Expert Analysis: Overseas Income Tax Supplementation Becomes Popular, Do Large Investors in the Crypto World Have Risks? What to Do When Encountering an Audit?

Editor | Wu Talks Blockchain

This AMA was hosted by FinTax and shared by Calix, Founder of FinTax, and Simon, Senior Tax Manager. Calix analyzes China’s recent foreign income tax actions, with a focus on its impact on Web3 practitioners and investors. Calix pointed out that the Chinese mainland tax bureau is able to cross-check residents’ overseas income through CRS data, foreign exchange records, payment platforms and other channels and methods, and the relevant collection and management work is gradually becoming obvious and systematic. For cryptocurrency income, although the law has not yet clearly defined, there are catch-all clauses such as “income from property transfer” in the tax law, and there are precedents for high-profit coin speculators to be chased for taxes. The future tax risks of crypto assets cannot be ignored. Simon explained the criteria for determining “tax residency” and related tax exemptions, and provided some suggestions for individual investors. The two also responded to practical issues such as how to comply with the declaration of labor remuneration on the chain, the tax verification cycle and the burden of proof.

The following content is a text summary; please listen to the full audio:

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Is the tax collection action sudden?

Cat Brother: Calix, as far as I know, since the beginning of this year, tax authorities in various provinces of mainland China have taken a series of tax inspection actions targeting individuals. Could you please introduce the relevant situation?

Calix: Specifically, since March and April this year, the tax bureaus in China, including Shanghai, Zhejiang, Shandong, Hubei and other places, have successively issued announcements requiring tax residents in China to pay back tax on their overseas income, with a penalty decision. This is not an entirely new policy or emergency – from past experience, there are cases of high-net-worth and high-income individuals being taxed every year because of undeclared overseas income. In the past, these cases were rarely publicized or reported, but this year’s special feature is that information has begun to be disclosed and media attention has increased, showing that this round of collection and management has a stronger “explicit” and systematic character. For example, this year, the tax authorities announced specific cases, and although the relevant amount is not large, it is clearly intended to send a signal, which reflects the upgrading of the tax collection and management mechanism - based on specific risk indicators, the internal “five-step work method” and other means to carry out a systematic assessment of the overseas income of natural persons.

From a deeper context, there are two key factors driving this action:

First, the tax authorities’ tax collection and management technology and tax-related data analysis capabilities have been significantly improved. In the past, it mainly relied on taxpayers to take the initiative to declare, but now through information integration and technical means, the data of the original “information island”, such as banks, foreign exchange records, etc., are opened.

Second, the finance is facing real pressure, although it is not convenient to elaborate on this point, it is also one of the driving forces.

Currently, the common subjects being audited include individuals investing in Hong Kong and US stocks, as well as those realizing overseas equity in internet companies. However, we believe that income from the cryptocurrency sector related to Web3 is also very worthy of attention and may become one of the key focuses in the future.

Do you need to pay taxes when investing in Hong Kong and US stock brokers?

Cat Brother: Regarding the recent tax audits, I noticed that some KOLs have posted stating that many friends around them have received calls from the tax authority, requesting them to self-check and pay the offshore income taxes for the years 2021-2023. Although these incomes may not necessarily be related to the crypto space, they are certainly related to Hong Kong stocks and US stocks. Some even say very clearly that if using brokers like Tiger Brokers, Futu Securities, or Interactive Brokers Hong Kong, they will be audited by the Chinese tax authority and taxed 20% on their income, only counting the profitable trades. Is this true?

Calix: Indeed, many KOLs have been discussing these situations recently. Based on the actual cases we have encountered, some of our clients have been subjects of investigations arising from these scenarios, including consultations through brokers and inquiries from cryptocurrency clients. The main focus we are currently seeing is concentrated on three types of accounts: overseas stock accounts, overseas bank accounts, and family trusts.

According to the public information, it is not possible to confirm whether the tax bureau obtains the data through a brokerage, but regardless of whether the source of the information comes from a brokerage firm, the essential reason is that the information of these overseas financial accounts is transmitted back to the Chinese tax authorities through the CRS (Common Reporting Standard) exchange mechanism. In fact, many friends don’t understand: in the context of CRS, as long as you are a Chinese national, then your overseas financial accounts, including balances and key information, will be regularly summarized and returned to the China Tax Bureau.

