Understanding the US China Tax Treaty is crucial for Americans living in the China and to Chinese non-U.S. citizens who have U.S. sourced income. This comprehensive guide breaks down the treaty's provisions, offering clarity on how it affects personal taxation and helps avoid double taxation.
Executive Summary
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Introduction to the US China Tax Treaty
The US China tax treaty, signed in 1987, serves as an agreement between the two countries for determining the taxation of income where both nations may have the legal right to tax according to their respective laws. The treaty covers, among many topics, avoidance of double taxation, residency tie-breakers and taxation of various forms of income, including business profits, dividends, interest, pensions, and capital gains. This article will focus on some of the key aspects of the treaty that hold particular significance.
Relief of Double Taxation
The China US tax treaty provides mechanisms for relief from double taxation, ensuring that income earned in one country by residents or citizens of the other is not taxed twice. In most cases, the treaty allows U.S. citizens and residents to claim a foreign tax credit for the income tax they pay to China (for Chinese sourced income) against their U.S. tax liability. Conversely, China offers a credit for U.S. taxes paid on U.S. sourced income against it's own tax liabilities.
Example
Chen Wei, a U.S. citizen living in Shanghai, earns an annual salary of $80,000. In China, he pays $25,000 in taxes for the year. Chen's U.S. tax liability for this income amounts to $22,000. Thanks to the relief of double taxation provision of the tax treaty, he is entitled to claim a foreign tax credit on his US taxes. Chen applies the $25,000 he paid in Chinese taxes against his U.S. tax obligation, effectively reducing his U.S. tax liability to zero and even generating a $3,000 credit surplus, which may be carried over to subsequent tax years.
The Savings Clause
The China US tax treaty contains a "savings clause" which allows the U.S. to impose taxes on its citizens according to its own laws, even if this contradicts the treaty provisions. As a result of this clause, the majority of the benefits and reductions offered by the treaty do not apply to U.S. citizens living in China.
Example
Liu Huan, a U.S. citizen, resides and works in Beijing, China, for an American bio-tech company. She performs all her work duties in China and has no physical business presence in the U.S. Although the China U.S. tax treaty exempts such income from U.S. taxation on the basis that there is no permanent establishment in the U.S., the savings clause overrides this because Liu is a U.S. citizen, thus requiring Liu to declare and possibly pay U.S. taxes on her income. Nevertheless, Liu can take advantage of foreign earned income exclusion or foreign tax credits for the taxes paid in China to avoid being taxed twice on the same income.
​Expert Tip: It's crucial for U.S. citizens to familiarize themselves with the savings clause exclusions in all tax treaties to accurately determine which tax benefits they can utilize. |
Tax Residency and the Tie-Breaker Rules
The United States and China each have their own criteria for determining who is a resident for tax purposes. It's possible for someone to meet the residency requirements of both countries simultaneously. To prevent the problems that dual tax residency could cause, the U.S. China tax treaty provides that the competent authorities of the United States and China will determine the individual's residency through a mutual agreement, taking into account the person's facts and circumstances.
Taxation of US-Sourced Passive Income
Passive income from U.S. sources, which is not tied to a U.S. trade or business, is generally taxed at a flat rate of 30% if earned by a non-resident alien. However, the US China tax treaty lowers this rate or totally exempt it from US taxation for certain types of income. We've summarized some of the tax treaty rates in the table below. It's important to note that that these rates generally do not apply to U.S. citizens due to the savings clause mentioned earlier.
​ | ​Tax Rate | Treaty Article Citation |
​Interest | 10% | 10(2) |
​Dividends - Paid by U.S. Corporations | 10% | 9(2) |
Dividends - Qualifying for Direct Dividend Rate | 10% | 9(2) |
Pensions | 0%* | 17(1) |
Social Security | 30%** | 17(2) |
*The provision does not apply to annuities.
**Tax rate applies to 85% of the social security payments you receive from the U.S. Government. Therefore, the actual tax rate you pay on your total social security payments is 85% of the rate listed in the table.
Income Earned While Temporarily Present in the US
Generally, income earned from work performed in the US would be considered US source income and would be subject to US taxation. However, the US China tax treaty lists certain exemptions where such income is not subject to US taxes. It's important to note that these exceptions generally do not apply to U.S. citizens because of the savings clause mentioned earlier. We've summarized some of these exceptions in the table below:
​Income Type | ​Maximum Presence in U.S | Required Employer or Payer | Maximum Amount of Compensation | Treaty Article Citation |
​Employee* | 183 days | Any foreign resident* | No limit** | 14 |
Contractor | 183 days*** | Any contractor | No limit** | ​13 |
Scholarship or fellowship grant | No specific limit | Any U.S. or foreign resident | No limit | 20(b) |
Teaching**** | 3 years | U.S. educational or research institute | ​No limit | 19 |
​Full-Time Students - remittances or allowances | No specific limit | Any foreign resident | No limit | 20(a) |
​​Full-Time Students - Compensation during training | No specific limit | Any U.S. or foreign resident | $5,000 | 20(c) |
*The exemption does not apply if the employee's compensation is borne by a permanent establishment that the employer has in the United States. **Does not apply to fees paid to a director of a U.S. corporation.
***Exemption does not apply to the extent income is attributable to the recipient's fixed U.S. base.
****Does not apply to compensation for research work primarily for private benefit.
Totalization Agreement
Unfortunately, China and the United States do not have a totalization agreement in place, which is particularly relevant for self-employment income. Such an agreement would help prevent the double taxation of self-employment income with respect to social security taxes. Without this agreement, a self-employed U.S. citizen working in China are subject to social security taxes in both countries.
State Taxes Tax Treaties
Numerous states within the United States impose income taxes on their residents. The adherence to the federal U.S. tax treaty provisions varies by state, some may recognize them, while others may not.
​Expert Insight: Always check with a tax professional about how state tax laws interact with the treaty, as this can vary significantly from state to state. |
Need Help Navigating the US China Tax Treaty?
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Frequently Asked Questions
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Authored by Lewis Grunfeld, CPA
Lewis is a seasoned expert in international and U.S. expatriate taxation. With over 10 years of international tax experience, he specializes in applying tax treaties to benefit expats, handling complex tax scenarios and ensuring significant tax savings for his clients. Lewis's expertise in international compliance and U.S. expat tax returns has made him a trusted advisor in the expatriate community.