China-United States International Income Tax Treaty Explained

United States China Income Tax Treaty: International Counsel

US China Tax Treaty

US Korea Tax Treaty: The United States has entered into nearly 60 bilateral income tax treaties, including China. When an income tax treaty is entered into between two nations, it works to modify certain tax implications of income associated with the different countries. The United States and China have entered into several different International Tax Treaties. These treaties impact how the IRS enforces US Tax law — and vice versa. The two main treaties are the Double Tax Treaty and the Foreign Account Reporting Act. The focus of this article will be the US and China Income Tax Treaty. The treaty impacts many different issues, including passive income, foreign pension, Double Taxation, and more. One important issue to keep in mind is that while the treaty is a good baseline for assessing tax issues between the respective countries, there are hidden issues (and roadblocks) to be aware of — the most common being the application of the Saving Clause. We represent many clients throughout China and the United States, who have China assets and income — including dual-citizens and residents with IRS, and China Offshore and Foreign Reporting issues and have prepared this guide to assist with common questions. Let’s review the US China Income Tax Treaty:

How is Income Taxed in the US?

Even though the U.S. follows a worldwide income model, there are still tax treaty, resident-related rules that can impact the taxation of certain items, such as Dividends, Income, Pension, and Social Security. We will focus this summary on some of the more common issues our clients confront when working to get into IRS offshore tax and reporting compliance.

US China Income Tax Treaty Explained

Our summary will focus primarily on the focus of Individuals impacted by Treaty provisions:

Article 4 (Residence) in the US China Income Tax Treaty

• • • For the purposes of this Agreement, the term “resident of a Contracting State” means any person who, under the laws of that Contracting State, is liable to tax therein by reason of his domicile, residence, place of head office, place of incorporation or any other criterion of a similar nature.

    • Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then the competent authorities of the Contracting States shall determine through consultations the Contracting State of which that individual shall be deemed to be a resident for the purposes of this Agreement.

Residence (Article 4) Non-Technical Summary and Example

A resident of either contacting state, is generally going to be the place a person intends on serving as the domicile or primary abode.

Article 6 (Income from Real Property) in the US China Income Tax Treaty

• • • Income derived by a resident of a Contracting State from real property situated in the other Contracting State may be taxed in that other Contracting State.

    • The term “real property” shall have the meaning which it has under the laws of the Contracting State in which the property in question is situated.

    • The term shall in any case include property accessory to real property, livestock and equipment used in agriculture and forestry, rights to which the provisions of general law respecting landed property apply, usufruct of real property and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources; ships and aircraft shall not be regarded as real property.

    • The provisions of paragraph 1 shall apply to income derived from the direct use, letting or use in any other form of real property.

    • The provisions of paragraphs 1 and 3 shall also apply to the income from real property of an enterprise and to income from real property used for the performance of independent personal services.

Income from Real Property (Article 6) Non-Technical Summary and Example

• • • A Chinese National who is a resident of a contracting state (U.S.), who has income from real property in other contracting state (China) may be taxed in the other contracting stated.

*The treaty, article 6 refers to “may” and not “only” — so the U.S. can presumably tax the resident on the same income, although the resident can claim a foreign tax credit for income taxes already paid.

Article 9 (Dividends)

• • • Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other Contracting State.

    • However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the dividends the tax so charged shall not exceed 10 percent of the gross amount of the dividends. This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.

    • The term “dividends” as used in this Article means income from shares or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights which is subjected to the same taxation treatment as income from shares by the taxation laws of the Contracting State of which the company making the distribution is a resident.

Dividends (Article 9) Non-Technical Summary and Example

• • • Dividends that are paid by a company which is a resident of a contracting state (China) to a resident of the other contracting state (U.S.) may be taxed in that other state (U.S.)

*In this scenario above, China may also tax the income, but the tax is limited to 10%

Article 10 (Interest)

• • • Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State.

