Foreign workers and businessmen in China sometimes face the challenge of paying for their taxable income. Especially, they are taxed both on their Chinese-sourced and worldwide income depending on their residency type. But thanks to tax treaties that China has established with other countries, foreigners can also qualify for a tax exemption as well as avoid double taxation.
Read our article about Foreigners in China: How to Qualify for a Tax Exemption
France and China, for example, have established a Franco-Chinese tax treaty since 1984. Through this, the problem of double taxation is alleviated. This convention was then reissued on December 28, 2014, to respond to the new problems encountered during the first part of the 21st century. Here we will try to summarize and explain the fundamental points of this convention and recall the basics of taxation in China for French taxpayers.
Presentation of the current state of taxation in China
A report from Société Générale (a French bank) allows us to take a look at the current state of taxation in China. China’s tax policy covers various taxation items including:
- Value-added tax (VAT)
- Consumption Tax
- Corporate Income Tax (CIT)
- Withholding Tax
- Social contributions paid by the employer
- Taxes based on bilateral agreements
The current rate of VAT in China is 16 percent. However, it varies according to the status of the taxpayer, the type of product and service, and the type of sector.
The standard corporate income tax (CIT) rate is 25 percent. But there are exceptions depending on the size of the company and its sector of activity. For SMEs and Startups with an annual taxable income of RMB 1,000,000 or less, the rate is effectively reduced to 5 percent from January 2019 to December 2021. On the other hand, high-and-new technology enterprises (HNTE) and high-tech service companies have a rate of 15 percent. Finally, enterprises engaged in industries promoted in certain regions (e.g. Qianhai Shenzhen-Hong Kong Modern Service Industry Cooperation Zone, Zhuhai New Hengqin Zone, Pingtan Experimental Zone, Western Regions) also have a 15 percent CIT rate.
Withholding tax rates in China are 10 percent for dividends, interest, and royalties. On the other hand, the VAT of 6 percent applies to interest and royalties (which can be waived when royalties are paid as part of a technology transfer). Lastly, social insurance contributions by employers vary from city to city.
As mentioned above, France and China are bound by a Double Taxation Treaty. This was signed in Paris on May 30, 1984, and entered into force on February 21, 1985. It was subsequently amended and supplemented in December 2015. This Franco-Chinese tax treaty aims to avoid double taxation and prevent tax evasion regarding income taxes.
Taxation rules for French employees and managers based in China
Fiscal residence
The old rules did not provide a definition of tax residence. China had considered individuals who stayed in China for more than one year as tax residents. But now, a person is declared as a tax resident in China if :
- this person is domiciled in China (his/her habitual residence) with a residence/hukou card or if he/she has family and economic interests in China;
- has been in China for more than 183 days during the relevant tax year.
Rules favorable to expatriates
In China, tax residents are subject to IIT (Individual Income Tax) on their worldwide income, while non-residents are only taxed on their Chinese source income. Thus, the wages of non-residents in China are only taxable if :
- the employment is exercised in China;
- such treatment is provided by a stable establishment;
- the services are performed in China by the employee.
There are, however, exceptions:
- If an expatriate stays more than 183 days in China without being domiciled, he or she may be exempt from IIT on their non-Chinese source income paid by non-Chinese entities or individuals. However, they must meet this 183-day criterion for less than 6 consecutive years. It can be added that 30 consecutive days outside China are sufficient for the 6-year count to start from zero.
- If a non-resident expatriate stays in China for less than 90 days in a year, he or she will be exempt from IIT under the same conditions as the previous point.
A new category of income
The IIT is a schedular tax, i.e. it taxes each category of income differently according to its origin. Thus, IIT rates can vary between 3 percent and 45 percent of the individual’s total income. What is taxed by the IIT is an aggregation of several types of income including wages and salaries. Gains from the acquisition of stock options of listed companies received by a tax resident are also considered as part of wages and salaries for IIT.
