In 2019, China introduced a significant change to its individual income tax (IIT) system by implementing the “six-year rule” for foreigners. This rule, which starts applying in 2024, determines how foreign residents are taxed on their overseas income.

What is the six-year rule?

According to the revised IIT system, foreigners who reside in China for 183 days or more each calendar year are considered tax residents. If a foreign individual remains a tax resident for more than six years, they become liable for tax on their global income, including income from foreign sources. This is known as the “six-year rule.”

China’s tax rates are relatively high for high-income earners — 35% for annual taxable income between RMB 660,000 (approximately £70,250) and RMB 960,000 (approximately £102,183), and 45% for income exceeding RMB 960,000. Due to these rates, foreigners often seek to avoid IIT on their overseas income.

The year 2024 is crucial as it is the first time the six-year rule will be enforced. Foreigners should carefully review their tax residency status and consider strategies to reset their six-year period.

How is the six-year rule period counted?

On 16 March 2019, China’s Ministry of Finance (MOF) and State Taxation Administration (STA) issued Announcement [2019] No. 34, which outlines the calculation of tax residency for foreigners.

The key points from the announcement are as follows:

• The six-year period calculation starts from 1 January 2019. Any residency prior to this date does not count.
• A year of residence is defined as staying in China for at least 183 days within a calendar year.
• Days spent in China for less than 24 hours in a single day are not counted.

Example:

Mr Chen, a Hong Kong resident working in Shenzhen, travels to China every Monday morning and returns every Friday evening. His stays are less than 24 hours on Mondays and Fridays, and he spends weekends in Hong Kong. Hence, for tax purposes, Mr Chen is considered to be in China for only three days per week. With 52 weeks in a year, his total stay amounts to 156 days, which is fewer than the 183 days required to be a tax resident. Consequently, Mr. Chen’s overseas income remains tax-exempt in China.

Resetting the six-year rule period

According to the MOF STA Announcement [2019] No. 34, if a foreigner has stayed in China for fewer than 183 days in any year within the previous six years, or if they leave China for more than 30 consecutive days, they can reset the six-year period.

Example:

Ms Patel moved to Shanghai on 1 January 2015 and has been living there since. However, since the counting of years started only from 1 January 2019, Ms Patel is not yet subject to global income tax in China. To avoid worldwide income tax starting in 2025, Ms Patel decided to spend January and February 2024 in Hong Kong. By leaving China for over 30 consecutive days, Ms Patel resets her six-year period.

Tax Implications After Six Years

From 2025 onwards, if a foreign individual has lived in China for 183 days or more in each year over the previous six years and has not left for more than 30 consecutive days in any year, they will be taxed on their global income.

Example:

Mr. Zhang moved to Beijing on 1 January 2019. Except for a two-month absence in 2025, he has lived in China for at least 183 days each year and never left for over 30 days. His tax obligations in China are as follows:

In this example, Mr Zhang’s two-month absence in 2025 triggers the six-year rule, making him liable for global income tax starting in 2025, though his absence allows him to reset his tax obligations in 2026.

The six-year rule affects various types of income, including wages, service remuneration, author’s fees, royalties, business income, interest, dividends, lease income, property transfer income, and contingent income. Foreigners should manage their residence days and departure times carefully to avoid unexpected tax liabilities.

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The extension of the individual income tax (IIT) preferential policies means that non-China domiciled tax residents (i.e., people who do not have a domicile in China but live for 183 days or more in China in a given tax year) can continue to enjoy tax exemptions on eight categories:

• Housing rental
• Expenses for children’s education
• Language training expenses
• Meal fees
• Laundry fees
• Relocation expenses
• Business travel expenses
• Home leave expenses

The policy extension has brought immediate relief for some foreign workers, who would have seen a significant increase in their personal tax liability, especially in terms of the cost of educating their children. Companies trying to hire and retain foreign talent will also benefit from this policy.

This extension of IIT benefits for foreign professionals followed another announcement on 29 December 2021 in which China extended preferential treatment for annual one-time bonuses until the end of 2023. Under this scheme, IIT on annual one-time bonuses is calculated separately, rather than being combined and taxed together with overall income.

The extension of this policy is aimed to reduce the tax burden of middle-income groups at a time when the Chinese economy has been showing signs of a slowdown. For example, the following groups are expected to benefit the most from separate IIT on bonuses: (1) employees with an annual one-time bonus no less than RMB36,000; (2) employees with an annual income (annual bonus + annual salary – social security payments and various deductible expenses) no less than RMB 96,000; and (3) employees with an annual salary higher than their annual one-time bonus

What does this mean for companies operating in China?

