At the end of 2018, the Chinese tax authorities announced significant reform of individual income tax (IIT). This included a new ‘six-year rule’ used to determine Chinese taxability of individuals not domiciled in China and whether they are subject to limited or worldwide income taxation.
In mid-March, guidance was jointly published in Bulletins No. 34 and 35 by the Finance Ministry and State Administration of Tax on the ‘six-year rule’, along with details on calculating taxable income that will impact:
New rules on the sourcing and calculation of tax provides clarity; including guidance for the first time on the impact of double tax treaties in determining taxable income. Details on the preferential treatment of incentive income for non-residents also gives clarification on taxation in light of announcements in 2018 that such treatment would be phased out in future years. While the rules are complex, they support individuals and global employers in proactively and clearly managing tax affairs in China. For many employees and businesses, there is also potential that the changes will reduce income tax cost in China.
While there are still some aspects requiring clarification, the regulations are intended to create a tax environment that incentivises and stimulates international mobility.
Definition of a ‘day’
The Bulletin clarifies that a non-domiciled individual would be regarded as tax resident in China if they are present for more than 183 days. A day refers to a full 24-hour day (12am to midnight) in China. Days where individuals spend fewer than 24 hours in China are not counted towards the 183-day residency threshold.
For example: Mr. Lee is a Hong Kong citizen and not domiciled in mainland China. He works in Shenzhen and travels there every Monday morning and returns to Hong Kong each Friday evening. In this scenario, Monday and Friday would not be counted as days in China for determining tax residency. Over a 52 weeks period, Mr. Lee would spend 156 days in mainland China and therefore be regarded as a non-resident for tax purposes in China.
Clarification on the ‘six-year rule’
Bulletin No. 34 states that non-domicile individuals who are present in China for more than 183 days in a tax year will be regarded as a tax resident in China. If they are tax resident for the previous six years (note, the current year is not included) and have not had a single trip outside China for more than 30 days in any of these years, the individual will be subject to China IIT on their worldwide income.
However, an individual would not be taxable on their worldwide income if they spend more than 183 days in China, but during the past six years (not including the current year), met either of the following criteria:
The following tables provide more information:
| New six-year rule (1 January 2019 to 31 December 2024) |
|
| Residence status | Tax position |
| Non-domiciled in China | Foreign income is exempt from China IIT |
| New six-year rule (2025 and onward) |
|||
| Residence status in the past six years | Current year residence status | Tax treatment on the current year | Six-year status in the following year |
| Six years (more than 183 days in any single year and without any 30-day trip) | More than 183 days without 30-day trip | Six-year residence + 183 days residence = worldwide taxation in current year | Six years |
| More than 183 days but with 30-day trip | Six-year clock restarts from the following year | ||
| Less than 183 days | Six years + less than 183 days = exempt for ‘foreign income’ | Restart the six-year clock from the following year | |
| There’s a less-than-183 residence days in any of the past six years | No limit on the residence status for the current year | No six years = exempt for ‘foreign income’ | Not applicable |
| There is a single departure of more than 30 days in any of the past six years | |||
Definitions of China-sourced income and foreign-sourced income
The definition is similar to the previous regulations:
The basic principle regarding sourcing of income remains the same as previous regulations in that income derived from periods spent working in China will be regarded as China-sourced income. An employee’s remuneration attributable to a period working in mainland China is defined as China-sourced income and periods working outside China is foreign-sourced income.
Domicile is important in sourcing:
The above sourcing principle applies only to individuals who:
The rule emphasises that only non-domiciled individuals can apply sourcing of income while China domiciled individuals are subject to worldwide taxation.
Significant changes to the formula for calculating apportionment of income:
Under the previous regulations, income paid in China and overseas was combined to calculate an individual’s tax liability, from which the tax liability was then apportioned. As the income itself was not apportioned, for many individuals it resulted in a high marginal tax rate on their income.
Under the new regulations in Bulletin No. 35, income is prorated based upon the number of days in and out of mainland China and tax then calculated. For many individuals, this will result in a lower tax rate.
Preferential tax treatment of incentive income for non-residents:
Bulletin 35 provides preferential tax treatments to equity incentive income and bonuses for non-residents. Equity and bonus income are apportioned first and then divided by six to determine the income on which tax is calculated. It’s important to note that this treatment applies only once per tax year.
Time apportionment for directors and senior management
For individuals in senior management roles, the apportionment of income differs. This impacts those in roles including: directors, supervisors and senior managers, or undertaking ‘senior management functions’ such as the general manager, deputy general manager, section chief, director and other similar management positions.
The calculation of taxable income may also differ for individuals who benefit from double tax treaty relief.
Interaction of apportionment with tax treaty relief
Bulletin No. 35 also clarifies the interaction of time apportionment with double tax treaties for the first time, applying a different calculation formula.
In addition, Bulletin 35 also provides two new concepts of ‘tax treaty relief for overseas employment income’ and ‘tax treaty relief for China employment income’. These refer to the clauses of tax treaty for ‘dependent services’ or ‘income from employment’. The applicability of these along with applicability of a double tax treaty should be reviewed comprehensively, considering wider corporate considerations including permanent establishment and cost-sharing arrangements.
Impact on tax withholding and annual reconciliation
At beginning of each year, individuals will need to estimate their days of presence and tax residence in China to identify whether withholding will be operated in accordance with rules for a tax resident or non-resident. Where the residency status differs from the initial estimation, an annual reconciliation will be required through a tax return to determine whether tax is due or a refund owing. Penalties and late payment surcharges will not be levied in such cases where there is additional tax due.
Time apportionment formula in domestic law and tax treaty situations
When calculating income under the time apportionment approach, any part day that a non-domiciled individual is present in China will be accounted as half a day. This differs from the counting approach for tax residency (both the 183 and 30 days trip tests).
| Cumulated residence days in China of non-domicile | Salary income calculating applicable formula | ||
| Bulletin No.35 | Bilateral tax treaty (Non-domicile individual is the tax resident of the other contracting party) |
||
| China-sourced income | Foreign-sourced income | ||
| ≤90 days | F1Notes | F1Notes | F2Notes |
| 90 days＜residence days in China≤183 days | F2Notes | ||
| < 6 years | F3Notes | ||
| > 6 years (and without any single trip more than 30 days) | Worldwide income taxation | ||
Time apportionment formula applicable to senior management
| No. |
Cumulated residence days in China of senior executives |
Applicable formula |
| 1 |
Non-tax resident |
Monthly salary income = China-sourced income (portion) |
| 2 |
Non-tax resident |
F3Notes |
| 3 |
< 6 years |
|
| 4 | > 6 years (and without any single trip more than 30 days) | Worldwide income taxation |
Income from independent services, contributions and royalties:
The income is applicable to monthly tax rates table for non-residents.
Tax reporting regarding changes for tax resident and non-tax resident
Individuals who are not-domiciled in China should estimate their residence status at the beginning of a tax year or upon their arrival in China. The individual is required to report this to the tax authority when completing their first IIT filing during the tax year.
Where tax residence status changes later in the year, an individual is required to follow certain steps to update their China tax position:
We hope that the information outlined in this insight will help you navigate the changing rules; whether you are an employer with a workforce in China or employee working in China. If you would like to discuss in further detail, please get in touch with your local member firm or one of global mobility services team.
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