Double taxation problems

The problems with the double taxation are mainly caused by the different interpretations adopted by the SAT and IRD in determining the source of income in the respective tax jurisdictions.

A typical problem giving rise to double taxation in Hong Kong and China is where a Hong Kong resident employee having cross-border activities receives an annual bonus. According to Chinese law, annual bonus cannot be time apportioned on a day-in-day-out basis.  Instead, it is only when the Hong Kong employee does not spend one single workday in China in a complete calendar month or months that the portion of the bonus attributable to such calendar month(s) can be excluded from Individual Income Tax.

Therefore, if that employee only spends 60 per cent of his time in China and the remaining 40 per cent of his time in Hong Kong every month, the bonus would be fully taxable in China and Hong Kong with only 60 per cent of the bonus excluded.  In other words, 40 per cent of the bonus is doubly taxed.

Solutions

The crux of these double taxation problems in Hong Kong and China is the difference in allocating the source of income between the two tax jurisdictions.  When both tax authorities take the view that they have the taxing rights on the same income, the amount is inevitably taxed twice.  In order to resolve the problems, the SAT now accepts the time apportionment of the salary and bonus income on the “physical day presence” basis so that it is in line with the apportionment basis adopted by the IRD.

There are two time apportionment formulae in PN 16 and they are applied depending on the number of days the Hong Kong (and Macao) tax residents’ stay in China:

For income derived by a Hong Kong resident employee which covers several months, the time factor in the above formulae will be the number of physical presence days in China during the earning period of the bonus and the number of calendar days for the earning period of the bonus.  For example, if the Hong Kong resident employee receives an annual bonus for year 2012 during which he spends 220 days in China, the time factor would be 220 / 366.

The new rule also says that in calculating the number of days for this time factor purpose, the day of arrival, day of departure and same day travel will be counted as half a day in China.

Special treatment

This special treatment is only applicable to those Hong Kong and Macao tax residents who are employed by a Hong Kong or Macao company or who are concurrently employed by both a Hong Kong/Macao company and a Chinese company. In other words, if the Hong Kong and Macao tax resident employee is employed by a Chinese company and work full time in China, this special treatment should not be applicable.

Also, as this special treatment is meant to eliminate double taxation suffered by Hong Kong and Macao tax resident employees working cross border in China, it is only applicable to Hong Kong and Macao tax residents, but not to tax residents of other jurisdictions as Hong Kong and Macao are geographically close to China.

However, if the foreigner can satisfy the definition of Hong Kong or Macao tax resident under the respective China/Hong Kong or China/Macao double tax arrangements, he/she can also be entitled to this special treatment.

PwC observations

It is no doubt that PN16 brings great news to many Hong Kong and Macao tax resident employees working cross border in China and their employers as it helps to eliminate the double taxation that they have been suffering for a long time.  Hence, it is important that these employees and their employers should revisit their employment and work arrangements as well as their current China and Hong Kong tax filing positions.

This special treatment is introduced by way of interpretation of the China/Hong Kong and China/Macao double tax arrangements. As mentioned above, it should be equally applicable to other foreigners as long as they are qualified as Hong Kong or Macao tax residents.  However, it does not apply to other non-Hong Kong or non-Macao tax resident as the previous SAT policies remain enforceable in their cases.  Hence, 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 at a later stage.

The requirement to secure special treatment may create additional administrative burden to these employees and their Chinese employers. Therefore, we would be keen to see that the SAT and IRD can help to improve this potential administrative hurdle by doing away with this written request requirement in the near future in order to facilitate those Hong Kong tax residents who want to secure this special treatment.