    • However, such interest may also be taxed in the contracting State in which it arises and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the interest, the tax so charged shall not exceed 10 percent of the gross amount of the interest.

    • Notwithstanding the provisions of paragraph 2, interest arising in a Contracting State and derived by the government of the other Contracting State, a political subdivision or local authority thereof, the Central Bank of that other Contracting State or any financial institution wholly owned by that government, or by any resident of the other Contracting State with respect to debt-claims indirectly financed by the government of that other Contracting State, a political subdivision or local authority thereof, the Central Bank of that other Contracting State or any financial institution wholly owned by that government, shall be exempt from tax in the first-mentioned Contracting State.

    • The term “interest” as used in this Article means income from debt claims of every kind, whether or not secured by mortgage, and whether or not carrying a right to participate in the debtor’s profits, and in particular, income from government securities, and income from bonds or debentures, including premiums or prizes attaching to such securities, bonds, or debentures.

Income (Article 10) Non-Technical Summary and Example

• • • Dividends that are paid by a company which is a resident of a contracting state (China) to a resident of the other contracting state (U.S.) may be taxed in that other state (U.S.)

*In this scenario above, China may also tax the income, but the tax is limited to 10%.

Article 12 (Gains) in the US China Income Tax Treaty

• • • Gains derived by a resident of a Contracting State from the alienation of real property referred to in Article 6 and situated in the other Contracting State may be taxed in that other Contracting State.

    • Gains from the alienation of movable (personal) property forming part of the business assets of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State, or of movable (personal) property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or together with the whole enterprise) or such a fixed base, may be taxed in that other Contracting State.

    • Gains derived by a resident of a Contracting State from the alienation of ships or aircraft operated in international traffic and of movable (personal) property pertaining to the operation of such ships or aircraft shall be taxable only in that Contracting State.

    • Gains from the alienation of shares of the capital stock of a company the property of which consists directly or indirectly principally of real property situated in a Contracting State may be taxed in that Contracting State.

    • Gains from the alienation of shares other than those mentioned in paragraph 4 representing a participation of 25 percent in a company which is a resident of a Contracting State may be taxed in that Contracting State. 6. Gains derived by a resident of a Contracting State from the alienation of any property other than that referred to in paragraphs 1 through 5 and arising in the other Contracting State may be taxed in that other Contracting State.

Gains Non-Technical Summary and Example (Article 12)

• • • When a citizen of China resides in the U.S., and sells real property in China, China may tax the sale.

Article 13 (Independent Personal Services)

• • • Income derived by an individual who is a resident of a Contracting State in respect of professional services or other activities of an independent character shall be taxable only in that Contracting State, unless he has a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities or he is present in that other Contracting State for a period or periods exceeding in the aggregate 183 days in the calendar year concerned.

    • If he has such a fixed base or remains in that other Contracting State for the aforesaid period or periods, the income may be taxed in that other Contracting State, but only so much of it as is attributable to that fixed base or is derived in that other Contracting State during the aforesaid period or periods.

    • The term “professional services” includes, especially, independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, dentists and accountants.

Independent Personal Services Non-Technical Summary and Example (Article 13)

• • • Income earned by a citizen of China, who is a resident in the U.S. is generally only taxed by the U.S. on the earned income (subject to various limitations)

Article 14 (Dependent Personal Services)

• • • Subject to the provisions of Articles 15, 17, 18, 19 and 20, salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that Contracting State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other Contracting State.

    • Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if:

      • • (a) the recipient is present in the other Contracting State for a period or periods not exceeding in the aggregate 183 days in the calendar year concerned; and

        • (b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other Contracting State; and

        • (c) the remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other Contracting State.

Dependent Personal Services Non-Technical Summary and Example (Article 14)

Unless articles 15, 17, 18. 19, or 20 applies, then the wages/salaries earned by a resident of a contracting state (U.S.) shall only be taxed in the U.S., unless the employment was conducted in China.

