Tax Analysts Blog

China's Fiscal Roadmap: Tax Like America

Posted on Jan 12, 2015

Jurisdictionally speaking, the Internal Revenue Code attempts to cast a broad net. The United States taxes its citizens' income on a worldwide basis, regardless of residency. As every American expat knows all too well, this means overseas earnings must be reported to the IRS as taxable income. It matters not whether you're a permanent resident of another country who hasn't set foot in the U.S. for decades.

The usual justification for this policy is that all Americans derive benefits from their citizenship and should help pay the country's bills. The policy also can be viewed as an antiabuse measure. It deters cross-border tax evasion that might otherwise occur if U.S. taxpayers disguised their domestic activities as foreign employment.

That said, the policy irks many observers. Critics point out that U.S. citizens living abroad don’t benefit from many of the public services their tax dollars support. Paying for things like national parks, aircraft carriers, and farm subsidies has limited utility to an American hedge fund manager living in Dubai. [We note that foreign earned income is subject to a statutory exclusion under code section 911 -- currently about $99,000 per year -- which largely eases these objections. It could just as easily be argued that such a generous exclusion in effect subsidizes the U.S. expat community.]

While the merits of the policy can be endlessly debated, everyone agrees that our citizenship-based tax model is a rarity in international terms. Almost no other countries impose income tax on this basis, with one glaring exception: China.

When the political leaders of the People’s Republic of China decided to modernize the country's federal tax system in the early 1990s, they carefully examined the rules in place in other counties. They eventually concluded their empire-building ambitions would best be served by adopting the key design features of the IRC -- including citizenship-based taxation of personal income.

Yet for the past 20 years, China's State Administration of Taxation (SAT) has declined to enforce this rule. As a result, Chinese expats have grown accustomed to not paying Chinese income taxes on their foreign salaries. The government’s failure to apply the law has been attributed to limited organizational resources inside the SAT and the nonavailability of pertinent income data from private employers. It's also been suggested that by going soft on expats, the government indirectly promotes the expansion and global influence of Chinese firms.

Whatever the case, Beijing is no longer looking the other way. Beginning in 2015, the government expects all Chinese citizens residing abroad to include their foreign salary and wages in taxable income. Why the change? The best answer appears to be that the Chinese government needs the money to meet its spending needs.

Viewed in isolation, this development could easily be overlooked. But when considered alongside other recent steps, it seems clear that China's central government is newly emboldened when it comes to revenue collection. As this trend continues, it wouldn’t be surprising to see China's tax framework become more like America's with each passing year.

We can criticize the code all we want, and for good reason, but it remains the envy of governments all over the world -- including the only other global superpower.

Read Comments (5)

Eric L.Jan 11, 2015

Unfortunately the NYT's claims that China has had U.S.-style citizenship-based
taxation since the 1990s are completely incorrect. We can't predict what the
Chinese government may do in the future, but the current Article 1 of the
Individual Income Tax Law (as of 2011) is very clear: "An individual who has a
domicile in the territory of China or who has no domicile but has stayed in the
territory of China for one year or more shall pay individual income tax in
accordance with the provisions of this Law for his incomes obtained in and/or
outside the territory of China. An individual who has no domicile and does not
stay in the territory of China or who has no domicile but has stayed in the
territory of China for less than one year shall pay individual income tax in
accordance with the provisions of this Law for his incomes obtained in the
territory of China."

Domicile is defined by reference to household registration (which can be
cancelled when you move abroad), location of family members, and center of
economic interests, and has nothing to do with citizenship. This definition is
in Article 2 of the Implementing Regulations for the Individual Income Tax Law;
unfortunately I can't find an authoritative up-to-date English translation, but
here is the Chinese version.

Of course I am just an anonymous dog on the Internet and you should
double-check my assumptions, but actual Chinese tax experts like Dr. Bernard
Schneider of the Queen Mary University of London School of Law have also
pointed out the complete incorrectness of the NYT article. Virginia La Torre
Jeker, a tax lawyer in Dubai, states in her AngloINFO column: "I have
unequivocally been advised by Dr. Bernard Schneider that China does not tax
non-resident citizens on a worldwide basis. Dr. Schneider explained that the
New York Times article is incorrect. He stated: 'Among other errors, the
article conflates the worldwide taxation of residents with worldwide taxation
of non-residents, confuses the definition of income with the definition of
residence, and misses the point that some people who are physically
non-resident may be resident for tax purposes."

