Much of my practice at Hwuason involves advising clients on the interaction between China’s tax laws and the tax laws of another country. It has often been said that international taxation is one of the few truly international areas of the law. As such, a China tax professional advising on the tax implications of cross-border transactions must be aware of more than just China’s tax laws
In this light, a few months ago I wrote about the effective end of the 23AG exemption for Australian tax residents in respect of foreign earned income. Since then I have had a number of inquiries about this issue. As such, a full explanation of the impact of the ending of the exemption and the taxation of Australian tax residents on China sourced income is timely. This post will be mostly relevant to Australians working in China, but it will discuss issues of China individual income tax that can be applied generally.
Liable to Taxation in Australia
If you are an Australian tax resident your assessable income includes your ordinary and statutory income derived directly or indirectly from all sources whether in or out of Australia; that is, you are taxable on your worldwide income. If you are not an Australian resident, then you will only be liable to taxation in respect of Australian sourced income. Accordingly, in respect of China earned income the potential for double taxation only arises if the person is an Australian tax resident.
The tests for residency for individuals are found in section 6(1) of the Income Tax Assessment Act 1936 (Cth). The first point to make clear, and what many people often do not understand, the question of resident for tax purposes in Australia has no connection to whether that person is a resident or citizen for immigration purposes.
The primary starting point is that a person is a resident of Australia if they “reside” in Australia (this is referred to as the “ordinary concepts” test). The word “reside” is considered to mean “to dwell permanently, or for a considerable time, to have one’s settled or usual abode, to live in or at a particular place” (Levene v IR Commrs (1928) 13 TC 486). This primary position is then expanded by three statutory tests:
- Where the taxpayers domicile is in Australia, unless they cease to reside in Australian and the Commissioner of Taxation considers the taxpayers permanent abode is outside of Australia;
- Where the taxpayer has been physically in Australia for more than one-half of the income tax year (i.e more than 183 days);
- Where the taxpayer is a contributing member the superannuation fund for Commonwealth government officers.
It is not within the scope of this posting to provide an in-depth explanation of these statutory tests. However, two critical points should be made. Firstly, all individuals have what is referred to as a domicile of origin (this will usually be the country of their father’s permanent home). The domicile of origin can be replaced by a domicile of choice but the important aspect of this is that is extremely difficult alter your domicile. Accordingly, in most cases a person’s domicile will never change, even if they live outside of Australia for more than five years. Secondly, as the a person’s domicile is unlikely to change, the question of residency is usually determined by whether that person’s permanent place of abode is outside of Australia. This test depends upon various factual circumstances but the Commissioner’s general practice is to require the person to live overseas for a two year period. It should be noted that it is highly doubtful that such a position has any basis in law. Other factors that the Commissioner will consider for this test include:
- Intended and actual length of the assignment.
- The duration and continuity of the presence in the overseas country.
- Establishment of a home outside Australia.
- Whether the family accompanies the individual to the host country.
- Whether the place of residence in Australia has been abandoned whilst overseas.
- The durability of association that the individual has with a particular place.
- Keeping bank accounts in Australia.
- The sale of Australian assets, such as a car or house, prior to departure.
- The place of education of children.
It should be noted that this position can be altered for the purpose of a double tax agreement. Under the China-Australian double tax agreement there is a mechanism, where a person is resident of both countries, for determining the appropriate country of residence for the purpose of the agreement. However, to be a resident for China tax purposes there is effectively a new to have resident in China for 5 continuous years. Accordingly, such an issue will generally never arise – because Australian tax law would generally treat a person as a non-resident after two years.
If you are non-resident for tax purposes, then no liability for taxation will arise in Australia in respect of income earned from employment in China. However, if you are an Australian tax resident then your China employment income will, ostensibly, be subject to tax in Australia. This was where section 23AG previously became operable. Until 30 June 2009 section 23AG provided an exemption from Australian tax for foreign employment income provided certain conditions were satisfied.
However, since 30 June 3009 the section 23AG exemption has been limited to income in respect of the following activities:
- The delivery of Australia’s overseas aid program by the individual’s employer.
- The activities of the individual’s employer in operating a developing country relief fund or a public disaster relief fund.
- The activities of the individual’s employer being a prescribed institution that is exempt from Australian income tax.
- The individual’s deployment outside Australia by an Australian government (or an authority thereof) as a member of a disciplined force.
- An activity of a kind specified in the regulations.
There were some good policy reasons for removing the 23AG exemption. Many taxpayers who were working short term secondments overseas were being paid in Australia and such income was not being taxed in the country in which they were working. Accordingly, such persons were generally receiving tax free income.
In the post 23AG environment there are two ways in which an Australian tax resident can avoid double taxation in respect of foreign employment income; the foreign income tax offset provided under Division 770 of the Income Tax Assessment Act 1997 or if a relevant double tax agreement provides relief.
Working in China
All persons working in China will generally be subject to tax on their China employment income. The exception to this is where they reside in China for less than 90 days, or pursuant to the China-Australian double tax agreement in respect of Australian tax residents, less than 183 days. Accordingly, Australians working in China on short terms secondments of less than 6 months will not be liable to tax in China and accordingly no issue of double taxation will arise.
However, in respect of Australians working in China for periods between 6 months to 2 years, there is a potential for double taxation. This double taxation is basically avoided by the foreign income tax offset mentioned above. One problem with relying on the foreign income tax offset is that the taxpayer must make an application for such relief, including providing proof of tax paid overseas. Such proof is not always easy to obtain in practice, particularly in respect of non-english speaking backgrounds. One issue that can arise in such environments is that the respective employer may not, without the employee’s knowledge, in fact have been paying tax in respect of the employee.