Trust Illustration: VCG

Recently, some foreign media outlets have spun a document on individual income tax relating to offshore trusts, issued by China's tax authorities in July, into claims that "China will start taxing overseas wealth from October 22" and that the government is "plugging a fiscal hole." A Chinese expert called such framing misleading, saying that it overlooks the policy's continuity, its transitional arrangements and its legislative intent.

The expert also noted that China's move is an internationally accepted practice - a compliance-improvement measure that implements the principle of taxing residents on their worldwide income, with the aim of enhancing transparency, preventing tax evasion and stemming disorderly outflows of assets.

The Financial Times reported on Wednesday that "from October 22, authorities will begin collecting a 20 percent tax on dividends and interest earned from offshore trusts, explicitly targeting wealthy Chinese who shelter their assets overseas." It also claimed that "the campaign has the potential to help Beijing fill a deepening fiscal hole in central government coffers."

Since its release, the document has drawn wide attention from foreign media outlets including Reuters, Bloomberg and CNBC. What is the actual policy? How should China's tax rules for overseas trusts be properly understood?

According to a joint announcement issued in July by the Ministry of Finance and the State Taxation Administration, Chinese resident individuals are required to declare and pay individual income tax on income derived from transferring assets into offshore trusts, as well as income generated during the lifetime of such trusts.

For trusts that have been under operation for more than three years, tax liabilities incurred at the establishment stage will be exempt from retroactive collection. However, income accrued during the trust's lifetime must be reported regardless of the establishment date. A three-month grace period is provided for voluntary disclosure, during which late payment penalties are waived.

"The announcement does not introduce new legislation, but detailed rules for more effective law enforcement. China's move is a normal step to improve its own tax administration system," Xi Junyang, a professor at the Shanghai University of Finance and Economics, told the Global Times on Thursday.

Official interpretations make it clear that in recent years some individuals have used offshore trusts for intergenerational wealth transfer and cross-border asset allocation, but some have exploited the fact that such trusts are set up in jurisdictions with low information transparency and low tax burdens to shift assets, conceal wealth and evade taxes. In line with the basic principle under China's Individual Income Tax Law that residents are taxed on their worldwide income, clarifying the tax rules for offshore trusts helps improve tax certainty and transparency, makes it easier for taxpayers to comply, promotes social fairness and safeguards the country's tax interests.

Xi Junyang noted that the move is not aimed at shoring up fiscal shortfalls - compared with the country's massive fiscal revenue, the tax involved here is limited in total and is not a major consideration. 

"Its core purpose is to improve the tax collection system: overseas income is taxable under the law to begin with. By highlighting it, the authorities can raise taxpayers' awareness and foster a habit of voluntary compliance, thereby ensuring the tax collection process runs smoothly," the expert added.

Taxing residents on their worldwide income and similar arrangements is a common practice in most major economies. For instance, the US Internal Revenue Service noted that US persons and their tax return preparers should be aware that US persons who create a foreign trust, or have transactions with a foreign trust, can have both US income tax consequences, as well as information reporting requirements. Failure to satisfy the information reporting requirements can result in significant penalties, as well as an extended time for assessment of any tax imposed with respect to the period to which the information relates.

"Some foreign media hype over this policy overlooks its continuity, its transitional arrangements and its legislative intent. China's move is a lawful, compliant and internationally accepted practice - a compliance-improvement measure that aims to enhance transparency, prevent tax evasion and stem disorderly outflows of assets," the expert noted.