Comments (0)

By Matthew, July 29, 2010 9:06 pm

I wanted to draw attention to an article I wrote on this topic a few months back entitled “Employee Remuneration in China’s New Tax Environment” (the link will obviously take you to the article). I didnt mention it at the time for the basic reason that I was on my relocation enforced hiatus. I think its a really useful article (even if I do say so myself) and is an area that not enough ex pats working in China have a strong knowledge on.

I actually used a small part of this article for a blog entry some time ago (see http://chinataxinsights.com/2010/02/05/off-shore-salaries-tax-compliance-nightmares-part-ii/)

Anyway this is a just a small indication of the fact that I am back

Comments (0)

By Matthew, February 5, 2010 11:24 am

In China, past lenient tax practices resulted in the development of poor tax practices. One in particular has been the practice of splitting employees salaries into two components (on-shore and off-shore) with only one being reported (the on-shore component) to the tax authorities in China. Where the employee was a foreign expatriate, depending upon the tax laws of that employee’s home country, this could result in a significantly lower overall tax burden for that employee. It was also not uncommon, and still is not uncommon, for local employees to have a portion of their salary paid off-shore, usually in a Hong Kong bank account. Using this method, employers could get away with paying an amount below what the market demanded because the employees’ after tax income would still be comparable with the after tax income they would have received had the employer paid them gross  salary commensurate with the market value and not used such an arrangement.

The problems with such a strategy

In China’s tough new tax environment such arrangements as described above carry with them significantly increased risk, for both employers and employees, than previously. Despite once being relatively pervasive, such an arrangement is not a legitimate form of tax planning – it is tax avoidance pure and simple. At the very least, all employees should be aware of this and be provided with a sufficient understanding of the risks that they bear by accepting it. As the saying goes, ignorance of the law is no excuse. This is particularly an issue if the relevant employment contract, as nearly all contracts with respect to such arrangements do, contains a clause indicating that appropriate payment of taxation liabilities is the responsibility of the employee. Such clauses will make it difficult to raise an ignorance argument by the employee if the arrangement is later subject to investigation by the authorities. From the employer’s perspective, such clauses provide absolutely no protection and are effectively pointless. Employers, as withholding agents, have an obligation to withhold and remit tax to the tax authorities in accordance with Article 5 of the Provisional Measures on Withholding Individual Income Tax. A clause in an employment contract cannot alter this legal requirement.

Solution

Smart employers should adopt a remuneration strategy that complies with current tax regulations and also maximizes the organization’s overall recruitment goals. Competitive packages can be assembled that meet the overriding objective of reducing costs and that do not rely on the crude arrangements outlined above. When formulating a remuneration strategy, particularly in respect of localized foreign expatriates, employers should look at the overall cost of employment and work with the employees strike a balance between cash and non-cash benefits. China’s individual income tax regime provides various opportunities for flexible remuneration strategies.

Comments (0)

By Matthew, January 27, 2010 11:01 am

China will impose a 20 percent tax on income from the sale of restricted shares, effective Jan. 1, the official Xinhua news agency reported on Thursday, in a move that could offer stability to the stock market.

Income from the sale of ordinary shares, including those in public offerings and secondary trading, would continue to be exempt from taxation, it added.

http://business.asiaone.com/Business/News/My%2BMoney/Story/A1Story20091231-189121.html

I didnt mention this news when it was first released primarily because it is not a significant issue that affects my particular practice and, to be honest, it is really not that newsworthy once you look at the issue properly. However, I have heard an amusing tale behind the policy change that I thought I would share. Also, a lot of the news on this issue has not been very clear, and in some cases somewhat misleading, so I thought I would try and to clarify the issue. For example, from the same article as above it is stated:

China has not taxed income from share sales by individuals since 1994 as it has sought to encourage the development of its capital market, Xinhua said.

This suggests that the exemption for tax applies to the sale of all shares by individuals in China when in reality the exemption is limited to shares listed on the stock exchange (Caishui [1998] 61). Secondly, the exemption has never applied in respect of income from employee stock options (either through the accretion in value derived or through tranfser of the shares) as such income is considered to be related to employment and therefore is characterised as employment income (for example, see Guoshuihan [2009] 461). This is actually very important to note, because this is when restricted shares are primarily used. In other words, restricted shares have, in many cases, not been exempt from tax in China.

A colleague of mine had an interesting story of why he thinks this exemption has been lifted. This story is  one that can only happen in China.

As China has developed over the past 15 years one of the problems faced has been the acquisition of land for development. As a lot of the land in the outlying was effectively “owned” by farmers. The cost of paying market rate for such land would have added a very significant capital burden for the developments. Accordingly, rather than pay the farmers money for this land, it was decided to grant them shares in publicly listed real estate holding companies. The government forced the farmers to accept this deal. The shares were restricted so that they could not be sold. At the time these shares were effectively worthless and accordingly there was a lot of anger over this issue. However, in 2008 the government removed the restrictions on the sale of these shares and overnight they became extremely valuable. Many of these farmers are now very wealthy. Obviously, many of them decided to cash in on their shares. The problem for the government was that the transfer of the shares would have been tax free under the exemption – hence the reasoning behind the new circular.

Interesting story. Is it the true explanation of the reasoning behind the change? I have no idea.