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January 22, 2015
Experts Question Accuracy of New York Times Story on Chinese Taxation
by Stephanie Soong Johnston

Full Text Published by Tax Analysts®

This article first appeared in the January 21, 2015 edition of Worldwide Tax Daily.

Some tax experts are questioning the accuracy of a recent New York Times article about China's renewed focus on taxing its citizens' worldwide income, including pointing out that the piece erroneously indicates that China is following the U.S. model of citizenship-based taxation.

The article, titled "China Wants Taxes Paid by Citizens Living Afar," appeared January 7 on the New York Times website and ran in the January 8 print edition. In the article, Hong Kong bureau chief Keith Bradsher reported on China's recent move to require citizens to report income they earn abroad. Bradsher wrote that tax authorities were "quietly beginning to enforce a little-known and widely ignored regulation: Citizens and companies must pay domestic taxes on their entire worldwide incomes, not just on what they earn in China."

Efforts to tax citizens in this way "puts China on the same side as the United States in a global debate over whether taxation should be primarily national or global," according to the article, which cites European countries, Australia, Canada, and Japan as examples of jurisdictions "on the other side of the issue" that "tax people within their borders but exempt most expatriates and overseas subsidiaries from paying income taxes in their home countries."

The article then traces the origins of China's move toward worldwide taxation to the 1990s, saying the country sent teams of tax officials abroad to gather information about creating a more modern tax code. According to the article, one team met with the IRS and obtained copies of the U.S. Tax Code and IRS regulations, then ultimately followed the U.S.'s lead in adopting the worldwide definition of income when creating its tax code in 1993. "Now, China is taking the first steps to enforce that broad definition," Bradsher wrote.

The piece also notes China's efforts to negotiate with the U.S. and other countries "to share information on overseas bank accounts belonging to Chinese citizens," obliquely referencing the U.S. Foreign Account Tax Compliance Act and highlighting China's enforcement of worldwide tax rules as a way to crack down on corruption and chase down shady officials who have fled China.

Also, the article discusses China's efforts to enforce corporate income tax laws. It says China's State Administration of Taxation (SAT) "has begun a separate campaign to curb tax evasion by Chinese companies as they start to make big overseas investments." That campaign, which includes new rules that ban, as of February 1, several types of international investments that are deemed tax shelters, could "indirectly hit many wealthy Chinese individuals" who invest overseas by using companies set up in the Caribbean, the article says.

The Blogosphere Reacts

Shortly after the article was published, the tax blogosphere started buzzing, with some bloggers expressing surprise and others, indignation.

The Isaac Brock Society, an organization focused on the U.S. government's treatment of its taxpayers living in Canada and abroad, immediately seized on the article, pointing out in detail what it considered to be inaccuracies in a January 8 blog post titled "No, China does not have citizenship-based taxation."

In the post, the organization points out that China, like most countries, taxes residents on their worldwide income and nonresidents on their domestic income; citizenship is not a factor under Chinese income tax law. The New York Times article conflates "two distinct concepts of 'taxation of resident individuals who earn overseas income' and 'taxation of non-resident citizens who earn income where they live' under the single label of 'worldwide taxation' (which almost always refers to the former concept)," according to the post.

Moreover, Bradsher's article mixes in a discussion about ways to tax resident corporations, the society said, but there's "no logical tie between taxing the worldwide income of resident corporations and taxing the worldwide income of non-resident citizens: almost all countries which do the former do not do the latter," except for the United States.

The society also noted in a January 9 post that the China Daily published a response to the New York Times piece that appears to dispute its accuracy. "China is gradually broadening its tax base, and is interested in including citizens' overseas income in the scope of taxation, which the foreign media describe as an imitation of the United States," according to a translation, by the society, of the China Daily story. "In reality, at present China does not have any concrete measures to tax citizens' overseas income."

Bloggers who first expressed surprise at Bradsher's claim that China is taxing its citizens' worldwide income later updated their posts to reflect criticisms about the story's accuracy. For example, Allison Christians, a professor at McGill University (and columnist for Tax Notes International) who writes the blog Tax, Society & Culture, posted a January 8 update to an earlier post about the article, saying that several colleagues had written to her to point out the errors in the story.

She also disputed the story's claim that China is on the same side as the U.S. in the global debate over whether taxation should be national or global. While there is an ongoing debate over whether multinationals should be taxed on their worldwide income, there is no discussion about taxing individuals based on nationality, she wrote, adding that "there is the United States, and then there is the rest of the world."

Virginia La Torre Jeker, a tax lawyer based in Dubai who writes a column for the expatriate blog AngloInfo, also wrote a January 11 update to an earlier post, saying that Bernard Schneider, a tax lawyer and lecturer in international tax law at Queen Mary University of London, had advised her that the article was incorrect.

"There has been a lot of discussion of the accuracy of the New York Times report," she wrote.

All the News That's Fit to Print?

Tax Analysts spoke with several experts on Chinese tax to get their opinions about the accuracy of the article.

