How to proceed tax evasion in China … legally

On the 26th of November 2013, France and China signed a new tax treaty leading to change the rules for expatriates and companies operating in the Chinese territory, or intending to settle there. However, solutions still exist to optimize tax amount.

Brief summary of China’s tax system

Chinese tax law stipulates that people from abroad who have worked in China for more than 183 days and less than 5 years (in this case, they are taxed on all their worldwide income) are taxed on their income from Chinese sources, that is to say related to their professional activities in China. Contrary to popular belief, tax rate in China may reach 45 % of taxable income. Moreover, Chinese tax authorities take into account workers’ income regardless of household expenses in which it is included in the calculation of the tax base.

Before an employee settles in China, it is common that this latter and his employer agree to respect the principle of equalization. This principle involves the employer to pay for his employee the difference between the amount of tax between France and China. However, some of the benefits of expatriate employee, such as a house or a car, cannot be taken into account in the calculation of the tax base. Allowances paid directly to the employee are often considered part of this income, and are taxed as such.

Except in exceptional cases, local structure in which the employee working is responsible to deduct the amount of the payroll tax and make monthly tax returns on behalf of the employee. At the end of the year, a discharge is issued by tax authorities indicating the amount of wages and taxes paid reported. Discharge must be retained by the employee and can provide evidence of tax payment in case of an audit in China or in the employee’s country of origin.

Companies specialized in tax optimization

Many companies in China have a department specialized in tax optimization. Indeed, China has for many years known a high growth rate (7.8% in 2012), attracting companies and workers. However, most of them are making a mistake by thinking that they can enjoy a flexible tax system and low tax rates, without having planned tax prior to their activity.

In addition, the influx of foreign companies and workers in the Chinese territory has been accompanied by a growing demand for services related to tax. Companies like INS Consulting offer, in addition to human resources management, to deal with Visa appliance and to optimize the salaries of expatriate employees. Large Chinese law firms as Dacheng are a better alternative for large companies who want to optimize the payment of dividends tax and get advice on various investments they intend.

Settle in Hong Kong: pros and cons

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Company creation in Hong Kong allows to have a commercial structure with many administrative and tax benefits within seven days. Moreover, VAT does not exist in Hong Kong, only one person is needed for the creation of the company and no minimum capital is required. In addition, if the activities are conducted outside Hong Kong, they are not subject to tax or duty. The company can also be managed from anywhere in the world. To our knowledge, there is no objection to create a company in Hong Kong. The only inconvenience that may occur is having to go there to open a bank account.

Regarding to French tax administration, the only risk to create a structure in Hong Kong concerns people living in France. French expatriates are therefore not affected. In theory, any person residing in France must disclose to the French tax authorities the companies and bank accounts opened abroad. The government taxes profits when repatriated to France. In practice, people who register a company in Hong Kong do not disclose such information to tax authorities in order to maintain Hong Kong tax advantages (neither VAT nor income tax have to be paid). Still a risk exists in this case because of the existence of the company and bank account has not been reported. However, this risk can be reduced by using ready names. Thus, even if it is checked in the Hong Kong companies’ register, the recipient’s name does not appear. In addition, Hong Kong has one of the highest banking secrets of the world.

Settle your head office in Hong Kong and expand your business in mainland China

A foreign company may have a head office in Hong Kong and register a representative office or WFOE (acronym standing for “Wholly Foreign Owned Enterprise”) in mainland China. This arrangement allows on one hand to quickly create a structure in Hong Kong as a head office, and on the other hand to repatriate legally (using the tax treaty between the two territories) profits from Chinese subsidiary firm in the Hong Kong parent company.

Creating a company in Hong Kong is possible and desirable for any type of business, even if it is a small business or a multinational corporation, but also to contractors, freelancers and self-employed who wish to quickly create a commercial structure without matters of minimum capital.

The impact of anti-tax havens reforms

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Various G20 meetings in 2009 and 2010 included China and the Special Administrative Regions of Hong Kong and Macao on the white list of countries that cooperate on transparency and exchange of information. Thus, Hong Kong is not considered as a tax haven because of the territoriality of activities tax base. In summary, either a company operates in Hong Kong (offices, customers, suppliers) thus it is taxed at 16.5% on its profits, or the company operates abroad, so it would not have to pay income tax.

According to several experts, a large share of FDI (Foreign Direct Investment) in China (25-60 % depending on the sources) comes from round spinning, a method which consists in exporting capital to Hong Kong or in another country with a favorable tax legal framework, and then import it back enjoying various tax benefits of FDI.

Thus the biggest investor in China happens to be the British Virgin Islands (BVI), a small archipelago of islands in the Caribbean with a population of 20,000 inhabitants. Hong Kong occupies the second place in the foreign investors in China hierarchy.

To conclude, it should be borne in mind that the economic and tax law in China is changing somewhat since 2007. Government continues to reform, especially in real estate and financial markets to avoid the economy to overheat. Nevertheless, China’s authorities still aim to keep China as the FDI biggest place.

 

Written by Yann Pellan

INS Global Consulting

 

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