To avoid mainland tax, take a trip

PUBLISHED : Sunday, 20 December, 1998, 12:00am
UPDATED : Sunday, 20 December, 1998, 12:00am

LONG-TIME foreign residents of the mainland had better leave the country on a regular basis next year or prepare, for the first time, to see their worldwide income - including interest, dividends and capital gains - taxed at rates as high as 45 per cent.

Mainland tax authorities have been tightening the screws on expatriate managers for a long time, issuing a flurry of circulars over the past several years that have forced a rethink of tax-planning strategies commonly used by foreign-owned enterprises and joint ventures based in China.

Among these tougher rules is one taxing foreigners on worldwide income after five years of residence on the mainland. That particular circular took effect on January 1, 1994, and has been ticking away in the background ever since. Next year - five years later - the ticking will give way to alarm bells.

'People need to be very careful,' said Bill Seto Ping-chun, a Shanghai-based tax partner for accounting firm Ernst & Young. '1999 will be the first year they will be considered a five-year resident.' Though this promises to be hard on anyone's bottom line, it could be particularly traumatic for Hong Kong people - not only because Hong Kongers are likely to number heavily among those who have spent five or more years on the mainland, but also because they are accustomed to the SAR's relatively benign tax regime, which hits only salary income and carries a top effective rate of just 16.5 per cent.

'Imagine that you come from a 15 per cent country that only taxes you on compensation. Suddenly you find yourself in China, where everything under the sun is subject to tax up to 45 per cent,' Mr Seto said.

Fortunately, there is a simple fix. Just make sure you get out of the mainland for at least 31 consecutive days or 91 cumulative days in the calendar year. This will cause you to fail at least one of the two 'physical presence' tests used to determine residency.

Fail one year, and you have to start the residency process all over again - in other words, your worldwide income is off the hook for the next five years.

But failing the five-year residency test does not mean you get off tax-free.

People spending more than one year or up to five years on the mainland are taxed on both China-earned income and income earned outside the mainland but paid by an entity based on the mainland.

This could apply, for example, to the expatriate manager of a joint venture who receives 75 per cent of his income from the venture and 25 per cent from the mainland unit of the venture's foreign partner.

Splitting contracts between a joint venture and its foreign partner has been a fairly common way to apportion the burden of relatively high expatriate salaries.

Obviously, foreign managers based in the mainland for five or fewer years might prefer to have the foreign partner's portion of their salary paid by an offshore entity.

Those spending from 91 days (or 184 days for Americans, Australians, Canadians and Hong Kongers) to a year on the mainland are taxed only on mainland-earned income.

People spending 90 days or fewer (or 183 days or fewer) there are completely exempt from Chinese personal-income tax.