Following the economic development in China, there is an increasing number of businessmen visiting the country. Some companies even establish offices in the
Mainland and send employees to work there. However, people are generally not aware of their exposure to the personal tax in China in respect of their China visits or stays. Actually, the exposure can be substantial as the tax rates on personal tax in China, namely Individual Income Tax, can be as high as 45%!

Know the new rule

The State Administration of Taxation in China has recently released a new rule - Guo Shui Fa [2004] 97 (“Circular 97”). The circular has clarified a number of questions many human resources professionals and foreign individuals working in China have raised in the past and brought several changes to them with retrospective effect from 1 July 2004. These changes may impact both visiting employees to China as well as people currently stationed in China. As various local industries continue to expand beyond Hong Kong into the Mainland, a good understanding on China?’stax system is a must. This article is written to help you grasp the key points of the new rules of game.

The new rules bring both good and bad news to us. Frequent visitors to China will be caught in the Individual Income Tax net more easily while daily commuters to China may pay less on their tax. Furthermore, a portion of senior management personnel (such as chief executive officers, general managers, directors of a functional sector, etc.) may be better off than other ordinary employees. Most importantly, everyone needs to maintain detailed travel records as this is the critical evidence to support any tax claim and the use of the favourable Individual Income Tax assessment formula. Now, we may go into the details of this influential and important rule.

Taxability of a visiting employee

Perhaps, most people may have heard of the well-known rule of thumb - the 90/183-day rule. It is generally understood that a person need not pay Individual Income Tax in respect of his or her remuneration from services rendered in China if he or she has not stayed in China for more than 183 days (applicable to tax residents from countries or regions with a tax treaty/ arrangement with China; for tax residents from other countries or regions, the threshold is reduced to 90 days) in a calendar year.

However, it is not absolutely correct. The 183-day rule remains valid only when the remuneration of the concerned visiting employee is not paid or borne by any China entity. If it is not the case, for example, part of the visiting employee’s remuneration is charged back to a China entity, the visiting employee who has stayed in China less than 183 days should still be subject to Individual Income Tax from his or her first day of service in China. Certainly, counting the number of days staying in China can be a good way to determine their Individual Income Tax taxability of visiting employees whose remuneration are not partly or fully paid or borne by any China entity.

Unfortunately, the method of counting days in China has also been a controversial area. Unlike the old principle generally adopted in the past where the day of arrival was counted and the day of departure was ignored, Circular 97 provides that “a day in China” includes any part of a day when a person is physically present in China. As such, both the day of arrival and the day of departure will be counted in determining the taxability of a visiting employee to China. In short, it is much easier for visiting employees to fall into the Individual Income Tax net now.

How much is the liability?

When an individual, who may be a visiting employee or a stationed expatriate employee, is considered to be subject to Individual Income Tax, the next essential question to ask is: which taxation method should be adopted to assess his or her Individual Income Tax liabilities? Depending on the situations, different formulas will be applied in the liabilities assessment. Basically, situations can be classified into the following five types:

1. Employees staying in China not more than 183 days in a calendar year;
2. Employees staying in China more than 183 days but less than one full year;
3. Employees staying in China for one full year but less than five full years;
4. Employees staying in China for five full years;
5. Employees who are considered as senior management personnel.

Circular 97 has clarified the taxation method for the above situation where an employee’s remuneration may be partly borne or paid by a China entity. As demonstrated in the following applicable formula for such cases, there are income apportionment and time apportionment considerations on Individual Income Tax assessment of this type of employee.

Formula 1 applicable for situation 1:

Individual Income Tax payable =
(A x B - C) x (D / E) x (F / G)

Where:
A is total worldwide taxable remuneration
B is applicable tax rates
C is quick deduction for calculation purposes
D is the remuneration borne or paid by a China entity
E is total worldwide remuneration
F is total working days in China in a month
G is total number of days of that particular month

In addition, Circular 97 has also reiterated the following applicable formulas for situation 2 and 3:

Formula 2 applicable in situation 2:

Individual Income Tax payable =
(A x B - C) x (F / G)

Formula 3 applicable in situation 3:

Individual Income Tax payable =
(A x B - C) x [1- ( X / E) x (Y / G)]

Where:
A is total worldwide taxable remuneration
B is applicable tax rates
C is quick deduction for calculation purposes
E is total worldwide remuneration
F is total working days in China in a month
G is total number of days of that particular month
X is the remuneration borne or paid by a non-China entity
Y is total working days outside China in a month

Similar to situation 1, time apportionment is still possible in situation 2 and 3. However, each formula above requires number of working days in China. It has become the most confusing area because recognition of “working days in China” for Individual Income Tax liabilities assessment purposes is different from that of “days physically present in China” for the purpose of taxability determination mentioned in the above.

”Half-day” principle

For Individual Income Tax liabilities assessment purposes, Circular 97 introduces a new “half-day” principle under which the day(s) on which an expatriate employee travels in and out of China will only be counted as half a day. Effectively, such days include:

• The day of arrival;
• The day of departure; and
• The day when same-day trip(s) is/are taken.

Perhaps, this new treatment does not have any impact on most expatriate employees as the old rule required that the day of arrival should be counted and the day of departure could be ignored. However, it should be favourable to those commuters travelling into China daily as their Individual Income Tax liabilities will be reduced by as much as 50%. Here are two examples for illustration purposes:

Case 1:
An employee arrived in China on 1 September 2004 for business and left China on 7 September 2004. His total number of working days is seven days under Circular 97 and the old rule.

Case 2:
Another employee arrived in China on 8 September 2004 for business and leaves China on the same day. His total number of working days in China is considered to be 0.5 days under Circular 97 instead of one day by the old rule.

In the meantime, Circular 97 does not provide any formula for situation 4.

Senior Management Personnel

Lastly, for situation 5 where the traveller is senior management personnel, some changes are also brought by Circular 97.

In the past, expatriate employees holding senior management positions in China such as chief executive officer, general manager, director of a functional sector, etc. should be fully liable to Individual Income Tax on the portion of income paid or borne by a China entity without considering where the services were rendered. Practically, the above formula 3 should be used for Individual Income Tax assessment in such cases.

Circular 97 now provides a more lenient treatment for those who are neither officially appointed nor “de facto” statutory directors and allows senior management personnel to pay Individual Income Tax on their China sourced income only if they do not spend a “full year” in China. In other words, the above formula 2 can be used. This change brings the Individual Income Tax treatment for expatriate senior management personnel in line with ordinary expatriate employees. As a result, their Individual Income Tax burden will greatly be reduced.

Nevertheless, the above lenient treatment is not available to everyone. Only tax residents from most of the countries or regions (i.e. 67 countries or regions at the moment) signed a tax treaty/ arrangement with China may enjoy it.

With the issuance of Circular 97, some long outstanding questions have been answered. However, in the presence of several formulas, it may sometimes cause confusion. In any case, a pre-assignment consultation with your professional tax adviser would be helpful.