With the implementation of the Common Reporting Standard (CRS), tax information has entered an era of transparency. Tax avoidance or tax evasion based on asymmetric information is becoming more and more easily discovered. When considering tax compliance and tax planning, it is suggested that high net worth individuals (HNWIs) should give priority to tax compliance, for it is the passport to wealth security.
Failing to comply with tax laws and regulations means you will face risks of paying back taxes, late fees, fines, or even being investigated for criminal responsibility. Moreover, in case of non-compliance with tax laws and regulations, your name will land on the “Individual Income Tax Credit System” list and you will be jointly punished by relevant authorities.
Tax compliance does not mean paying taxes reasonably, rather paying taxes according to law. One misconception is that, as long as taxes are paid reasonably, you will not be subject to tax inspection. Although reasonable tax payment can reduce the possibility of tax evasion, it cannot exempt you from the legal liability due to tax evasion. Tax compliance does not mean that it is not necessary to consider tax planning. It is a right of taxpayers to make tax planning on the premise of tax compliance so as to legally reduce their tax burden. So, how do HNWIs make tax planning on the premise of tax compliance? The author suggests you consider the following points.
Residential status and source of income
Resident individuals and non-resident individuals have different tax liabilities in China. Resident individuals declare and pay individual income tax in China for their income from domestic and overseas sources, while non-resident individuals only pay individual income tax in China for their income from domestic sources. After the Individual Income Tax Law was revised, the judgment standard of resident individuals has become clearer. If you are a HNWI with a large amount of cross-border income, it is especially important to make your residence plan and arrange your residential status in advance. If you are non-resident individual, you may have different tax liabilities in China depending on your income sources. Since different tax burdens are imposed in different countries, reasonably arranging your income resources will help reduce your tax burden.
Sources of income and tax liabilities
According to the relevant provisions of the Individual Income Tax Law, different types of income will bear different tax liabilities. As an HNWI with more income types, it is suggested for you to systematically sort out your past income types and accurately judge your tax liabilities. When sorting out your income types, you need to distinguish income sources (domestic income or overseas income).
When judging tax liabilities, it is important for you to judge whether you need to undertake any tax liability for your income in China. This should be based on the relevant facts of income and the relevant provisions of China’s Individual Income Tax Law. Misjudgment on tax liabilities will result in paying more or less tax. The former counts against you as a taxpayer, while the latter will pose tax risks to you.
Income type and applicable tax rate
According to the Individual Income Tax Law, there are nine types of income and three kinds of tax rates. Different tax rates may apply to different types of income. However, there are some overlapping and ambiguous areas between different types of income. For example, the tax rate applicable to income obtained by an individual limited partner from a limited partnership enterprise by transferring its equity of the invested enterprise depends on whether the income is classified as operating income, or income from property transfer. Accurately defining income type and applicable legal tax rate can reduce risks.
Declare tax truthfully and pay it in full
The declaration of individual income tax should be made according to the facts, otherwise a failed or false declaration will result in fines and even criminal liability. As an individual, you should pay individual income tax in full and on time; otherwise, you will be fined.
In order to declare and pay tax on time and truthfully, first sort out the types of income comprehensively to avoid a misstatement or understatement of income amount. Second, define your income types accurately – if they are not correct, your applicable tax rates may be wrong. Third, apply for deducting various expenses and deduction items according to law, to accurately determine your taxable income.
Tax planning and tax avoidance
Tax compliance represents the interests of the state, while tax planning represents the interests of taxpayers. Only by paying taxes according to law can the interests of taxpayers be safeguarded and the interests of the state not be harmed. Tax avoidance is not protected by law, but is often subject to anti-tax avoidance investigation and adjustment. However, tax avoidance is tolerable under law. In the case of tax avoidance found, a taxpayer only needs pay back tax and the corresponding interests, and need not pay a late fee, not to mention fines and criminal liabilities. Therefore, tax avoidance often becomes one of taxpayers’ choices due to its concealment and non-illegality.
In contrast, reasonable and legal tax planning is protected by law. To make tax planning legal, transactions must be arranged according to the provisions of tax law. Tax law stipulates the tax consequences of transactions, so different transactions will face different tax consequences. Tax planning should meet the relevant provisions of tax law in terms of transaction subject, transaction object, transaction consideration and transaction method. Only in this way can the results of the planning be protected by the tax law. The reasonableness of tax planning means that a transaction should have a reasonable commercial purpose instead of reducing, exempting or postponing tax payment as its main purpose
The consequence of tax planning is quite different from that of tax avoidance, but it is difficult to define the nature of the former. Taxpayer and tax authority often disagree with each other on whether a transaction arrangement considering both commercial and tax purposes is determined as tax avoidance or tax planning. In practice, it is common for taxpayers to mistake tax avoidance for tax planning, thus leaving potential tax risks.
Liu Yungang is a partner at AllBright Law Offices
11-12 Floor, Shanghai Tower,
No. 501 Yincheng Middle Road,
Pudong New Area, Shanghai 200120, China
Tel: +86 21 2051 1000
Fax: +86 21 2051 1999
Email: [email protected]