The reason why relevant inspection cases were not heard of in the past is that the tax authorities may not have had sufficient means or resources to utilize this data. However, in recent years, data analysis capabilities have significantly improved, and the tax authorities have begun to proactively analyze CRS data.

Therefore, it is not important whether to identify through brokerage channels. The key point is: as a tax resident of China, if your overseas assets and income are sufficiently “conspicuous,” they are likely to come to the attention of the tax bureau. In the long run, such overseas assets will inevitably face scrutiny and taxation by the Chinese tax authorities.

Will the middle class also be investigated?

Cat Brother: If the double high groups are currently the focus of attention for the tax authorities, will the overseas income of the middle class also be monitored by the tax authorities?

Calix: From the few cases of the tax compensation in our previous article, which was close to 100,000 readers, the amount involved is actually not very large, and it can basically be classified in the “middle class” range. To put it bluntly, high-net-worth individuals have stronger tax planning capabilities and higher tax-related amounts, while middle-class groups are more likely to be “exposed” to the tax system. The reason is that the middle class generally does not hire professional tax accountants or lawyers to plan, and their overseas income is often salary or labor remuneration, and this part of the income often needs to be remitted to China through foreign exchange, and bank statements and foreign exchange quotas will leave obvious traces. At present, a very key observation indicator of the tax department is the foreign exchange inflow and outflow records of personal accounts. For example, have you used up your exchange quota within a year? Are there multiple cross-border remittances? Are there frequent foreign exchange transactions between family members? If there are anomalies in these figures, the tax authorities can basically determine that you may have a source of income overseas. Therefore, there is no need to talk about whether the middle class has become the focus, but from the perspective of information availability, the overseas income behavior of the middle class is easier to track in terms of data, but faces a higher identifiable risk.

Has the cryptocurrency industry been included in the tax scope?

Cat Brother: What is the attitude of the Chinese tax authorities towards income in the cryptocurrency space? Will there be special attention on tax collection in this area?

Calix: This is a very interesting question, in fact, our company initially chose to do financial and tax services in the currency circle, which was based on relevant practical cases. When I first started my business, the financial and tax compliance of the crypto industry was not recognized by the mainstream in the circle, and many people felt that “the cryptocurrency industry should not be compliant”, and even felt that this direction was very strange and difficult to do. But the reason why I insisted on it was because in the early days, when I was still working as the chief financial officer of a U.S. listed company, a friend made hundreds of millions of yuan by speculating in currency on the exchange, but was targeted by the tax bureau, and was not only required to pay back taxes, but also encountered high fines and late fees, and the whole process was very painful. Therefore, I can clearly say that the taxation of currency speculation income is not groundless, and there are indeed many large-scale tax audit cases in reality. It’s just that because this circle is relatively closed and the dissemination of information is limited, the outside world may not know about it. As for why we rarely see large-scale taxation of cryptocurrencies, I think the core is that the nature of cryptocurrency income is not clearly defined at the legal level. If the tax authorities do not have a clear legal framework, it is more difficult to collect taxes across the board. However, we should also note that the Individual Income Tax Law has catch-all clauses, such as “income from property transfer” and “other income” can be the basis for taxation. Bitcoin’s breakthrough of $100,000 has unleashed a huge wealth effect, and the industry has long become an important gathering place for high-net-worth individuals, and the tax authorities will certainly not ignore it. In Europe and the United States, the rules for paying taxes on cryptocurrencies are relatively clear, and there are clear regulations on what taxes to pay under any circumstances, but whether they can be traced and whether they take the initiative to declare is another matter. In contrast, China does not yet have a systematic tax framework. I think the tax authorities maintain a very close technical focus, and some of the tax officials have quite a professional understanding of cryptocurrency.

How does the tax bureau identify overseas income?

Cat Brother: How do the tax authorities in mainland China know about the overseas income of mainland residents? If I do not transfer my overseas income back to the country or if it is held in financial institutions with non-Chinese backgrounds, will I not be taxed?