"China does not tax nonresident citizens on their worldwide income, has never done so, and I have not seen anything public to suggest they are planning to," Schneider said.

He pointed to article 1 of China's Individual Income Tax (IIT) Law, which says an individual who has a "zhusuo" (domicile or habitual abode) in mainland China or who has no zhusuo in mainland China but has resided there for a year or more must pay tax on income earned inside and outside China. However, an individual who has no zhusuo in mainland China and who doesn't reside there or resides in mainland China for less than a year must pay tax only on income earned domestically.

While the word "zhusuo" is not used consistently across Chinese law, it's clear that the word does not mean citizenship or nationality, according to Schneider. In fact, there is no reference to the words "citizen," "nationality," or "national," in the IIT law or in the implementing regulations, he said.

Schneider conceded that article 56 of the Chinese Constitution says that Chinese citizens have a duty to pay taxes, which could be used to make the argument that China is authorized to tax on the basis of citizenship. "But the reality is that that's not the way the Individual Income Tax Law is structured," he said.

Pieter de Ridder, tax partner with the Mayer Brown Tax Transactions and Consulting Group, said the New York Times article "is not entirely wrong, but it would have been clearer if it would have talked about 'domiciled persons' rather than citizens."

According to de Ridder, China's IIT law subtly distinguishes between persons who are domiciled and those who are resident or physically present in China. Domiciled persons are subject to tax on their income regardless of whether they live in China, as long as their stay outside China is temporary, such as for education or work purposes, he said. People who are classified as domiciled outside China are those who "habitually" reside in China as a result of household registration, family, or economic interests, he said.

"So, from this perspective, it is conceivable for the [Chinese] tax authorities to seek to enforce their income tax charging provision on those Chinese nationals who temporarily stay abroad," he added.

One key question is what constitutes temporary and non-temporary stays abroad, de Ridder said, adding that much will depend on the facts of each case, such as whether Chinese nationals have deregistered with the local municipal authorities of the place where they stayed before leaving China; whether they kept bank accounts in China; and whether they brought their family with them when they went abroad. He said he expects China to clarify the difference between a temporary and non-temporary stay abroad within the next 12 to 24 months, when efforts to improve international tax information sharing go into effect.

In addition to supporting the OECD's base erosion and profit-shifting project, China has been pursuing automatic exchange of information in tax matters, which is in line with its goal to tax the income of individuals who reside in the country as well as the income of those who are domiciled in China but are temporarily living abroad, de Ridder explained.

China is one of more than 50 jurisdictions that have committed to the OECD's new standard on automatic information exchange, pledging to implement it in 2018.

De Ridder noted that China's tax treaties override its domestic income tax laws, and therefore can, in some cases, restrict China's right to tax domiciled persons. "Accordingly, if a Chinese national relocates to a tax treaty country, China's rights to tax that person's income may be restricted due to the terms of the tax treaty, whereas it would generally not be restricted if the same person relocates to a non-treaty country," he said.

Wei Cui, associate professor and co-director of the tax LLM program at the University of British Columbia, said China's local tax bureaus likely are trying to enforce the rules on taxing Chinese domiciled persons' worldwide income, which may end up clarifying the definition of domicile. "But I don't think we are close to taxation on a citizenship basis," he said. "So this is where the report clearly goes wrong."

He also disputed the article's claim that "Chinese officials chose the American definition of income, with its worldwide scope," when issuing China's tax code, noting that China defines taxable income with a schedular system as opposed to a global system. Under a schedular system, an item of income is considered nontaxable unless it's included in a schedule, while under a global system, an item of income is considered taxable unless it is excluded. "When you say 'definition of income,' you mean a lot more than just whether it's worldwide," Cui said.

Schneider said he agrees that China has a broad definition of income in the sense that it taxes both domestic and foreign-source income. But just because a jurisdiction has a broad definition of income that includes foreign-source income "does not mean the jurisdiction taxes its nonresident citizens -- as opposed to its residents -- on their worldwide income," he said.

Lili Zheng, co-leader of Deloitte Asia Pacific International Core of Excellence, who was quoted in the article, said Bradsher was correct in saying that citizens and companies must pay domestic taxes on their worldwide income in situations when a Chinese citizen is also a Chinese tax resident.

She said she was unaware of any changes in the law that would allow China to move to a system of citizenship-based taxation identical to that of the U.S., but she did note that enforcement of existing income tax laws is on the rise.

Other Objections

Cui challenged the article's contention that China's decision to switch from a business tax regime to a VAT regime is one reason local governments are looking to claw back lost income. According to the article, local governments under the previous regime levied a 5 percent tax on the revenues of companies in the real estate and service industries and shared those tax revenues with the central government. Under the new VAT regime, tax revenues go directly to the central government, the article says.

However, "business tax was completely claimed by local governments, and VAT is shared with the central government," Cui said. "All that may be esoteric the first time you hear it, but once you cover Chinese tax, it's common knowledge."

