On August 31, the discussion on the new individual income tax law, which has attracted attention from all sectors, achieved substantive results. According to the progress of the draft, the new individual income tax law is proposed to be fully implemented starting from January 1 of next year. Meanwhile, it is proposed that from October 1, 2018, to December 31, 2018, the basic deduction standard for wages and salaries will be increased to 5,000 yuan per month, and the new comprehensive income tax rates will be applied.
This draft of the individual income tax law is the first major reform of the personal income tax system in 30 years, which will have a significant impact on ordinary Chinese tax residents, foreign residents, and high-net-worth clients. In particular, the overall wealth planning of high-net-worth individuals, especially regarding succession planning schemes involving overseas structures, needs to be re-examined. Based on the content of the draft, the following is an analysis of the impacts and changes for high-net-worth individuals.
1. Determining Tax Resident Status Requires Counting Days
Redefinition of tax resident status: Introducing the classification of tax resident individuals and non-tax resident individuals.
According to the draft amendment to the individual income tax law, individuals with or without a domicile in China (in practice, individuals without a domicile basically refer to foreign individuals) who have cumulatively stayed in China for more than 183 days within a natural year constitute Chinese tax residents, and their global income is subject to individual income tax.
Compared with the current individual income tax law, this shortens the trigger time for tax residency. This increases the difficulty for high-net-worth individuals who aim to avoid becoming Chinese tax residents.
Tax residency determines to whom the individual income tax law applies and over whose global income it exercises jurisdiction. Under the new tax resident rules, the single legal fact of whether one holds a Chinese passport should have no impact on the determination of tax resident status; the key is the individual's duration of stay in China. This is good news for high-net-worth individuals holding Chinese passports, as holding a Chinese passport does not automatically lead to being considered a Chinese tax resident. However, from another perspective, this tax resident rule will help CRS take effect, and it will be easier for risks to be exposed for high-net-worth individuals with overseas financial accounts.
With the implementation of CRS, information on overseas bank and other financial accounts of Chinese tax residents will become transparent, which brings great challenges to high-net-worth individuals with overseas asset allocations.
The main affected groups are:
① High-net-worth individuals who possess permanent residency in other countries
If they are in a high-tax country, it generally will not lead to double taxation. However, if it is a low-tax country, their tax burden will increase significantly.
② Individuals holding multiple passports
If overseas assets are discovered, they will be taxed.
③ Foreigners serving as senior executives in China
Those with significant economic interests will also be subject to individual income tax.
2. Assisting CRS, Overseas Account Tax Risks Are More Easily Exposed
As of August 2018, 83 countries and regions have confirmed that they will exchange financial account information with China:
Andorra, Argentina, Aruba, Australia, Austria, Azerbaijan, Bahamas, Bahrain, Barbados, Belgium, Belize, Bermuda, Brazil, British Virgin Islands, Bulgaria, Canada, Cayman Islands, Chile, Colombia, Cook Islands, Costa Rica, Croatia, Curacao, Cyprus, Czech Republic, Denmark, Estonia, Faroe Islands, Finland, France, Germany, Gibraltar, Greece, Greenland, Grenada, Guernsey, Hungary, Iceland, India, Indonesia, Ireland, Isle of Man, Italy, Japan, Jersey, South Korea, Latvia, Lebanon, Liechtenstein, Lithuania, Luxembourg, Malaysia, Malta, Mauritius, Mexico, Montserrat, Nauru, Netherlands, New Zealand, Norway, Pakistan, Panama, Poland, Portugal, Romania, Russia, Saint Kitts, Saint Lucia, Saint Vincent and the Grenadines, Samoa, San Marino, Saudi Arabia, Singapore, Slovak Republic, Slovenia, South Africa, Spain, Sweden, Switzerland, Turks and Caicos Islands, United Arab Emirates, United Kingdom, Uruguay
The vast majority of countries' information exchanges are for the 2018 annual financial account balances (some are for 2017, such as Bermuda, BVI, Cayman Islands, Saint Kitts, etc.; and some are for 2019, such as Cook Islands, etc.).
The new individual income tax law will be implemented from January 1, 2019, and the 183-day standard for determining tax resident status will also apply to the 2019 tax year. As for whether an individual was a Chinese tax resident in 2018 and before, it needs to be judged according to the pre-amended individual income tax law. So, does the new individual income tax law have no impact on the 2018 CRS exchange? The author believes that although the individual income tax law takes effect on January 1, 2019, it will still assist in the exchange of 2018 annual account information (the exchange content is the balance at the end of 2018, exchanged around September 2019).
Under the existing definition of tax residents, tax authorities and domestic and foreign banks are confused about the determination of Chinese tax resident status. The final result is that there is a lot of confusion about whether Chinese passport holders with overseas accounts, new immigrants who have changed to foreign passports, and Chinese citizens working abroad who only hold residence cards or green cards are Chinese tax residents.
The greatest value of the new individual income tax law is to announce the rules of the game in China to the world: from the date the amendment is passed, China will use 183 days as a clear standard for determining tax residents, and announce it widely. The 183-day tax resident definition standard is simple and clear, and it is easy for both tax authorities and banks to operate. Such a definition standard is the best partner for the tax information exchange CRS!
Such a simple, clear, and easy-to-judge tax resident determination standard will make CRS truly begin to take effect. Overseas banks are expected to increase their scrutiny of tax compliance for Chinese clients because China now has a clear tax resident standard.
