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China Focus Eliminating Double Taxation in Mainland China for Hong Kong and Macau Tax Residents Working Cross Border Jacky Chu, Tax Partner, PwC

business chambers and professional bodies, ﬂagged the double taxation problem faced by some Hong Kong employees working across the border to both the

1 China Focus Eliminating Double Taxation in Mainland China for Hong Kong and Macau Tax Residents Working Cross Border Jacky Chu, Tax Partner, PwC International Assignment Services (HK) Berin Chan, Tax Partner, PwC International Assignment Services (HK) About two years ago, PwC, along with some business chambers and professional bodies, ﬂagged the double taxation problem faced by some Hong Kong employees working across the border to both the Mainland State Administration of Taxation (SAT) and Hong Kong Inland Revenue Department (IRD) through different channels. 28 H UMAN R ESOURCES s September 2012

2 September 2012 s China China Focus S ince then, these tax authorities have tried to resolve such problem through consultation. We are very pleased to see that the SAT has ﬁnally issued the Public Notice [2012] No 16 (PN 16) dated 26 April 2012 to address the problem in favour of Hong Kong (and Macau) tax residents. The PN 16 took effect on 1 June 2012 and applies to income obtained after the effective date. Double taxation problem The SAT and IRD adopted two different interpretations to determine the source of income in the respective tax jurisdictions, thus causing the double taxation problem. Let us use two hypothetical examples to illustrate the problems. Example one A Hong Kong tax resident with a permanent home and family in Hong Kong is employed by a Hong Kong company and seconded to work in the Mainland as the General Manager of its Mainland factory. His travel details are indicated in Table 1. Table 1 Workdays spent in the Mainland 236 Workdays spent in Hong Kong (ie two meetings per month) REUTERS/Stringer China 24 Non-workdays spent in Hong Kong 105 Total days in a year 365 According to the Mainland Individual Income Tax (IIT) law, his employment income shall be subject to IIT in full even though he returns to Hong Kong during weekends and holidays, and occasionally (eg two days a month) reports duties to his supervisors in Hong Kong. On the other hand, in Hong Kong, he would need to apply for an income tax relief (commonly known as Section 8(1A) (c) claim) as he spends more than 60 days in Hong Kong in a year of assessment and performs services (ie meetings) in Hong Kong. The Section 8(1A)(c) claim intends to exempt the portion of employment income attributable to services rendered in another tax jurisdiction where income tax on the same income has been paid in that jurisdiction. However, the Inland Revenue Ordinance (IRO) does not provide a clear calculation method. The IRD s general practice is to adopt a physical day basis to apportion the income that would be subject to Hong Kong Salaries Tax (HKST). Under the current practice of the IRD, the tax position of a Hong Kong resident working in the Mainland and Hong Kong would be as indicated in Table 2. Table 2 Under current practice Total employment income Percentage of income allocated to each location (based on 365 days) Portion of income subject to tax in each location Portion of income being double taxed Hong Kong Mainland HK$1,000,000 ( ) days = 35% 365 days HK$350,000 HK$1,000,000 HK$350,000 (35% of the income being doubly taxed) H UMAN R ESOURCES s September

3 China Focus September 2012 Example two A Hong Kong tax resident has cross-border activities and receives an annual bonus. According to the Mainland IIT law, annual bonus cannot be time apportioned on a day-in-day-out basis. Only if the employee does not spend any workday in the Mainland in a complete calendar month(s), the portion of the bonus attributable to such calendar month(s) can be excluded from the IIT. Therefore, if that employee spends only 60% of his time in the Mainland and the remaining 40% in Hong Kong every month, the bonus would be fully taxable in the Mainland whereas only 60% of the bonus would be excluded from HKST by applying the Section 8(1A)(c) claim. In other words, 40% of the bonus would be doubly taxed as indicated in Table 3. Table 3 Under current practice Hong Kong Mainland Bonus entitlement Percentage of bonus allocated to each location (based on 365 days) Portion of bonus subject to tax in each location Portion of bonus being double taxed Solutions HK$500,000 ( ) days = 40% 365 days HK$200,000 HK$500,000 HK$200,000 (40% of the income being doubly taxed) In order to resolve the double taxation problem, the SAT is now in line with the apportionment basis adopted by the IRD. It accepts the time apportionment of the salary and bonus income on the physical day presence basis. There are two time apportionment formulae in PN 16 depending on the number of days the Hong Kong and Macau tax residents stay in the Mainland as indicated in Table 4. For income attributable to several months (such as bonus), the time factor in the formulae in Table 4 will be the number of days the employee is physically present in the Mainland during the earning period of the bonus over the number of calendar days for the earning period of the bonus. For example, if the employee receives an annual bonus for the year 2012 during which he spent 220 days in the Mainland, the time factor would be 220 / 366. According to PN 16, the day of arrival, the day of departure and the same day travel will each be counted as a half day in the Mainland when calculating the number of days for this time factor purpose. Requirements to secure this special time apportionment treatment (special treatment) This special treatment is only applicable to Hong Kong and Macau tax residents employed by a Hong Kong or Macau company or concurrently employed by both a Hong Kong or Macau company and a Mainland company. In other words, if a Mainland company hires the employee to work full time in the Mainland, this special treatment should not be applicable. Table 4 No of physical presence days Portion of income IIT payable = IIT on full income in the Mainland in the month borne by PRC entity x No of calendar days in the month Full income x Staying in the Mainland for more than 183 days in any 12-month period but less than one full year¹ IIT payable = IIT on full income x No of physical presence days in the Mainland in the month No of calendar days in the month ¹ A person stays in the Mainland for one full year if he does not leave the Mainland for more than 30 days in a single trip or for more than 90 days in total. 30 HUMAN RESOURCES September 2012