Article 15 (Directors’ Fees)

• • • Directors’ fees and other similar payments derived by a resident of a Contracting State in his capacity as a member of the board of directors of a company which is a resident of the other Contracting State may be taxed in that other Contracting State.

Directors’ Fees Non-Technical Summary and Example (Article 15)

Director’s Fees earned by a resident of a contracting state (U.S.), as a result of being on the Board of Directors for a company that is a resident in the other contracting state (China) — may be taxed in China.

Article 17 (Pensions and Annuities)

• • • Subject to the provisions of paragraph 2 of Article 18, pensions and other similar remuneration paid to a resident of a Contracting State in consideration of past employment shall be taxable only in that Contracting State.

    • Notwithstanding the provisions of paragraph 1, pensions and other payments made by the government, a political subdivision or a local authority of a Contracting State under its social security system or public welfare plan shall be taxable only in that Contracting State.

Pensions & Annuities Non-Technical Summary and Example o(Article 17)

Subject to Article 18, pensions paid to resident of a contracting state (U.S.) in consideration for past employment shall only be taxed in the U.S.

Article 18 (Government Employees and Pensions)

• • • (a) Remuneration, other than a pension, paid by the government or a political subdivision or a local authority of a Contracting State to an individual in respect of services rendered to that government or subdivision or authority shall be taxable only in that Contracting State.

    • (b) However, such remuneration shall be taxable only in the other Contracting State if the services are rendered in that other Contracting State and the individual is a resident of that other Contracting State who:

      • (i) is a national of that other Contracting State; or

      • (ii) did not become a resident of that other Contracting State solely for the purpose of rendering the services.

        • (a) Any pension paid by, or out of funds created by, the government or a political or a local authority of a Contracting State to an individual in respect of services rendered to that government or subdivision or authority shall be taxable only in that Contracting State.

        • (b) However, such pension shall be taxable only in the other Contracting State if the individual is a resident of, and a national of, that other Contracting State. 3. The provisions of Articles 14, 15, 16 and 17 shall apply to remuneration and pensions in respect of services rendered in connection with a business carried on by the government or a political subdivision or a local authority of a Contracting State.

Government Employees and Pensions Non-Technical Summary and Example (Article 18)

Renumeration other than pension paid by the government of a contracting state (China), to a person for services to the Chinese Government, shall only be taxed in China. But, the income shall only be taxed in the U.S., if the services were rendered in the U.S. and the person is a resident of the contracting state (limitations apply).

Article 22 (Elimination of Double Taxation)

• • • In the People’s Republic of China, double taxation shall be eliminated as follows:

      • (a) Where a resident of China derives income from the United States, the amount of the United States income tax payable in respect of that income in accordance with the provisions of this Agreement shall be allowed as a credit against the Chinese tax imposed on that resident. The amount of credit, however, shall not exceed the amount of the Chinese tax computed with respect to that income in accordance with the taxation laws and regulations of China.

      • (b) Where the income derived from the United States is a dividend paid by a company which is a resident of the United States to a company which is a resident of China and which owns not less than 10 percent of the shares of the company paying the dividend, the credit shall take into account the United States income tax payable by the company paying the dividend in respect of the profits out of which the dividends are paid

Elimination of Double Taxation Non-Technical Summary and Example (Article 22)

The U.S. will allow for a Foreign Tax Credit for citizens or residents of the U.S. on taxes due to the U.S., against any tax already paid to China, and vice versa

PROTOCOL 1 (P2) – Savings Clause in the US China Income Tax Treaty

• • • Notwithstanding any provision of the Agreement, the United States may tax its citizens. Except as provided in paragraph 2 of Article 8, paragraph 2 of Article 17, and Articles 18, 19, 20, 22, 23, 24 and 26 of this Agreement, the United States may tax its residents (as determined under Article 4).

What is the Saving Clause?

