400,000 Taiwanese Managers Feel the Pinch
China Cracks Down on Tax Evasion, Chasing Every Penny
What China touts as the largest individual income tax reform in two decades seems to lessen taxpayers’ burden. However, the reform also closes loopholes and threatens draconian measures against tax evasion, making sure that Taiwanese expats don’t avoid a single penny in income tax.
China Cracks Down on Tax Evasion, Chasing Every PennyBy Pei-Hua Lu
From CommonWealth Magazine (vol. 662 )
Around 400,000 Taiwanese managers work in China, according to the Directorate General of Budget, Accounting and Statistics (DGBAS), amounting to about half of all Taiwanese working abroad. When China’s revised individual income tax law takes full effect on January 1, 2019, these managers will become the prime target of tax investigators.
Some people think the tax reform is good news. “In private, Taiwanese managers are saying that one article lowering taxes is better than 31 articles or 100 articles giving preferential treatment to Taiwanese,” reveals a Taiwanese expat who did not want to be identified.
In what China is advertising as the largest tax reform in 20 years, the individual income tax threshold for foreigners has been raised from 4,800 renminbi per month to 5,000 renminbi per month. Under the revised law, new deductions have been added, such as for children’s education, housing loan interest, and housing rent. Most palpable for Taiwanese managers will be the widening of tax brackets with income tax rates below 30 percent.
A Taiwanese expat named Chou explains that, under the old taxation system, a tax rate of 25 percent applied to taxable incomes between 9,001 renminbi and 35,000 renminbi per month. Under the new system, people earning taxable monthly incomes of 10,000 renminbi must pay only 10 percent in taxes.
But some also warn that expats should take precautions against tax audits. Taiwanese managers in particular could come away empty-handed because most have underreported income in past tax returns. Now China is using big data to audit taxes, keeping a close tab on tax evasion.
Change No. 1: Stricter Tax Residency Definition Reduces Tax Avoidance Possibilities
Under the old system, Taiwanese expats who did not have domicile in China were not considered tax residents if they had been absent from China for more than 30 days in a single trip or more than a cumulative total of 90 days in one of five consecutive calendar years. Their non-China sourced income was exempt from Chinese taxation unless such income was paid by Chinese companies or organizations.
In Taiwanese business circles, this rule is jokingly called the “postpartum rest clause”, alluding to the one-month long recuperation period that women traditionally take following childbirth.
Under the new system, only half of the clause remains in place as the cumulative total of 90 days has been scrapped. This change mostly affects entrepreneurs.
Liu Chung-hui, accountant with KPMG Taiwan, notes that business owners often divide their time between China and Taiwan, spending half a month on either side of the Taiwan Strait, thus easily accumulating 90 days outside of China in a given tax year. In the future, this arrangement will no longer work. Under the new system, entrepreneurs need to keep in mind that they must leave China for more than 30 days on a single trip within a five-year period.
If they fail to fulfill this requirement, they will be regarded as tax residents of China with relevant taxpayer obligations.
Liu points out that in the past, non-domiciled individuals only had to leave China for more than 30 days in year six of working in China to return to non-resident status. But now the 30 days have been extended to 183 days.
This means that Taiwanese managers will have to stay away from China for half a year to ensure that their income earned outside China remains exempt from income tax.
“This is basically not feasible; how can a Taiwanese manager spend just half a year in China?” remarks Liu. Once foreigners become tax residents of China, they become liable for tax on their worldwide income.
Change No. 2: Personal Services are Included in the General Income, Leading to Higher Tax Rates
China used to tax eleven categories of income, using different tax rates. A progressive tax rate applied to some categories, while a flat rate applied to others. Under the new system, income derived from salary, labor services, authorship and royalties will be taxed on a consolidated basis, using seven tax rates ranging from a minimum of 3 percent to a maximum of 45 percent, depending on annual taxable income.
Liu points out that some high-ranking Taiwanese managers earn income from two companies, drawing a salary from one and remuneration as a board director or supervisor from the other. In the past, a board member’s remuneration was taxed as income from personal services with a flat rate of only 20 percent.
But now, salary and remuneration will both be calculated toward the general income, which will cause a marked increase in taxable income, possibly leading to a higher tax rate. If a tax rate above 20 percent applies, the taxpayer effectively faces a tax hike. (Read: Taiwan: The Undiscovered Asian Offshore Tax Haven?)
Change No. 3: Crackdown on Offshore Tax Evasion Due to the Introduction of the Common Reporting Standard (CRS)
Taiwanese expats who earn income or hold assets abroad need to be careful given new information gathering and reporting requirements under the CRS, which is also known as the global FATCA (Foreign Account Tax Compliance Act).
From September, China began to exchange tax information with other countries, which means that Chinese tax authorities might get their hands on information regarding financial transactions of Taiwanese business people who bank in Hong Kong or Singapore.
How Disastrous is the Potential Onslaught?
As Liu explains, even Taiwanese expats who are not tax residents in China will find it hard to escape scrutiny. “If a rich person opens a bank account in Hong Kong this year, and if the provided contact information and the incoming and outgoing payments all point to China, then the Hong Kong bank might tell the Chinese tax administration your account balance.”
If the expat cannot prove that the income was derived outside China, they will have to pay a large amount in back taxes.
Furthermore, the new system introduces anti-tax avoidance provisions. Previously, Taiwanese businesspeople who bought a stake in a Chinese company would set up a shell company between their China-based companies and the invested companies in an offshore location. As a result, they would leave dividends received from invested companies in the tax haven and were therefore not taxed for income from these dividends in China.
From next year, dividends that remain outside China will be treated as China-sourced income and taxed if Chinese tax authorities determine that the respective shell company is controlled by the Taiwanese investor.
Change No. 4: Big Data Facilitates Tax Audits
China relies on state power to exploit big data for tax audit purposes. Therefore, Taiwanese managers will find there is not much of a grey area left for avoiding taxes.
In the past, Taiwanese expats reported their China-sourced income on their Chinese tax return and their Taiwan-sourced income in Taiwan. Although this was illegal, the Chinese tax authorities were not able to find out.
“The Chinese state tax administration has known all along about this problem regarding Taiwanese expats. Now they only need to pull data on company salaries to discover that a Chinese national with a manager position at the same level earns more than the Taiwanese. Investigating has become very easy,” explains Liu.
PwC Taiwan partner Patrick Tuan, a China tax expert, notes that in the future, every taxpayer will have an identification number. As China gradually streamlines its local taxation bureau system, social insurance will be uniformly collected by the state tax administration. Against this backdrop, it will become more difficult for companies to underreport wages or social insurance fees, or pad tax deductions.
Source: Pei-Hua Lu
Now that China is getting tough on tax avoidance and tax evasion, more and more Taiwanese managers are beginning to play by the rules when filing their tax returns, since they are aware that the risk of getting caught and being punished is getting higher. (Read: Red Blockchain Rolling in Taiwan)
For instance, when hiring Taiwanese expats, some Taiwanese companies no longer stick to the established practice of dividing salaries up between China and Taiwan to save taxes, but rather employ them as local hires or let Taiwanese higher-ups from the Chinese subsidiary come to Taiwan to recruit employees, so that payroll is entirely dealt with in China, tax returns are filed correctly, and taxes paid as required.
China is using a carrot-and-stick approach as the country improves its domestic taxation environment. In that regard, China only epitomizes the epochal changes currently under way in the global tax environment. And Taiwanese businesses that are active across national borders will have to take the global hunt for taxes more seriously.
Translated by Susanne Ganz
Edited by Tomas Lin