Calix: It’s not really a complicated question, it’s about the CRS framework. The core objective of the Common Reporting Standard (CRS) introduced by the OECD has been adopted by many countries, and the core objective is to understand the assets of tax residents in their overseas financial accounts to identify potential tax avoidance. The information exchanged by the CRS is mainly the basic financial data of the account, such as the account balance, the identity of the account holder, etc. In theory, the account information of Chinese nationals and Chinese tax residents with overseas financial institutions will be exchanged back to the Chinese tax authorities on a regular basis. However, it should be noted that the account balance data alone cannot be directly taxed. The tax authorities also need to restore the specific source and use of funds, communicate with taxpayers, and reasonably confirm the tax items before completing the collection and management. This means that the process is not automated, and that there is manual work and forensics after the data is captured. The exception is the United States, of course, which is not a member of the CRS system and has its own independent information exchange framework (FATCA). Although there is no CRS data exchange mechanism between China and the United States, I understand that there may be other channels for obtaining some information, but the exact means have not been publicly disclosed, and it is difficult for me to speculate here. In addition, in addition to CRS, tax authorities are now also relying on cross-border payment data, payment platform information, fund flow records, etc. for indirect identification. For example, whether you frequently receive money from overseas and whether you have capital transactions that are highly related to overseas business can be used as supporting evidence to identify whether you have foreign income.

Finally, one more point to add: against the backdrop of enterprises “going abroad” becoming the norm, many large companies in China will basically set up branches, accounts, or have certain revenue in Hong Kong or other overseas markets. Once there is a significant amount of domestic capital flow, the tax bureau can easily trace and identify whether it has overseas business income.

What to do after being notified by the tax bureau for inspection?

Cat Brother: If someone is notified to undergo a tax audit, how long does the entire process usually take? Is there a lot of flexibility for negotiation and compromise between the two parties during this process? Could you share one or two related cases?

Calix: Generally speaking, the cycle from the receipt of the notice to the completion of the initial verification is about two months; If the case goes to the audit stage, the cycle may be extended to six months. The exact length of time depends on several factors: the degree of cooperation between the tax authorities and the taxpayer, the complexity of the case itself, and the direction of the final negotiations. Each of these variables can lead to strong individual differences in each case. As for the negotiation space, we have indeed seen quite a few cases where there is a large fluctuation. For example, the tax authorities may claim that the amount of tax to be levied is relatively high at the beginning, but in the subsequent process, through data review, it is found that part of the amount belongs to living expenses, debt repayment, or there are loss deductions that have not been included in the calculation, which may significantly affect the final taxable amount. The difference between the actual tax amount and the preliminary determination can sometimes reach more than 90%, and the key lies in whether the information is sufficient and whether the evidence is in place. If the tax office already has access to your financial account data, such as your deposit amount, withdrawal history and account balance on a trading platform, they may be able to directly calculate your actual profit, including the principal invested and accumulated losses. However, if your funding path is more complex, such as having multiple accounts moving around, or involving frequent transactions with corporate accounts and various sources of funds, they may not be able to fully restore the real situation. In this case, the Inland Revenue Department will ask you to explain the source and purpose of the funds. For example: Is this money your income? Is it a transfer between your own accounts? Is it an investment or a living expense? You need to back up your claim with contracts, invoices, fund details, transfer records, and other materials. Only if the data can be recognized by the tax authorities can it be used as a basis for adjusting the tax base. Otherwise, if you can’t explain it clearly, you may face the risk of determining the tax burden by “maximizing profits”.

How is tax residency status determined?

Cat Brother: Does having Chinese nationality mean being a Chinese tax resident?

Calix: Regarding the determination of tax residency status, this is actually a technical issue that many clients will inquire about during the consultation process. Next, I will invite our Senior Tax Manager Simon from FinTax to explain it in detail.

Simon: Hello everyone, I am Simon. The concept of “tax resident” is very crucial in China’s individual income tax collection. Many clients often ask: If I am a Chinese national, does that mean I am definitely a Chinese tax resident? In fact, this is not the case; nationality and tax resident status are not entirely equivalent. Chinese tax law primarily determines whether a person is a Chinese tax resident based on two criteria: the “domicile standard” and the “residency days standard.”

First, the residence standard: Even if you work or live abroad for a long time, if you have not formally renounced your Chinese nationality, and your family members or main economic interests are still in China, the tax authorities may determine that you have a “residence” in China, thereby considering you a tax resident of China.