Overall, these policy extensions are likely to be of benefit for companies in China, as it may help them to attract new talent. It is also a positive outcome for the international education sector, as it means that foreign professionals in China may no longer need to reconsider sending their children to pricey international schools.

Nevertheless, companies that made preparations for the original tax income policy change, such as amending labour contracts, restructuring salary packages, and reshuffling staff allocations, may need to roll back the decisions for the time being and save their plans for possible future needs.

Portions of this article first appeared in Dezan Shira & Associate’s China Briefing

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Last year, seven regions (Chongqing, Shaanxi, Shanghai, Beijing, Hebei, Fujian, and Qinghai) in China announced an increase in their minimum wage. In 2018, 15 out of the 31 regions in mainland China increased their minimum wages, while 20 provinces did so in 2017.

Local governments in China are required to update their minimum wages at least every few years but have the flexibility to adjust wages according to local conditions. Most provinces set different classes of minimum wage levels for different areas depending on the given region’s level of development and cost of living. For example, a higher minimum wage class for the provincial capital and the most developed cities, and a lower class for smaller cities and rural areas.

A complete guide to China’s minimum wages can be found below.

China’s minimum wage: Understanding regional variation:

Hunan, Gansu, Guizhou, Tianjin, and Zhejiang are among the regions likely to adjust their minimum wages in mid to late 2020, given that they have not done so in the past two years.

Chinese regions often opt to increase minimum wages to keep pace with the cost of living increases, so other regions may also adjust their wage standards later this year.

That being said, 2020 might see fewer wage increases than usual given the coronavirus pandemic, which has shifted the need to reduce the financial burden on enterprise and job stabilisation to the forefront. The reorientation of priorities are also set against the backdrop of an ongoing US-China trade war and an economic slowdown.

Regions may opt to freeze local wages in order to maintain their economic competitiveness amid the uncertainty.

Currently, the highest minimum wages are in parts of Guangdong, Jiangsu, and Zhejiang provinces, which have all surpassed the RMB 2,000 (US$289) mark, as well as in the municipalities of Beijing, Shanghai, Shenzhen, and Tianjin.

Shanghai continues to have the highest minimum wage in China, at RMB 2,480 (US$358) per month, followed by Shenzhen and Beijing, both at RMB 2,200 (US$318) per month.

At the lowest end, the minimum wage in certain rural areas of Liaoning (RMB 1,120/US$162), Hunan (RMB 1,130/US$163), and Anhui (RMB 1,150/US$166) slightly higher.

However, while China is still among the most unequal countries in the world in terms of income inequality, it has made some progress over the past decade.

According to China’s National Bureau of Statistics, the country’s Gini Coefficient dropped from 0.491 in 2008 to 0.465 in 2016, where a higher number denotes greater inequality.

Impact on China’s labour costs

Minimum wages only tell part of the story of labour costs in China. As China’s economy moves up the value chain and transitions to innovation and services, most workers employed by foreign-invested enterprises earn above the minimum wage. For example, workers in Shanghai made an average of RMB 9,723 (US$1,405) per month through the first quarter of 2019 – over four times the local minimum wage.

Moreover, employer social insurance and housing fund obligations add an additional 37.25 percent to an employee’s salary on average. China’s rapidly rising wages are partly explained by the country’s labor pool which, while enormous, is gradually shrinking.

In 2018, China’s employed population declined for the first time ever, falling by 540,000 to a total of 776 million. This trend is exacerbated in China’s wealthy coastal regions – a traditional hotbed of foreign investment and manufacturing – which migrant workers are leaving in favour of inland China.

According to the National Bureau of Statistics, in 2016 the migrant worker population in coastal provinces fell by 0.3 percent, while that of Western provinces grew by 5.3 percent.

For foreign investors, rising wages are an unavoidable feature of doing business in China. Nevertheless, when other factors like productivity, infrastructure, transportation costs and access to a massive domestic market are considered, China may still emerge as the more cost-efficient option compared to countries with lower statutory labour costs.

When comparing locations for foreign investment into China, minimum wages are a helpful barometer to gauge labour costs across different regions.

From there, identifying industry-specific wage levels, availability of talent, and access to regional incentives offer a more nuanced view of ultimate labour costs within a given region.

This article was first published by China Briefing

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