According to Cui, Bradsher's article repeats the misconception that local governments are short of revenue, and that all tax policy is based on that purported fact. In his view, local revenue shortage is not a uniform phenomenon, and often, the supposed causal connection between revenue shortages and changes in tax policy is unsubstantiated.

Jinyan Li, professor at Osgoode Hall Law School at York University in Toronto, disputed the article's discussion of the origins of China's modern tax code, saying that the first Chinese income tax laws were the Joint Venture Income Tax Law and the IIT law, both passed in 1980, not in the 1990s.

"China has sent many, many study groups overseas to research and learn the design and operation of tax systems and [had] many foreign experts teaching [the groups] in China in the late 1970s and early 1980s," she said. "The 1993 reforms were not the 'roots' of the Chinese tax system."

Another point that Cui and Schneider found odd was the article's reference to the SAT's "separate campaign" to crack down on tax-dodging Chinese companies with new rules that take effect February 1.

Li said the article was likely referring to a general antiavoidance rule that the SAT issued in a December 2014 bulletin. "The GAAR provides the SAT with the legal tool to crack down on tax haven entities -- entities without economic or business substance or used as 'U-turn' investment vehicles by wealthy individuals and Chinese enterprises," she said.

Setting the Record Straight?

Tax Analysts contacted Bradsher to get his reaction to the controversy his article sparked among tax experts. He e-mailed a lengthy response in defense of his piece January 16, saying:

    There is no question that China is increasingly looking at ways to tax the income that its citizens earn from overseas sources, whether they are living overseas or whether they are living in China. This emphasis on taxing worldwide income, and not just income paid to Chinese citizens from entities in China itself, is starting to resemble the American hunt to tax the worldwide income of its citizens as well. My article identified this trend and I tried to explain it in terms that would be clear to people who are not tax professionals.

    One technical aspect of China's pursuit of its citizens' worldwide income has attracted attention since the article ran, mainly from people who are upset about the United States' government's pursuit of the worldwide income of American expatriates. The question involves what if any legal provisions China may provide for its citizens to avoid paying Chinese income taxes while they are residing overseas.

    My understanding from big accounting firms dealing with the Chinese tax authorities and with affected companies and employees is that China assumes that Chinese citizens are residents of China except if they go to great lengths to break that link. I also did not want to go into the very complex question of foreigners who are resident in China, as they were not the focus of the story. So I did not specify in my article whether taxation was based on passport or tax residency, since the two are largely the same for Chinese expatriates. I referred to "individuals" in the lead of the article and then alternated between "individuals" and "citizens" farther down in the article for readability. But I refrained from mentioning either passports or nationality, so as to avoid confusing readers who are not tax professionals with that issue.

    While I had discussed the residency point with tax partners at big accounting firms before writing the article, it is only one of many aspects of China's pursuit of worldwide income, and I could not cover all aspects in limited space. I dealt with some of this at greater length in the International New York Times printed version of my article. That version of the article was much longer than the subsequent U.S. version (and hence the web version). A much higher proportion of the readers of the International New York Times edition . . . would likely be interested.

    I had to trim the article considerably for the U.S. edition, and therefore automatically for our web site, for space reasons. Among the deleted paragraphs was one on how to avoid paying Chinese taxes as a Chinese expatriate. The number of Chinese expatriate readers who would qualify for the narrow exemption is likely tiny. So the paragraph on establishing foreign residency seemed like a good candidate.

    The relevant paragraph from the International New York Times said:

    'Unlike the United States, China does have a narrow loophole for its overseas citizens to avoid income taxes. To qualify for exemption, Chinese nationals must prove that they have permanently moved overseas, have acquired permanent residency in another jurisdiction, no longer own a home in China and have their primary business or other income outside China and their family outside China.'

    I remain interested in China's efforts to tax the worldwide income of its people and companies, whether they are inside or outside China, and am very curious to hear about whatever proves to be the first big tax case that China pursues against its expatriates.

Bradsher also noted that a tax professional probably would have cut different paragraphs from the full-length, original version of his article for publication in the U.S. and online, but he emphasized that he wrote the piece for a general audience, not tax professionals.

"The point of the article was to highlight that China was starting to go after worldwide income, not just income from entities located in China," he said. "The residency versus citizenship debate was a separate although related point that I did not delve into within the space constraints of the shorter U.S./online version of the article."

Schneider said he was surprised by Bradsher's response. "Among other things, the article confuses the definition of income and the definition of who is a taxpayer, and it confuses the taxation of residents on their worldwide income with the taxation of nonresidents on their worldwide income," he said.

"Another problem with the article is that it suggests that another country, and a very important one, is joining the citizenship-based taxation bandwagon, thereby justifying the U.S. position," he said.

Schneider said he agrees that it appears that China is chasing down domestic taxpayers with unreported foreign assets, and that it has changed its position on FATCA to get information on those tax dodgers.

"If that's what the article had said, that China is ramping up enforcement on domestic tax avoiders, and perhaps had said this is in conjunction with China's anti-corruption crusade, then I don't think anyone would have objected to it," he said.

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