China recently clarified how it will implement the "six-year rule" to determine foreign workers' tax residency in China, following the introduction of a new Individual Income Tax (IIT) Law last year.
On March 16, 2019, China's Ministry of Finance and State Taxation Administration published the Announcement on the Criteria for Determining the Residence Time of Individuals without Domicile in China (see here for the official announcement), which explains how the tax residency of foreigners in China will be calculated.
The announcement clarifies, among other things, when tax authorities will begin counting days spent in China for the purposes of determining the tax residency status of foreign workers. In other words, the announcement details how the so-called "six-year rule" will be enforced.
According to the six-year rule rule, foreigners who are residents of mainland China for six consecutive years will be subject to taxation on their worldwide income. Before the announcement, however, some of the details of the rule – which was updated with the passing of the new IIT Law – remained unclear.
Foreign taxpayers should take note of the updated rules as they plan their tax obligations in China and abroad.
Tax residency rules relaxed, new details released
Before the new six-year rule was announced, many observers thought that tax authorities would make taxation of foreigners' overseas income stricter. Ultimately, however, the authorities went the other direction and mostly widened preferential policies for foreign taxpayers.
Compared to the previous " five-year rule", the six-year rule provides a looser tax policy for foreigners (including residents of Hong Kong, Macau, and Taiwan) who work in China but also earn overseas income. The relaxed stance on taxation of foreigners' overseas income is part of a policy to attract foreign investment and encourage high-level foreign talent to work in China.
The key points of the six-year rule are:
- Under the old policy, if a foreigner stayed in China for five consecutive years, his or her worldwide income would be taxed in China. Now, the new IIT Law extends the five years to six, allowing foreign workers in China more time to avoid paying taxes on income sourced overseas.
- In relation to the six-year rule, if there is a single departure outside of mainland China of more than 30 consecutive days at any point during the six years, the clock to count tax residency will be reset.
- The management of tax filing will be streamlined so that taxpayers no longer need to get pre-approval from local tax authorities to enjoy tax benefits. Now, taxpayers can enjoy tax benefits at the point of filing.
In addition to laying out the key features of the six-year rule, the announcement describes how days and years spent in China are defined.
- Since the start of 2019, a foreigner is deemed to have spent a year in China if he or she stays in the country for at least 183 days within a given calendar year.
- Those who stay in China for less than 24 hours within a single day will not be counted as having a day of residence.
- The number of years of residence to calculate the six-year rule will be determined beginning from January 1, 2019. The number of years spent in China before 2019 will not be included in the calculation.
How to determine tax residency status in China
As stated above, the six-year rule contains a number of exemptions and conditions to calculate tax residency status. Here, we present some examples to demonstrate how a foreigner's tax residency status would be determined under different situations.
How to count tax residency status for one year
Mr. Li is a Hong Kong resident who works in Shenzhen city. He goes to Shenzhen to work every Monday morning and returns to Hong Kong every Friday evening. On Mondays and Fridays, he stays less than 24 hours in mainland China, so the two days are not counted as being full days spent in China for tax purposes.
In addition, Saturdays and Sundays are not counted either, because Mr. Li spends them in Hong Kong. That means that although Mr. Li works in mainland China during the weekdays, for tax purposes he is only counted as being in mainland China for three days.
If we count 52 weeks in a year, Mr. Li will be staying in mainland China for 156 days – less than the 183 days needed to be considered a tax resident. As a result, all of Mr. Li's income from overseas (including Hong Kong) will be tax exempt in mainland China.
How to count a tax residency reset
Mr. Li moved to Shenzhen on January 1, 2013 and still works there today, in March 2019. If we count the times Mr. Li stayed in Shenzhen for over 183 days in a year, he has exceeded six years in mainland China. Despite this, because all years before 2019 were cleared from the count with the passing of the new IIT Law, the counting of years spent in China only started from January 1, 2019.
As a result, even though Mr. Li has been living in China since 2013, he will only be taxed on his worldwide income starting from 2025. However, to avoid this exposure to taxation on worldwide income in 2025, Mr. Li decided to spend January and February 2024 in Hong Kong.
By doing so, Mr. Li will have left mainland China for over 30 consecutive days, thereby resetting the clock. Consequently, Mr. Li will not have to pay taxes on his worldwide income.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.