Understanding China’s Five-Year Tax Rule

The five-year tax rule is an important and misunderstood factor in determining a tax strategy for expatriates living in China. Foreign nationals who reside in China for more than five years can be considered Chinese tax residents and therefore liable with tax authorities on their global income. In this article, we outline the main points of this rule and consider strategies for compliance.

• According to the 5-year rule, expatriates who have lived in China for more than 5 consecutive full years become Chinese tax residents and are subject to individual income tax on their worldwide income from the sixth year onwards for every full year spent in China.
• Once the 5-year residence is established, the expatriate will be subject to IIT on his or her income from sources within and outside China, including earnings from dividends, capital gains, foreign interest, rental income, etc. from the sixth year onwards for every full year spent in China.
• One full year is defined as a fiscal year (Jan 1 to Dec 31) during which the expatriate does not leave China for a period of more than 30 days consecutively or 90 days cumulatively. Note, a fiscal year for expatriates from Hong Kong is considered as a period of consecutive 12 months. Also, days of arrival and departure from China are counted as days in China. For example, if you are flying to the United Kingdom on Monday and returning on Friday, it counts as three days outside China.
• The full five-year period is interrupted and restarts from zero when the expatriate leaves China for a period of more than 30 days consecutively or 90 days cumulatively within a fiscal year.
• If the expatriate has been in China for five full consecutive years then he or she pays tax on his or her worldwide earnings. However, the expatriate can break the five-year residence in China only if he or she spends less than 90 days inside China any one-year after the sixth year.
• The requirement to file annual tax return was applied in 2006, which means after 5 years, (i.e. in 2011) it becomes easier for tax officials to trace the tax records of individuals who have living in China since 2006.

Example: Mr. A, an expatriate has been living in China since January, 2005 and making a lot of short trips out of China ever year. Since he has been residing in China for over seven years, he would like to know if the five-year rule is applicable to him. Below are the details of his time spent inside and outside China:

• In 2005, Mr. A spent only 6 days out of China so 2005 is considered a full year for tax purposes under the 5 year tax rule. However, in 2006, he spent more than 30 days consecutively outside China. So the full 5 year period is interrupted and restarts from 2007. At the end of 2011, the full consecutive 5 years are completed. Therefore, he becomes a Chinese tax resident in 2012 and is subject to individual income tax for his worldwide income from 2012 onwards for every year spent in China.However, there are two ways Mr. A can be exempt from paying taxes on offshore income in China under 5-year rule:
  • He stays out of China for more than 30 consecutive days in 2012 and he will not be subject to tax on worldwide income for 2012. But he will face this requirement every year, or
  • He spends no more than 90 days inside China in 2012, which will reset his five-year count.

  Therefore, if you are an expatriate and have been living in China for a few years, make sure that within the five years you’re either spending less than 90 full days inside China or one long trip of 30 full days outside China to reset your five year count.

  For assistance with your tax planning and simulations, contact S.J. Grand.