Limiting Tax Exposure for American Expatriates in China
Oct. 5 – American expatriates’ global income may be exposed to China individual income tax (IIT) at marginal rates reaching 45 percent. The expatriate may also be required to contribute to the new Chinese social insurance program, and Chinese entities employing such an expatriate may be required to contribute at a multiple of roughly three times the individual contribution. In short, tax and social insurance payments in China can accumulate to a truly burdensome level.
However, it is possible to limit expatriate exposure to China IIT through detailed planning around (among other things) the specific amount of time the expatriate spends in China, as well as the formal characterization of the expatriate’s employment status and local income. Two options to consider in structuring an American expatriate’s China employment for tax efficiency are the option of secondment and the option of part-time employment.
An attractive arrangement to avoid exposure to China income tax is for an American expatriate to be seconded to a China entity for a period of less than 183 days, as well as less than six months (See “six months” discussion below) and to only receive salary from the American entity. The China entity to which the expatriate is seconded could be a subsidiary of an American parent or an independent China entity. However, the salary of the expatriate must not be charged back to the Chinese entity. In theory, the expatriate’s foreign salary would be totally exempt from China IIT during this less-than six month period.
The number of actual days passed in China and also the concepts of “six months” and “permanent establishment” are important to this analysis. According to the China-U.S. double taxation agreement (DTA), an American becomes subject to Chinese individual income tax once he or she has spent 183 days in China, and any American visitor should be tracking the days spent in China to avoid triggering such exposure. Perhaps the more perilous criterion for determining tax exposure relates to the tax concept of “permanent establishment” and the six-months rule in the US-China DTA. An American enterprise (formal or informal operations in China) that is deemed to be a China “permanent establishment” will be subject to China taxation. This includes, among other taxes, individual income tax and corporate income tax. According to the DTA, a “permanent establishment” will be deemed to have been established after, among other things, a company’s representative has been doing business in China for a cumulative period of “six months.”
How the “six month” period is calculated is an evolving concept. It may eventually be calculated on the basis of the actual number of days spent in China, just as is the current test for determining an individual’s income tax exposure. However, at the moment, the old rule of calculation still applies. In order for an American expatriate to escape liability for IIT, he or she must pay attention to the 183 days rule and also, perhaps most importantly, to the old six-month rule. This six-months rule seeks to establish that there have been six one-month long absences from China in any twelve-month period. Therefore, it is critical to remain outside of China for a full month of time before returning. Just one day spent in China will “spoil” the accumulation of days that might otherwise have eventually amounted to a full month of time and assisted in freeing the expatriate of unwanted IIT liability after six such one-month long periods had been accumulated in any given twelve-month period. Carefully planning one’s visits to China takes on critical importance.
It should be borne in mind that a “representative” of a China representative office (RO) would not be able to be “seconded” to a China RO. Once a “representative” is registered as such at a China RO, then his or her global income will be subject to China individual income tax from the very first day. If he or she is a part-time “representative,” then he or she will be taxed on the ratio of days actually spent in China each month, also starting from the first day of employment in China.
If an American expatriate cannot avoid spending six months or more in China, then another option to limit tax exposure may be to enter into a part-time employment contract with a local Chinese entity from the very beginning of the expatriate’s work in the country. The expatriate would need to hold another part-time position outside of China simultaneously with his or her China part-time employment. The American expatriate’s IIT would be calculated monthly on the basis of his or her global income on a ratio of the number of days spent in China during any given month.
As a general rule, it would be best to receive as little income as possible within reason directly from a Chinese entity. This would not be relevant during the first six to nine months of employment in China, since IIT would be calculated on the basis of global income. However, it would become relevant if the expatriate remains in China longer than one year (more than 275 days in China) because locally-derived income is weighted more heavily in the formula used to calculate IIT for those expatriates remaining in China for a full year. It may also be relevant from the very beginning of employment because it may increase the social insurance withholding amount, but only if the expatriate’s salary is an amount below the limit used to calculate the maximum contribution to social insurance.
China IIT reporting and payment is made on a monthly basis (and annually if total annual income is above RMB120,000). The filing and payment must be made during the first 15 days of the month following the month in which work was performed. For instance, if an American expatriate enters into a part-time employment contract with a local entity and begins work in June, then he or she will be required to report global income and make payment during the first 15 days of the subsequent month of July.
Please note that if an American expatriate has attempted to avoid spending “six months” in China (or 183 days), but then inadvertently crosses the “six months” line, then he or she may:
- Be obligated to start filing monthly individual income tax returns and paying individual income tax every month thereafter;
- Be obligated to pay fines and penalties; and
- Be obligated to file an individual income tax return and pay all taxes that shall have accumulated for the first six months he or she has spent in China.
Assuming part-time employment, monthly taxes thereafter would be calculated on the numbers of days spent in China during each subsequent month. Photocopies of passport stamps may need to be provided to tax authorities when IIT returns are filed. Such American expatriates may also have inadvertently exposed their overseas corporate parent to China taxation because the corporate parent may be regarded as having a “permanent establishment” in China through the expatriate representative remaining there for “six months.”
One Year and Five Year Thresholds
Note that once an American expatriate has spent more than one year in China (more than 275 days), then the expatriate’s global income will be exposed to China IIT on the basis of a formula that gives greater weight to the portion of salary receive from the China entity. For this reason, if there is a possibility an expatriate will remain in China for as long as one year, then it is better to allocate as little salary as possible within reason to the China entity.
Once five years have been spent in China, then all global income of any kind must be reported and may be exposed to China taxation.
Chet Scheltema is an American business lawyer based in Dezan Shira & Associates’ Beijing office. He assists U.S. companies to establish operations in China.
Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.
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