Understanding the Five-Year Tax Rule for Foreigners: Do You Need a Tax Holiday in 2016?

The five-year tax rule for foreigners is something that most of us have heard about but often is not fully understood. In short, regardless of whether you are teaching English, own your own business or work for one of the big multinationals, if you stay in China for a prolonged period of time, you are likely to have to take action to avoid being subject to worldwide tax in China.

The rule
An expatriate is considered tax resident in China once they have spent more than 90 or 183 days (depending on the tax treaty between China and the country they are currently tax resident in) consecutively or cumulatively inside China. Importantly, this tax liability is only for income derived from inside China and not their worldwide income.

Under the five-year rule, any expatriate who has resided in China for more than five consecutive full years will become liable for income tax not only on their China derived income but also on all income earned worldwide unless they have broken the rule as detailed below.

This tax is not just on income from employment, but also includes income earned worldwide from dividends, capital gains, foreign interest, properties outside of China with a rental income, HK companies, pension withdrawals and sale of stocks and shares.

The rule specifically states that the relevant period is “five full consecutive years” with a full year being classified as the Chinese fiscal year from January 1 to December 31. So for instance, if you arrived in China during May 2009 the full years will be counted from January 1, 2010. If you have not broken this consecutive period as detailed below, you will then become liable for worldwide income tax in China starting from January 1, 2015.

Breaking the rule
There are essentially two ways to break the 5 year rule and reset the clock back to zero. The expatriate would need to leave China for a period of more than 30 full days consecutively or 90 days cumulatively within a fiscal year.

In our experience, by far the most common of the above is for the expatriate to take an extended holiday of more than 30 consecutive full days as they near the five-year point. Care needs to be taken with the wording of this exemption as it requires “more” than 30 consecutive days. It is also important to note that a full day does not include arrival and departure days as these are counted as days in China.

Examples
An expatriate has become aware of the five-year rule after completing four full years in China. Going into the fifth year, they decide to take an extended holiday of more than 30 consecutive days in order to reset the clock, but they are unsure exactly how to plan this in order to minimize the time away from their employment. They plan to leave on March 4, 2016, so what is the earliest they can return?

• Depart on March 4, which is not counted as a full day
• 31 consecutive full days ends on April 4
• Can return to China on April 5

For regular travelers, the 90-day cumulative rule may come into effect, but particular caution should be given to “full days” as the 90 days will likely be made up from many different trips. What you might call a three-day business trip may only constitute one full day for the purpose of the five-year rule, for instance if you fly on the Monday, spend all of Tuesday out of China and then return on the Wednesday.

Once the five-year rule has been triggered
Once the five-year rule has been triggered the ability to reset the clock to zero becomes much more onerous. If in the sixth year onwards the expatriate leaves China for more than 30 days consecutive or 90 days cumulative, it would mean that they have broken tax residency for the year, but will not have reset the five-year clock. This results in the expatriate having to do the same the next year in order to prevent worldwide taxation in China.

In order to reset the five-year clock back to zero after it has been triggered, the expatriate can only stay in China for a period of 90 or 183 days during the fiscal year (depending on the tax treaty between China and the country they are residing in). This can obviously have huge consequences as it may result in the expatriate having to spend three quarters of a year outside of China.

In summary, most people will either be clearly inside or outside of the five-year rule. If you are on the cusp, and you are uncertain as to whether this affects you then talk to a professional in the area as the financial consequences of being caught by the five-year rule can be significant.

Please note that the Beijinger does not necessarily endorse the views presented in this article.

About William Frisby
William originally arrived in Beijing as a finance guy on a bicycle and will probably leave as a finance guy on a bicycle. He works for Premium Finance Group (PFG), a financial consultancy that has been established in China for over ten years. PFG offers clients no-nonsense, personalized advice and serves the whole of China from their Beijing and Shanghai offices. Services include international property, investment, insurance and financial planning. To contact William, email william.frisby@premiumfinance-group.com.

Photo: KPSOL