduction is allowed to resident individuals in computing the amount of taxable income from royalties.30 If the single payment is less than RMB 4,000, the sum of RMB 800 may be deducted without regard to the actual amount of expenses incurred in earning the royalties. If the single payment is RMB 4,000 or more, the deduction is 20% of the payment.
Individuals are taxed, on a per payment basis, at a flat rate of 20%.31
Foreign tax credits are available for taxes paid on foreign-source royalties.32
Royalties received by non-resident individuals from a Chinese source are subject to Chinese tax.
The withholding tax rate on Chinese-source royalties paid to non-residents is 20% of the gross amount, which is generally reduced by tax treaties to 10%. [Page1033:]
In Chinese tax law, there is no separate concept of capital gains as opposed to other forms of gains. Gains are taxed as income and do not receive any special tax treatment.33 In particular, article 2(7) of the IIT Law imposes tax on “income from the transfer of property”, which is defined in article 8(J) of the IIT Rules as “income derived by individuals from the assignment of negotiable securities, share rights, structures, land-use rights, machinery, equipment, means of transportation and other property”. Under article 1 of the FIT Law and article 5(7) of the Enterprise Income Tax Regulations, income from the transfers of property falls under “income from other sources”.
The term “capital gains” is defined in article 6(E) of the IIT Law as “the proceeds from the transfer of property that exceed the original cost of the property plus reasonable expenses”.
There are no specific rules dealing with the cost of property for the purpose of computing capital gains.
Though the term “property” is not defined for tax purposes, in computing capital gains, property includes buildings, structures, facilities ancillary to such buildings and structures located in China and land-use rights.
Generally, tax on gains from the disposition of other property, such as personal use property and intellectual property, are not collected.
No distinction is made between capital losses and ordinary business losses, since capital gains are currently taxed as “other income” and subject to rules similar to those applicable to enterprises on their income from business and property. For individuals, similar rules apply as capital gains are currently taxed as “income from the transfer of property”. No carry forward of losses is available for individuals.
The source of capital gain or loss is the place where the property giving rise to the gain or loss is situated.
Residents are liable to tax on taxable gains from sources inside and outside China.
The tax rate for individuals on income from the transfer of property is 20%.34
[Page1034:]
Non-residents are taxable in China only on their Chinese-source capital gains at a rate of 20%.
A Circular issued by the SAT on July 21, 1993 clarified that income of a foreign national from the transfer of B shares or overseas shares issued by an enterprise within Chinese territory is exempt from taxation in China.
Withholding tax at a rate of 20% is imposed on capital gains realized by non-residents from sources in China. However, withholding tax may be exempted or reduced by decision of the State Council or by a tax treaty.
1 The Law was adopted by the Third Session of the Fifth National People’s Congress (NPC) on September 10, 1980; first amended by the Decision on Amendments to the Individual Income Tax Law of the Fourth Session of the Standing Committee of the Eighth NPC on October 31, 1993, then amended by the Decision on Amendments to the Individual Income Tax Law of the 11th Session of the Standing Committee of the Ninth NPC on August 30, 1999.
2 The Rules were adopted by the State Council on January 28, 1994 with immediate effect. Guo Wu Yuan Ling [142] 1994.1.28.
3 Guo Shui Fa [1994] No.089.
4 Article 6 of the IIT Rules.
5 Under the previous law in force before January 1, 1994, it was possible for an individual in these circumstances to gain exemption for foreign source income.
6 Article 7 of the IIT Rules.
7 Cai Shui Zi (95) No. 98.
8 Article 6(D) of the IIT Law.
9 Article 6 of the IIT Law.
10 Article 8 of the IIT Rules.
11 Article 8 of the IIT Rules.
12 Article 5 of the IIT Law.
13 Article 6 of the IIT Law.
14 Article 28 of the IIT Rules.
15 Article 12 of the IIT Law.
16 Article 7 of the IIT Law.
17 Article 33 of the IIT Rules.
18 Article 33 of the IIT Rules.
19 Article 6 of the IIT Law.
20 Article 7 of the IIT Law, article 12 of the FIT Law and article 12 of the Enterprise Income Tax Law.
21 Article 19 of the FIT Law.
22 Article 19(1) of the FIT Law.
23 Article 3 of the IIT Law and Article 5 of the FIT Law.
24 The gross amount is subject to tax under article 6 of the IIT Law.
25 Article 4 of the IIT Law.
26 Article 19 of the FIT Law.
27 Article 7 of the IIT Law, article 12 of Enterprise Income Tax Law and article 12 of the FIT Law.
28 Article 1 of the IIT Law.
29 Article 5 of the IIT Rules and article 6 of the FIT Law.
30 Article 3 of the IIT Law.
31 Article 3 of the IIT Law and article 5 of the FIT Law.
32 Article 7 of the IIT Law, article 12 of the FIT Law, article 28 of the FIT Rules and article 12 of the Enterprise Income Tax Law.
33 Article 2(I) of the IIT Law.
34 Article 3 of the IIT Law.