When you fill in that you are a tax resident of another country on an account opened at an overseas bank, but the stamps on your passport prove that you have been in China for more than 183 days, you do not need the opinion of a tax professional; the bank itself can determine that you have already constituted a "Chinese tax resident." When you hold a Hong Kong passport but spend most of your time in China, writing "Hong Kong tax resident" is clearly no longer so easy to pass at the bank. A complete copy of a passport will expose an individual completely to the monitoring of the bank's compliance department. Even if the account manager is your best friend, they may not take the risk for you, because the bank's compliance department might make the banker lose their job; the bank's compliance department will not be attracted by your story of being a "non-Chinese tax resident" because the provisions in the national anti-money laundering legislation that tax evasion is an upstream crime for anti-money laundering have already put a tight constraint on the bank.
3. Anti-Tax Avoidance Rules Are a "Sharp Knife"
The addition of anti-tax avoidance rules in the individual income tax law is just an inevitable result of CRS. If the new individual income tax law has re-woven the net by modifying the tax resident rules, and the CRS rules have caught the fish, then the newly added anti-tax avoidance rules are the real sharp knife. Please remember that high-net-worth individuals and their affiliated companies must follow the arm's length principle, and the structure of holding financial accounts through offshore companies will no longer work!
A common view is: overseas financial accounts are under the name of an offshore company, not under an individual's name, so even if they are exchanged, there is no need to pay supplementary taxes in China. Now, this view is definitely wrong—this is the power of the anti-tax avoidance rules.
The individual income tax law has added Article 8: "In any of the following circumstances, the tax authorities have the right to make tax adjustments according to reasonable methods:
(1) Business dealings between an individual and their related parties do not comply with the arm's length principle, thereby reducing the tax payable by the individual or their related parties, and there is no justifiable reason; (Arm's length principle)
Let's analyze with the simplest example: A Chinese tax resident individual holds 100% of an offshore company, and the offshore company holds an account. The transfer of funds from this account to the individual's account is easily regarded as dividend distribution (20% individual income tax in China) or a loan (interest paid at market interest rates, with 20% individual income tax on the interest).
If the offshore company holds an aircraft or yacht, the individual also needs to pay usage fees according to the fair market value for the use of the aircraft, yacht, etc. Otherwise, the tax authorities can make adjustments, treating it as the individual receiving investment benefits such as dividends.
(2) Enterprises established in countries (regions) where the actual tax burden is significantly low, controlled by resident individuals, or jointly controlled by resident individuals and resident enterprises, have no reasonable business needs, and do not distribute or reduce the distribution of profits that should belong to the resident individuals;
In the same simple example, a Chinese tax resident individual holds 100% of an offshore company, and the offshore company holds several accounts. Offshore companies are usually in tax havens such as BVI or Cayman Islands. Even if the offshore company does not distribute dividends, in the absence of business needs, applying this clause will treat it as dividend distribution and pay 20% individual income tax in China.
(3) Individuals implement other arrangements that do not have reasonable commercial purposes to obtain improper tax benefits.
"Where the tax authorities make tax adjustments in accordance with the provisions of the preceding paragraph and need to collect supplementary taxes, they shall collect the supplementary taxes and charge interest in accordance with the law."
4. Personal Tax Resident Planning
Due to the adoption of the internationally accepted 183-day standard, foreign individuals (including Hong Kong and Macau passport holders) will have to start counting days. If they stay in China for 183 days, they will become Chinese tax residents. For those Chinese entrepreneurs who hold foreign passports but spend most of their time in China, the foreign passport itself will no longer be able to provide you with substantial tax advantages.
Chinese passport holders need to determine whether they are Chinese tax residents according to the new 183-day tax resident rule. Similarly, such a clear tax resident rule also provides space for individuals to plan their own tax resident status. The core of tax planning for high-net-worth individuals is the planning of tax resident status. For the planning of personal tax resident status, some Chinese entrepreneurs may have to spend more time abroad. This is also the experience of countries with similar tax resident rules.
5. Giving Up Chinese Household Registration, Beware of "Exit Tax"
Article 10 of the individual income tax law has added a new provision—"In any of the following circumstances, the taxpayer shall handle tax declaration in accordance with the law: ... (5) Cancellation of Chinese household registration due to moving abroad...". It is generally believed that this is China's "exit tax".
Cancellation of Chinese household registration is the trigger factor. Therefore, if high-net-worth individuals want to give up their Chinese household registration (usually accompanied by giving up their Chinese passport), it will trigger a "tax clearance" in China. Such a provision is still only principled, and its specific application remains to be further clarified. If following some practices in other countries, it is usually deemed in tax law that assets are disposed of according to market fair value, and individual income tax needs to be paid.
6. Buying and Selling Passports to Avoid CRS, It's Time to Stop
Once the amendment to the individual income tax law is passed, buying and selling passports as a so-called CRS "planning" scheme can stop.
The greatest value of legislation is to announce the country's rules of the game to the world: from the date the amendment is passed, China will use 183 days as a clear standard for determining tax residents, and announce it widely. When you buy a passport from a certain country but live in China most of the time, how can you continue to tell your story of being a "non-Chinese tax resident"? Of course, you will say that such a result is the same under the tax resident definition of the current tax law! No, the tax resident status rules under the current tax law have become a concept with unclear connotations and extensions in reality, and in fact, they have become no rules at all. Since China does not have clear tax resident rules, banks are naturally willing to let it be vague.
This tax reform will have a significant impact on ordinary tax resident individuals, foreign executives, and high-net-worth individuals, especially in the wealth planning of high-net-worth individuals involving overseas structures.
The implementation of anti-tax avoidance clauses and CRS gives tax authorities the ability to find information on individuals' global accounts. BVI companies without commercial rationality will easily become the object of taxation. After the tax reform, local tax bureaus will also have more initiative and interpretation rights, and personal tax planning must be more cautious. Therefore, appropriate solutions should be sought in a timely and early manner to avoid tax risks.
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