Robert GoulderJan 14, 2015

Eric L. – Thank you for the detailed input re: the NYT piece and the citations to
Dr. Schneider and Ms. Jeker. I believe their description of the jurisdictional
reach of the PRC tax code, as you’ve outlined it, is correct. No quarrel with
their reading of the statute. What I’m referring to is the phenomenon known as
“deemed residence by nationality.” That is where the SAT adopts the position:
We understand that you (PRC expat) are technically a non-resident, but we’re
nevertheless regarding you as one for tax purposes. Being considered a tax
resident of County X by virtue of holding a passport issued by County X sounds
very much like citizenship-based taxation. Thus the parallels to U.S. federal
tax policy. Why that occurs on a selective basis to Chinese nationals is anyone’s
guess. My blog post envisions the practice going mainstream – perhaps inspired
by Beijing's desire to replicate FATCA. The ideal scenario would be for the SAT
to clarify their position going forward; should that involve a rejection of
CBT then the practice of deemed-residence-by-nationality should be eliminated.
For another insightful perspective on the topic (which takes the opposing view)
I encourage you read Professor Allison Christians’ blog: Tax, Society & Culture.
Thanks again for participating in the discussion.

Eric L.Jan 15, 2015

Mr Goulder - thanks for your reply. From what I can see, the State Administration of Taxation have already clarified their position last year: Chinese citizens can qualify as non-domiciled if they have permanent residence, family ties, and economic relationships abroad or if they have a tax treaty
claim to non-residence.

And China's tax treaties lack one other essential element of U.S.-style
citizenship-based taxation: the "own-citizens saving clause" (saying that a
party can tax its own citizens as if the treaty didn't exist). Without these,
any future Chinese move towards CBT would be toothless.

Geopolitically, there shouldn't be an obstacle for China to ask to add such
clauses: the Philippines, which is in a much weaker negotiating position than
the U.S. or China, managed to get one in every one of its treaties until it
abolished CBT in 1997. But within the past two years (during which China signed
seven new or updated tax treaties) China has shown no sign of asking for such
clauses in their treaty negotiations.

Bernard SchneiderJan 21, 2015

Mr Goulder,

I am not aware of any jurisdiction that has "deemed residence by nationality."
Such an equation of residence and nationality would indeed be the functional,
although not quite the conceptual, equivalent of citizenship based taxation.
China does something very different; worldwide taxation by China is triggered
by having a "zhusuo" (domicile or habitual abode) in China. Because domicile
is a "stickier" status than physical residence, it is possible to be domiciled
in a jurisdiction even when not actually resident there. China is not unique
in this regard; many jurisdictions use domicile or domicile-like factors to
determine whether an individual is "truly" non-resident and therefore should
not be subject to taxation on a worldwide basis.

Although probably most individuals taxed on this basis are Chinese citizens, it
is their domicile, not their citizenship, that is the basis for worldwide
taxation by China. Conversely, it is possible to be a Chinese citizen without
being domiciled in China.

Bruce B.May 29, 2015

Your example of "Paying for things like national parks, aircraft carriers, and
farm subsidies has limited utility to an American hedge fund manager living in
Dubai." is a common, and highly misleading example of the vast majority of US
citizens who live outside the US. The vast majority of us have modest incomes
(I'm an ESL teacher, for example), and have very little, if anything, in common
from a taxation point of view with your example. We're not using our nonUS
residence as a tax dodge of any sort, we're just living our lives as average,
everyday (and *tax-paying*) residents in the countries we live in.

Your statement "It could just as easily be argued that such a generous
exclusion in effect subsidizes the U.S. expat community." is also highly
offensive, and equally misleading. What the hell is being subsidized? We pay
taxes in our countries of residence, and often at a higher rate than US-based
residents. Do we derive *any* benefit for these supposed "subsidies"? If the
restrictions and closing of US Embassies and consulates is any indication, or
the almost total lack of any kind of direct representation in Washington is an
indication, or the fact that we use absolutely nothing (roads, services, parks,
etc.) in the US is an indication, what, exactly, is being "subsidized"?

So it can *not* be argued that tax exclusions "subsidize" the approximately 8
million US citizens who are living outside the US. To repeat: we pay (often
higher) taxes in the country of our residence. The vast majority of us are
either lower of middle income wage earners. And despite what you've written
here, the US is, for all practical purposes, virtually the only country in the
world that taxes based on nationality. For a reasonable, knowledgeable and
complete list of the minor (with a capital "M") exceptions, take a look at this
article published by the McGill University law professor Allison Christians.

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