The Saving Clause basically says the contacting states (China and U.S.) can disregard the treaty, when applicable, and still tax the resident/citizen as if the treaty was not in place.

Reporting Forms for China

The following is a summary of five (5) common international tax forms.

FBAR (FinCEN 114)

The FBAR is used to report “Foreign Financial Accounts.” This includes investments funds, and certain foreign life insurance policies.

The threshold requirements are relatively simple. On any day of the year, if you aggregated (totaled) the maximum balances of all of your foreign accounts, does the total amount exceed $10,000 (USD)?

If it does, then you most likely have to file the form. The most important thing to remember is you do not need to have more than $10,000 in each account; rather, it is an annual aggregate total of the maximum balances of all the accounts.

Form 8938

This form is used to report “Specified Foreign Financial Assets.”

There are four main thresholds for individuals is as follows:

• Single or Filing Separate (in the U.S.): $50,000/$75,000
• Married with a Joint Returns (In the U.S): $100,000/$150,000
• Single or Filing Separate (Outside the U.S.): $200,000/$300,000
• Married with a Joint Returns (Outside the U.S.): $400,000/$600,000

Form 3520

Form 3520 is filed when a person receives a Gift, Inheritance or Trust Distribution from a foreign person, business or trust. There are three (3) main different thresholds:

• Gift from a Foreign Person: More than $100,000.
• Gift from a Foreign Business: More than $16,076.
• Foreign Trust: Various threshold requirements involving foreign Trusts

Form 5471

Form 5471 is filed in any year that you have ownership interest in a foreign corporation, and meet one of the threshold requirements for filling (Categories 1-5). These are general thresholds:

• Category 1: U.S. shareholders of specified foreign corporations (SFCs) subject to the provisions of section 965.
• Category 2: Officer or Director of a foreign corporation, with a U.S. Shareholder of at least 10% ownership.
• Category 3: A person acquires stock (or additional stock) that bumps them up to 10% Shareholder.
• Category 4: Control of a foreign corporation for at least 30 days during the accounting period.
• Category 5: 10% ownership of a Controlled Foreign Corporation (CFC).

Form 8621

Form 8621 requires a complex analysis, beyond the scope of this article. It is required by any person with a PFIC (Passive Foreign Investment Company).  The analysis gets infinitely more complicated if a person has excess distributions. The failure to file the return may result in the statute of limitations remaining open indefinitely.

*There are some exceptions, exclusions, and limitations to filing.

Received a Gift or Inheritance From China?

If you are a U.S. Person and receive a gift from a Foreign Person, Foreign Business or Foreign Trust, you may have to file a Form 3520. The failure to file these forms may lead to IRS Fines and Penalties (see below).

Which Banks in China Report U.S. Account Holders?

There are thousands Foreign Financial Institutions within China that report US account holder information to the IRS. The list can be found here: FFI List:.

What is important to note, is that the list is not limited to just bank accounts. Rather, when it comes to FATCA or FBAR reporting, it may involve a much broader spectrum of assets and accounts, including:

• Bank Accounts
• Investment Accounts
• Retirement Accounts
• Direct Stock Ownership
• ETF and Mutual Fund Accounts
• Pension Accounts
• Life Insurance or Life Assurance Policies

Totalization Agreement & the US China Income Tax Treaty

The purpose of a Totalization Agreement is to help individuals avoid double taxation on Social Security (aka U.S. individuals living abroad and who might be subject to both US and foreign Social Security tax [especially self-employed individuals] from having to pay Social Security taxes to both countries).

The United States has entered into 26 Totalization Agreements, but not with China.

US China Income Tax Treaty is Complex

In conclusion, The US and China tax treaty is a great source of information to help better understand how certain income may be taxed by either country depending on the source of income, the type of income and the residence of the taxpayer. The tax outcome may be changed depending on whether or not the savings clause impacts how tax rules will be applied for certain types of income.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure on matters involving the United States-China Tax Treaty.

Contact our firm for assistance.