September 2012 China Focus This special treatment is only applicable to Hong Kong and Macau tax residents because these two special administrative regions are geographically close to the Mainland.

4 September 2012 China Focus This special treatment is only applicable to Hong Kong and Macau tax residents because these two special administrative regions are geographically close to the Mainland. It is not applicable to tax residents of other jurisdictions. However, if a foreigner satisfies the definition of Hong Kong or Macau tax resident under the respective Mainland/Hong Kong or Mainland/Macau double tax arrangements, he or she can also be entitled to this special treatment. In this respect, it is worth noting the SAT s view expressed in Guoshuihan [2007] No 403 on the determination of the tax residency of an individual who is both a temporary tax resident of Hong Kong and a tax resident of another jurisdiction. The SAT may need to review other relevant factors in order to determine whether PN 16 can be applied. Further, PN 16 requires that if the employee wants to secure this special treatment, he/ she must complete the record filing as required by Guoshuifa [2009] No 124 (Circular 124). Observations PN 16 brings great news to the Hong Kong and Macau tax residents working cross border and their employers as it helps to eliminate the double taxation that they have been suffering from for a long time. Hence, it is important that these employees and employers revisit their work arrangements as well as their current Mainland and Hong Kong tax filing positions. To allow time apportionment of the bonus in the same way as monthly salary is a major breakthrough as the previous SAT policies² issued more than a decade ago stated that a bonus could not be time apportioned on a day-in-day-out basis. This latest breakthrough will surely be welcomed by many Hong Kong and Macau tax residents and their employers. This special treatment does not apply to non-hong Kong and non- Macau tax residents as the previous SAT policies remain enforceable in their cases. It remains to be seen whether this special treatment would be extended to other foreigners through further negotiation between the tax competent authorities of their jurisdictions with the SAT. One of the requirements for securing this special treatment is to comply with the Circular 124 record filing. This circular requires the employees to comply with the record filing requirement if they want to secure the IIT exemption under a double tax treaty or arrangement (eg if they travel to the Mainland for not more than 183 days in any 12-month period and fulfil other factors under the Dependent Personal Services article of a double tax treaty or arrangement). This is a new compliance requirement for those qualified Hong Kong and Macau tax residents who want to secure this special treatment under PN 16. This record filing requirement may create additional administrative burden to these employees and their Mainland employers (who are statutory withholding agents) as IIT filing is done on a monthly basis. In addition, as part of the Circular 124 process, Hong Kong tax residents need to produce a copy of the tax resident certificate that the IRD issued. According to the current practice, the IRD would issue the tax resident certificate only at the written request of an in-charge local tax bureau in the Mainland. This issuance procedure can be time consuming and challenging. However, we are aware that some local tax bureaus have taken a more relaxed approach and may consider accepting other supporting documents to replace the tax resident certificate under certain circumstances. Hence, it is worthwhile to check with the in-charge local tax bureau on the detailed requirements. ² Guoshuifa [1996] No 183 and Guoshuihan [1997] No 546 HUMAN RESOURCES September

5 REUTERS/Bobby Yip 32 HUMAN RESOURCES September 2012

September 2012 2012426 [2012]1616 1620126 1 1 236 24 105 365 60 8(1A)(c) 2 $1,000,000 365 (105 +

6 September [2012] (1A)(c) 2 $1,000, ( ) 365 = 35% $350,000 $1,000,000 $350,000 35% 8(1A)(c) 2 60% 40% HUMAN RESOURCES September

7 September 2012 China Focus 60%8(1A)(c) 40%3 3 $500, ( ) 365 = 40% ¹ $200,000 $500,000 $200,000 40% / ¹ 3090 ² ² HUMAN RESOURCES September 2012

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