In our previous articles about the investigation of the tax affairs of a company run by Mr Chan, we noted that the Inland Revenue Department (IRD) assessor had examined the staff payroll, in particular for employees who claimed to be working in China, and the management fees paid to appointed service companies.
After reviewing all the relevant correspondence, the assessor concluded that the management fees could not be regarded as deductible expenses for Mr Chan's company. He judged that they were made to business entities without commercial substance or expert employees and were therefore made mainly for tax evasion purposes.
Nevertheless, Mr Chan contended that the salaries paid to his merchandiser and quality controller should not be subject to income tax in Hong Kong, since they spent much of their working time on the mainland. He made a similar argument for himself and his wife, saying they regularly negotiated with buyers overseas and accompanied them to visit the factory in China as part of their efforts to secure sales contracts.
In explaining the IRD's point of view, the assessor made it clear that if a Hong Kong resident is employed by a Hong Kong company and is required to perform certain duties across the border, all income derived from that employment is subject to Salaries Tax. Therefore, since Mr Chan's merchandiser and quality controller had an employment contract with his Hong Kong company and performed only part of their duties in China, they would be assessed for Hong Kong income tax.
If their employment contracts stipulated that they had to render services only in mainland China and not in Hong Kong, all related income would then be regarded as attributable to services performed on the mainland and assessed accordingly.
In the case of staff employed by Mr Chan, who were paid partly by a local firm and partly by a mainland entity, the payment of Hong Kong Salaries Tax and Individual Income Tax (IIT) in China would be determined by the following:
1. For aggregated periods of stay in China not exceeding 183 days, income paid by the mainland entity would be subject to China IIT. The income paid by the Hong Kong employer would not be subject to China tax, but would subject to Hong Kong tax.
2. For aggregated periods of stay of more than 183 days, the total income received from the mainland entity and the Hong Kong employer would be subject to IIT in China. The tax would be apportioned on a time basis for the total income earned.
The IRD assessor therefore left Mr Chan in no doubt that only if staff were clearly assigned to work in his China factory, did not render any services in Hong Kong, and were stationed in China for more than 183 days during the year, would they be exempt from income tax in Hong Kong.
For any staff who were assigned to the factory in China, stayed there for more than 183 days a year, and were also required to render services in Hong Kong, their total income was fully assessable in China. Nevertheless, these employees could apply for exemption from Hong Kong Salaries Tax on that part of the income paid in China or claim a tax credit.
Regarding the director's fee paid to Mr Chan and his wife by the Hong Kong company, the agreement signed between Hong Kong and China for the avoidance of double taxation on income provides guidance. The obligation for a Hong Kong resident to pay tax on a director's fee earned as a member of a company's board depends on whether the company is resident in Hong Kong or China. Since Mr Chan's company was resident in Hong Kong, any director's fee would be wholly subject to Hong Kong tax only.
|Q & A on income tax payments in China|
|Q1 ||Under what circumstances will income attributable to services rendered by a Hong Kong resident on the mainland be exempt from Individual Income Tax in China?|
|A1 ||A Hong Kong resident will be exempt from income tax in China only if the following conditions are satisfied:|
the Hong Kong resident stays in the mainland for a period or periods not exceeding an aggregate of 183 days in the calendar year concerned the income is paid by or on behalf of an employer who is not a mainland resident the income is not borne by a permanent establishment or a fixed base which the employer has in the mainland.
|Q2 ||Is a director's fee subject to the 183 days rule?|
|A2 ||The 183 days rule does not apply to a director's fee, according to the double tax agreement signed between Hong Kong and the mainland. If a director's fee is received from company resident in Hong Kong, the whole amount is fully subject to Hong Kong Salaries Tax. However, if the director's fee is received from a company resident on the mainland, then the whole amount is fully subject to the mainland's Individual Income Tax. |