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

For cryptocurrency income, although the law has not yet clearly defined it, there are catch-all provisions in tax law such as "capital gains from property transfers," and there have been precedents of high-earning cryptocurrency traders being pursued for tax payments.

Organization: Wu Says 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 those who make high profits from coin speculation 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 exemption provisions, 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 textual summary; please listen to the full audio.

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Was the tax补税行动 sudden?

Cat Brother: Calix, as far as I know, 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, reflecting the upgrading of the tax collection and management mechanism - based on specific risk indicators, the internal "five-step work method" and other means are used to systematically assess the overseas income of natural persons.

From a deeper background perspective, two key factors have driven this action:

First, the tax authorities' tax collection and management technology and tax-related data analysis capabilities have been significantly improved. In the past, taxpayers mainly relied on voluntary declaration, 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 sector is facing real pressure. Although it is inconvenient to elaborate on this point, it is also one of the driving forces.

At present, the common targets of verification include people who invest in Hong Kong and U.S. stocks, and realize overseas equity of Internet companies. However, we believe that Web3-related cryptocurrency revenue is also worth paying attention to, and may become one of the focuses in the future.

Do investors in Hong Kong and US stock brokers need to pay taxes?

Brother Cat: In response to the recent tax audit, I noticed that some KOLs posted that many of their friends had received calls from the competent tax bureau, asking them to self-check and pay back the 2021–2023 foreign income tax. Although these incomes may not be related to the currency circle, they must be related to Hong Kong stocks and U.S. stocks. Some people even made it clear that if you use brokerages such as Tiger Brokers, Futu Securities, and Interactive Brokers Hong Kong, you will be audited by the China Tax Bureau, levied a 20% income tax, and only accumulate profitable transactions. Is this true?

Calix: It's true that quite a few KOLs have been talking about these situations lately. Judging from the actual cases we have come into contact with, some of the customers we serve do have those who are investigated from these scenarios, including through brokerage consultation, currency circle customer consultation, etc. What we are currently seeing is mainly concentrated in 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 people have not heard much about these audit cases in the past is that the tax office may not have had the means or resources to use the data in the early days. However, in recent years, data analysis capabilities have also increased significantly, and the tax office has begun to proactively analyze CRS data.

Therefore, it does not matter whether it is identified through the brokerage channel. Here's the point: as a PRC tax resident, if your overseas assets and earnings are "conspicuous" enough, they are likely to be in the IRD's view. In the long run, sooner or later, such foreign assets will face the attention and collection of Chinese tax authorities.

Will the middle class also be investigated?

Cat Brother: If we say that the high-income group is currently the focus of attention from tax authorities, will the overseas income of the middle class also be scrutinized by the tax authorities?

Calix: From the few cases of back tax 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 as what you call "middle class". 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 circle been included in the tax scope?

Mao Di: What is the attitude of the Chinese tax authorities towards income from the cryptocurrency trading circle? Will there be special attention to tax collection in this area?

Calix: This question is very interesting, in fact, our company initially chose to do financial and tax services in the currency circle, which was derived from 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", which 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 authority identify overseas income?

Brother Mao: How do the Chinese mainland tax authorities know the overseas income of mainland residents? If I don't transfer my foreign income back to China, or if there is a non-Chinese financial institution, will I not be taxed?

Calix: It's not 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, I would like to add that in the current context where "going overseas" has become the norm for enterprises, many large-scale companies in China will basically set up branches, accounts or have certain revenues in Hong Kong or other overseas markets. Once there is a large amount of domestic capital exchanges, in fact, it is completely possible for the tax bureau to find out whether it has overseas business income.

What should I do after being notified by the Inland Revenue Department for verification?

Cat Brother: If someone is notified to undergo a tax check, how long will the whole cycle take? Is there a lot of flexibility for negotiation and concession between the two sides in this process, and can you share one or two relevant cases?

Calix: Generally speaking, the period 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 it cannot be explained clearly, there is a risk that the tax burden will be determined by "maximizing profits".

How is tax residency determined?

Cat Brother: Is having Chinese nationality the same as being a tax resident in China?

Calix: Regarding the determination of tax residency, this is actually a technical question that many clients ask during the consultation process. I'm going to ask Simon, our senior tax manager at FinTax, to explain it in more detail.

Simon: Hello everyone, I am Simon. The concept of "tax resident" is very critical 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, it is not the case; nationality and tax resident status are not completely equivalent. Chinese tax law mainly determines whether a person is a Chinese tax resident based on two criteria: the "domicile standard" and the "days of residence standard."

First, residence criteria: 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, then the tax authorities may determine that you have a "residence" in China, thereby considering you a Chinese tax resident.

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 to live 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, working in blockchain-related jobs, and does not participate in Cryptocurrency Trading, only receiving his salary in the form of USDT. He hopes to convert these U back to the domestic currency using a Hong Kong card, in order to use it for future schooling or visa applications, and he also wants to comply with tax reporting as proof of income.

But he is a little worried, because the income is distributed through corporate accounts such as Backpack and BR, and then transferred back to the mainland through Hong Kong cards. He checked some information, including the explanation on GPT, and some people said that this kind of income belongs to the remuneration issued by the exchange, which does not conform to the nature of labor remuneration, so he has not dared to withdraw money. How should I deal with this situation?

Calix: It's not complicated. If it is true that he gets USDT because of the provision of labor and the performance of job duties, it is a typical "labor remuneration". The key is to: 1) keep a complete labor contract or service agreement; 2) Keep a record of USDT issued every month; 3) In the process of converting USDT to RMB, all on-chain transfer records, Hong Kong card arrival records, and remittance paths must be kept completely to ensure that the fund flow path can be self-certified closed-loop. As long as these materials can corroborate each other and explain the source and purpose of income, they can be used as salary income to declare individual income tax in China according to law.

Wayne: If he has received this salary in Hong Kong before and has paid taxes, can he deduct it in China?

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 that is allowed under the Individual Income Tax Law to avoid double taxation.

Wayne: Does that mean he better have a formal labor 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, a question can be extended - - is it possible to plan your own tax residency status through some means?

Calix: There are actually many strategies for this issue, depending on your objectives and specific circumstances. Some methods are more complex, such as setting up a family trust; others are 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's "183-day" rule and domicile criteria were just mentioned. 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 residency 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.