Second, the number of days of residence: If you have lived in China for 183 days in a tax year (i.e., from January 1 to December 31 of the Gregorian calendar year), you may be recognized as a tax resident in China even if you do not have a domicile. In practice, we have encountered many cases where some clients stay overseas for a long period of time for study, work, family visits, tourism, etc., but when they return to China after completing these activities, the tax bureau will often determine that China is still their “habitual place of residence” based on their normal life after returning to China, so they will be regarded as Chinese tax residents.

How to declare on-chain labor income?

Wayne: Hello everyone, I am Wayne. I would like to ask a practical question on behalf of a friend: He has recently entered this industry and is engaged in on-chain related work. He does not participate in cryptocurrency trading and only receives a salary in the form of USDT. He hopes to exchange these U back to the domestic currency via a Hong Kong card, so that he can use it for studying or visa applications in the future. He also wants to comply with tax declaration as proof of income.

But he is somewhat worried because these earnings are disbursed through corporate accounts like Backpack and BR, and then transferred back to the mainland via a Hong Kong card. He checked some information, including explanations on GPT, where some say that this kind of income belongs to compensation issued by exchanges and does not conform to the nature of labor remuneration, so he has been hesitant to withdraw funds. How should this situation be handled?

Calix: This is actually not complicated. If he obtains USDT due to labor provided and fulfillment of work responsibilities, it would be classified as typical “labor remuneration.” The key points are: 1) Retain a complete labor contract or service agreement; 2) Keep records of USDT disbursed each month; 3) Preserve all on-chain transfer records, port card receipt records, and remittance paths during the process of converting USDT to RMB, ensuring the flow of funds can self-verify a closed loop. As long as these materials can corroborate each other, clearly explaining the source and use of income, it can be declared as wage income for individual income tax in the country.

Wayne: If he had received this salary in Hong Kong and paid taxes on it, can he deduct it in the mainland?

Calix: Yes. If he has paid individual income tax in Hong Kong in accordance with the law, this part of the income will be consolidated into the salary income under the Chinese tax standard when he returns to China, and then the tax payable will be calculated according to the domestic tax law. If it is calculated that he should pay 20 yuan, and he has already paid 10 yuan in Hong Kong, then he only needs to pay 10 yuan in China. This is a “foreign tax credit” mechanism allowed in the Individual Income Tax Law to avoid double taxation.

Wayne: Does that mean he better have a formal employment contract as supporting documentation?

Calix: Yes, it’s ideal to have a formal employment contract. If not, other forms of contracts, job descriptions, service agreements, etc., can also be supplemented to prove that it is “labor income”. If the company is willing to cooperate with the issuance of the explanation, it will be more conducive to the recognition of the tax authorities.

Can tax identity be planned?

Cat Brother: Here we can extend a question — can one plan their tax residency status through certain means?

Calix: There are actually a lot of strategies for this question, depending on your purpose and your specific situation. Some methods are more complex, such as setting up a family trust; There are also some more basic paths, such as adjusting the number of days of residence.

Taking family trusts as an example, there is indeed some controversy over its tax treatment in China, but from past practice, it has indeed played an effective role in tax planning under a specific structure. Of course, it is uncertain how the policy will evolve in the future, so this method should be judged on a case-by-case basis. In a relatively simple way, it is based on the criteria for “tax residency” in China’s tax law. For example, Simon just mentioned the “183 days” rule and the domicile criterion. If a person has been living abroad for a long time and has no actual economic interests or residence arrangements in China, it is theoretically possible to avoid being recognized as a Chinese tax resident through daily arrangements and filing paths. Personally, I believe that China’s tax law still lacks clear operational guidelines on the “tax resident deregistration” mechanism. If a person has Chinese nationality or household registration, but has been absent from China for many years and no longer has actual economic activities or sources of income in China, it is theoretically possible that he or she will no longer be recognized as a Chinese tax resident. For example, if you live in Singapore or Hong Kong for a long time, it stands to reason that you should pay taxes according to the local tax laws, and have nothing to do with the mainland. However, in practice, there are great differences, involving factors such as residence, income path, and capital allocation, so it is recommended to plan according to individual circumstances. From a legal point of view, there is space, and the key lies in whether there is a clear strategy and compliance enforcement.