Navigating Chinese taxation – Insights for German companies part IV: Compliance risks relating to individual income tax in China

In this part, we will share the topics we have experienced relating to common com­pliance risks and challenges from tax authorities regarding individual income tax (“IIT”) in China, which is noteworthy to German Companies.

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It is widely known that foreign expatriates may enjoy certain IIT-exempted allowances as part of the remune­ration for their working in China, including housing, meal and laundry, children’s education, home visit allowances, etc., according to the prevailing Chinese IIT regulations that is valid until end of 2027. While it is noted in daily practices such allowances provided to foreign expatriates are often not well-documented, which may lead to potential tax risks resulting in failure in enjoying such IIT exemption treatment with late payment surcharges imposed to the employers.

Quite often that Chinese tax authorities would launch a tax inspection particularly upon the IIT-exempted allowances that Chinese employers provided to their top management personnels. Invoices are crucial to support the authenticity of such allowances. Tax authorities would inspect the contract, payment records, invoices for a detailed crosscheck for dates, contractual party, payee, invoice issuer among the documents. Thus, careful inspection and collection for such documents is important controlling work during daily practices.

In many tax treaties signed between China and other countries, service PE in China is defined as furnishing services by a foreign enterprise through its employees or personnel, when the activities in China continue for a period or periods aggregating more than 183 days within any 12-month period. When a service PE is constituted, each personnel ever working for the service PE might be subject to Chinese IIT on each of their working day for the project in China. The German companies who send their employees to work in China would need to set up a shadow payroll for them in Germany.

In many tax treaties signed between China and other countries, 183-days-rule has been agreed to protect the taxation right of the home countries of foreign expatriates. Taking the Sino-German tax treaty as an example, it is agreed that remuneration derived by a German tax resident in respect of an employment exercised in China shall be taxable only in Germany if all the following three conditions are met:

It is noteworthy that as long as the German individual is present in China for more than 183 days in a 12-month period, as dispatched by the employer in the home country, the remuneration derived from all the days he/she is present in China during the two calendar years covering the 12-month period need to be subject to Chinese IIT, according to Chinese tax regulations. It is therefore important for the dispatching company to evaluate the tax payment obligation in the home country on those days out of the above-mentioned 12-month period within the two calendar years, because different tax treatments by local tax laws of the different countries might lead to complication.

According to Chinese IIT regulations, individuals who are not domiciled in China but physically reside in China for no less than 183 days in a calendar year would be regarded as a Chinese resident taxpayer for that calendar year. As a resident taxpayer, the IIT calculation methods and annual IIT filing obligations are substantially different from non-resident taxpayers, which is noteworthy by the employer.

For individuals who do not have a domicile in China but have been a Chinese resident taxpayer for more than six consecutive years, namely having resided in China for more than six consecutive years in each of which they resided in China for 183 days or more, they would need to declare worldwide income in Chinese IIT filings.

That means if the employee is under dual employment contracts with dual salary payments with two employers in and outside China, the IIT taxation base in China shall include the worldwide salary income. While indi­viduals may exit China for more than 30 days on a single trip in any year in which they resided in China for no less than 183 days, by this way the consecutive years in each of which they resided in China for 183 days or more could be counted anew from zero.

This is known as the “six-year” rule.

​Before dispatching an employee to work in China, it is necessary for the German employer to know about the tax implications, tax compliance requirements, and tax consequences for the employee’s IIT in China. It is important for the company to know about all the employer’s obligations according to the IIT laws and regu­lations in China, so as to avoid pitfalls in the future, which might include but not limited to challenges or even penalties from Chinese tax authorities, or unnecessary disputes with the dispatched employee in terms of increased tax burdens or unexpected tax compliance obligations in China and the home country.