Tax deductions and calculation methods
Deductions from the IIT are very limited. Taxpayers cannot deduct losses and expenses incurred for the purpose of earning wage income. However, there is a monthly lump-sum deduction of RMB 5,000.
Among the deductions from IIT are deductions from employee social security contributions, which are called “specific deductions”. On January 1, 2019, tax authorities created additional specific deductions. Thus, one can obtain a tax allowance on :
- the costs related to the child’s education
- continuing education
- housing loans
- residential rents
- health care spending
- the cost of care for the elderly
However, there is a ceiling on these deductions. For tax purposes, expatriate residents in China who enjoyed exemption from IIT on benefits in kind related to these same costs, but without a ceiling, should thus be disadvantaged by the reform. Therefore, a transitional arrangement is put in place, giving them the possibility to apply the old rules until December 2021.
In addition, there has been a change in the methods of calculating the IIT. Indeed, the latter is deducted at the source monthly and regularized at the end of the year. Employers are responsible for the payroll deduction. However, the calculation differs on whether or not one is a tax resident in China. Tax residents have their overall income subject to monthly installments of IIT on the sum of salaries already paid – the sum of monthly allowances of RMB 5,000, on specific (and additional specific) deductions as well as on other deductible items. The monthly salary will therefore not be fixed. The amount will decrease as the tax progressivity increases. Non-residents, on the other hand, will have their total income taxed on a monthly basis or at the time of payment of the income (net of the RMB 5,000 monthly lump-sum allowance). No annual tax return is required unless an exception is made.
The contribution of the Franco-Chinese tax treaty
Improvements made by the agreement
One of the first fundamental things that the 2014 tax treaty has brought is the broadening of the concept of permanent establishment.
Construction sites
- The duration of a construction or installation project for a future permanent establishment in China is extended to 12 months.
- The value of the supervision or equipment of the construction site no longer needs to be greater than or equal to 5 percent of the total amount of the sale made by the enterprise.
Stable service establishments
As discussed earlier, the provision of the existing personnel services in China for more than 183 days in any 12-month period is taxable. However, there has been a relaxation of this clause for French companies that send employees to China to perform any type of service. The risk of these companies being considered as permanent establishments is also reduced because the calculation is now based on the actual number of days of service.
On the other hand, the tax treaty provides for a less costly dividend remittance. Therefore, a withholding tax of 5 percent takes place if and only if the French company holds a stake of at least 25 percent in its capital.
Broadening China’s taxing power
As in the current treaty, gains resulting from the disposal of holdings of at least 25 percent in the capital of a Chinese company are taxable in China. However, in the new treaty, China gains a broader right to tax: the assessment of the 25 percent threshold is both direct and indirect, which will broaden China’s possibilities to claim capital gains tax. Moreover, it is sufficient to have held at least 25 percent of the capital of the company sold at any time during the 12 months preceding the sale.
In China, capital gains on the sale of securities by non-residents are taxed at a rate of 10 percent. The agreement provides for a tax credit equal to the French tax on capital gains, which is in principle equivalent to an exemption in France. This clause is typical, as in general, the tax credit is equal to the foreign tax. Recently, China’s State Taxation Administration announced a new policy concerning foreign income taxes that also underpins how foreign tax credits are calculated.
Read more about it on our recent post about Foreign Income Tax Policy for Resident Taxpayers in China
The fight against abuses
There is, however, a significant change that will affect the profitability of financing operations in particular, since the new agreement eliminates the mechanism of fictitious tax credits. These credits relate to dividends, interest, and royalties that were increased to up to 20 percent. The new tax treaty eliminates them purely and simply by providing that the amount of tax paid in China that gives rise to a tax credit corresponds to the effective and definitive tax borne in China on the income concerned.
Article 24 of the new treaty aims at limiting the benefits of the treaty including the exemption or reduction of withholding tax). The limit applies in cases where the main purpose of the transactions is to benefit from the tax treaty contrary to the purpose and reason of the provisions.If you want to know more about doing business in China during the coronavirus outbreak, contact our team for consultation and assistance. Follow us on social media to get the latest news!
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