Income tax liabilities for mainland Chinese employees in Hong Kong – what employers need to do

As reported in the Hong Kong media recently, changes to China’s tax residency guidelines mean that Chinese employees of state-owned enterprises (SOEs) based in Hong Kong now need to declare their Hong Kong income and pay taxes in mainland China on it. While Hong Kong is the first, and so far only, location where these measures have been applied, it is likely that enforcement will widen worldwide. This will have a significant impact on both employees who are classified as citizens of mainland China, and their employers. It is therefore important for both parties to understand what this means for them.

Hong Kong is home to over 300 000 people from mainland China who work in the city but remain citizens of China. For many, the news that Hong Kong residents would now be subject to tax in China on worldwide income came as a surprise. However, it should be noted that China has required its citizens, including people based overseas who retain their mainland China residence status, to pay taxes in mainland China on worldwide income for a long time. Until recently, however, this obligation has seemingly not been enforced by tax authorities. 

As per our understanding of the relevant legislation, an individual who is classified as domiciled in China is subject to tax in China on their worldwide income, and domicile exists where an individual is habitually resident due to household registration, family or economic ties. As such, employees from mainland China working in Hong Kong (or anywhere else outside mainland China) who retain their Chinese residency status (or ‘Hukou’), are required to pay tax in China on any income they earn from employment outside the country.

In the case of cross-border assignments of employees for work, most companies have a policy in place to help protect the employee from the additional tax liability the employee may incur in the host and/or home location during the assignment through a process of either tax equalisation or tax protection. Furthermore, our Expatriate Market Pay survey report for Hong Kong shows that over 60% of companies employing expatriate staff in Hong Kong will either tax equalise or tax protect their expatriate staff working there. Market practice therefore suggests that the onus will fall on employers of staff who have been assigned from mainland China to work overseas in helping them meet the taxes due on their assignment income. However, the principles of tax equalisation mean that employees should still make contributions towards the taxes due in China and the host location, equivalent to the hypothetical tax liability that they would have incurred in China on their notional home salaries. 

For employees who are classified as domiciled in China and work overseas but are not international assignees, the situation is not so clear cut. Firstly, there is a question of who is responsible for declaring the China domiciled employee’s salary to the relevant tax authorities in China and the second question is enforcement. In general, the onus would typically fall on the employee to pay their taxes. As such, in cases where a person is employed in one country but also subject to taxes on that income in another country, it is the employee’s obligation to declare their income and pay their taxes in that country, rather than the obligation of the employer. 

On the issue of enforcement, the recent steps taken by the tax authorities in China have involved them requesting SOEs in Hong Kong and elsewhere to assist them in ensuring compliance with the law. It is unlikely that they would be able to request other companies, such as non-SOE employers of Chinese tax residents outside China, to help them enforce the law. While an employer would obviously comply with any legislative requirement in the country in which they operate, they may deem it to be none of their business to comply with a request in relation to their employees from an organisation which has no jurisdictional authority in the location in which they operate. 

Also, in terms of the assistance that the company should provide, as mentioned above in the case of a cross-border assignment where a citizen of mainland China is employed there and is then assigned by his/her employer to work overseas, under the principle of no-gain, no-loss associated with the home-based compensation approach, the tax due on the assignment income over and above the employee’s hypothetical tax liability in the home location should be borne by the company when calculating the employee’s assignment compensation package. However, in the case of a person who remains tax resident in China but is employed overseas directly by an overseas entity, it is likely that the employer should not need to provide any form of compensation to the employee to account for their home country tax liability. 

For example, in a scenario where a Hong Kong company directly recruits an employee from mainland China, from the employer’s perspective the fact that the employee is also a resident of another country is not their concern and they will be less inclined to provide any form of additional compensation to the employee to help them in meeting their extra-territorial financial responsibilities. This is confirmed by our Permanent Transfers policy survey which showed that in this type of employee relocation approximately 95% of respondents stated that it was the employee’s responsibility to meet any ongoing tax liability on their employment income in their home country. Indeed, from our experience of working with companies who employ US citizens – the most notable example of employees working overseas who remain subject to tax in their home country – outside the USA, tax liability in the US on employment income is the responsibility of the employee (with the exception of cross-border assignees as already mentioned).

Double taxation agreements (DTAs)

Owing to the stricter enforcement of this requirement of tax residents to pay taxes in China on their worldwide income, it is important for employers and employees to be aware of the existence of double taxation agreements (DTAs). These treaties are typically uniquely concluded between the relevant parties and therefore vary from country to country. However, in the context of personal income tax they generally confer the primary right to tax an employee who is liable to income taxes in both countries to the location where the employee is performing their work. The tax paid in this location can then be credited against the employee’s tax liability on the same income in their home location. There is such an agreement in place between China and Hong Kong. 

Therefore, to illustrate how this would work in practice, in the example of an individual who is employed in Hong Kong and earns an annual salary of HKD 1 000 000 per annum and remains a tax resident in China, the tax due on that income in Hong Kong is approximately HKD 100 000 and the equivalent of HKD 250 000 in China. If a DTA was not in place, the employee’s total tax liability would have been HKD 350 000, leaving them with a net salary of HKD 650 000. However, the DTA allows the employee to credit the HKD 100 000 tax that the employee has paid in Hong Kong, which is the source of their employment income, against their tax liability on the same income in China. As such, the employee’s total tax liability will be HKD 250 000, which is equal to the HKD 100 000 paid in Hong Kong and HKD 150 000 paid in China (tax liability of HKD 250 000 in China minus HKD 100 000 paid in Hong Kong). 

This is a simple illustration of how the process works and there are still complexities associated with differences in tax years between jurisdictions, exchange rates, and also a preference for tax to be paid first and then reclaimed later. However, China has DTAs in place with over 100 countries worldwide, so employers and employees should familiarise themselves with these as they can significantly reduce the employee’s tax burden on their employment income. 

Conclusion

For companies who have been assigning staff from mainland China and have operated in compliance with tax guidelines, the recent news regarding escalated efforts by authorities will not have any impact on how they manage their assignments. The current situation is more likely to be of concern to companies who were not in compliance and for citizens of mainland China who work outside of China and are not classified as cross-border assignees. As mentioned, while the enforcement has been only seen initially in Hong Kong, it is global in scope. For companies who have cross-border assignees originating from mainland China and don’t have a policy regarding tax management, now is the time to put a policy in place. For other categories of China tax residents working outside of China, the onus of meeting this additional burden, as we have seen, will likely fall on the employee. 

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