The United States- People’s Republic of China Income Tax Treaty Explained

The major purpose of an income tax treaty is to mitigate international double taxation through tax reduction or exemptions on certain types of income derived by residents of one treaty country from sources within the other treaty country. Because tax treaties often substantially modify U.S. and foreign tax consequences, the relevant treaty must be considered in order to fully analyze the income tax consequences of any outbound or inbound transaction. This article discusses the implications of the United States.-People’s Republic of China Income Tax Treaty (“U.S.-China income tax treaty”).

Definition of Resident of Treaty Purposes

In order to take advantage of the U.S.-China income tax treaty, an individual or entity must be classified as a tax resident of either the United States, China, or both. Residency is determined by local law of the United States and China.

How Tax Residency Determined in the United States for an Individual

A United States citizen will always be classified as a resident of the United States for purposes of the treaty. In order for a non-U.S. citizen to be classified as a resident of the United States for purposes of the treaty, he or she must satisfy either the green card test or substantial presence test.

Green Card and Substantial Presence Tests

Under the green card test of Section 7701(b), a lawful permanent resident (green card holder) for any part of a calendar year for U.S. immigration purposes is a U.S. resident for U.S. federal income tax purposes until the green card status is rescinded or administratively or judicially determined to have been abandoned. You have advised us that you have not been issued a green card from the United States immigration authorities.

Under the substantial presence test of Internal Revenue Code Section 7701(b)(3), an alien present in the United States 183 days or more in a single taxable year, including partial days, is a U.S. resident for that year. Furthermore, an alien may also be considered a U.S. tax resident for the current calendar year under the substantial presence test if present at least 31 days in the testing year and the following formula amounts to 183 days or more by adding all of the days present in the year, one-third of the days present in the first preceding year, and one-sioth of the days present in the second preceding year.

Taxation of in the People’s Republic of China

Individuals who have a “place of abode” in China are subject to individual income tax on their worldwide income. For this purpose, individuals having a “place of abode” in China means those who maintain a place of residence in China because of their legal residence status, family or economic ties. In China, an individual’s “place of abode” for tax purposes is determined by whether they are considered to have a domicile (habitual residence) due to family, economic, or legal ties, or if they meet the 183-day physical presence rule. Residents are taxed on global income, while non-residents are only taxed on China-sourced income.

Relief from Double Taxation

Article 4 of the United States-China income tax provides for a so-called treaty tie-breaker provision. Assuming that an individual is a resident of both the United States and China under Article 4(1) of the treaty, it is necessary to apply Article 4(2) to assign residence exclusively to one country for purposes of the treaty.

Article 4(2) contains a series of tie-breaker tests used to determine an individual’s exclusive residence for purposes of the treaty. Article 4(2) provides:

Where by reason of provisions of paragraph (1) an individual is a resident of both Contracting States, then the individual’s tax status will be determined by the competent authorities.

(a) In making the determination of an individual’s tax status, the competent authorities will determine that the individual is a resident of the Contracting State in which he has a permanent home. If he has a permanent home in both countries, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closest (centre of vital interests);

(b) If the Contracting State in which the individual’s centre of vital interests is located cannot be determined, he shall be deemed to be a resident of the Contracting States in which he has an habitual abode.

(c) If the individual has a habitual abode in both Contracting States or in neither of them, he shall be deemed to be a resident of the Contracting State of which he is a national.

(d) If the individual is a national of both Contracting States or of neither of them, the competent authorities of the Contracting States shall settle the question.

The best way to understand how the treaty tie-breaker operates is through an example.
For our example, let’s assume Tom is a citizen of China and moves to the United States in early 2026 to work for a social media platform known as I Byte at Dancing. Tom obtains a visa to work in the United States and remains a citizen of China. Tom owns a home in China which he rents during the time he is in the United States. Tom moves his immediate family to the United States and brings all his personal belongings with him to the United States. Tom rents a home in the United States through a long term lease and purchases automobiles in the United States.

We will analyze Tom’s case under the tie-breaker tests in Article 4(2) in the order in which they are presented. Subsection (a) of the tie-breaker provision deems an individual to be a resident of a Contracting State in which he has a permanent home available to him. The concept of a “permanent home” is explained in the Commentaries to Article IV(2) of the OECD Model Treaty. Generally, a permanent home is a home that an individual has retained for his permanent use, as opposed to a place that is retained for a stay of short duration. Permanent use means that the individual has arranged to have the dwelling available to him at all times continuously. See Commentary to the OECD Model Treaty, paragraph 11-13.

Here, Tom owned a home in China. However, the home was rented during the time he was in the United States. He also leased a home in California for an indefinite period of time. At a minimum it appears that Tom leased the California home with the intention of residing in it through the 2026 calendar year. Neither the Treaty nor the OECD Model Treaty provide any guidance as to the time threshold that must be crossed in order for a home to qualify as “permanent.” However, Tom’s intention to use the home at least through the 2026 calendar year and the fact that Tom actually resided there for most of the 2026 calendar year would satisfy whatever time element might be applicable under the treaty

However, if, after an analysis of all the surrounding facts and circumstances, it is determined that Tom had a permanent home available to him in the United States as well as in China, his residence will next depend on where his personal and economic relations were closest (“centre of vital interests”). Under this test consideration is given to a person’s family and social activities, and his place of business and the place from which your property is managed. Commentators on the OECD Model have explained that in applying the centre of vital interests test: “[t]he circumstances concerned in the fiscal year concerned are decisive.”

Here, Tom maintained some economic relations with China after he moved to the United States. For example, Tom owned real property in China and received rental income from the rental property. However, during most of the 2026 tax year, Tom’s primary personal and economic interests, his family and place of employment, were all in the United States. Therefore, in light of the fact that most of Tom’s significant relations for the 2026 tax year were with the United States, providing support for finding that Tom’s centre of vital interests was with the United States, and not China.

It should be understood that under the treaty, the determination of residency is done on an annual basis rather than on a longer term basis such as “lifelong activity.” There is no indication in the treaty or the OECD Model Treaty that an individual’s lifelong activities must be taken into account in determining whether a person is a resident for treaty purposes. However, paragraph 15 of the Commentary on Article IV(2) of the OECD Model Treaty does acknowledge that the combination of certain factors (some of which include long term relations) may indicate that a dual resident has retained his centre of vital interests in a State other than the one in which he is presently residing. The sentence of paragraph 15 states:

“If a person who has a home in one State sets up a second in the other State while retaining the first, the fact that he retains the first in the environment where he has always lived, where he has worked, and where he has his family and possessions, can together with other elements, go to demonstrate that he has retained his centre of vital interests in the first State.”

This sentence may support an argument that certain historic facts can be relevant in determining residence, at least when the centre of vital interests test is being applied. However, based on our example, Tom’s facts and circumstances come within the intended scope of this sentence. As an initial matter, since Tom’s immediate family did not remain in Tom’s home in China, there is a question as to whether his facts and circumstances are covered by paragraph 15. There is also an issue as to whether the “other elements” referred to in paragraph 15 would demonstrate that Tom has retained his centre of vital interests in China. In particular, the circumstances of Tom’s presence in the United States could be interpreted to indicate that Tom has shifted his professional relations toward the United States. As of the beginning of 2026, Tom’s professional contacts are now in the United States and his employment in the United States has become the focus of Tom’s livelihood. In fact, it is reasonable to assume that if Tom’s employment in the United States is successful, Tom will intend to remain in the United States with your immediate family for a number of years.

The facts before us strongly suggest that Tom’s centre of vital interests is in the United States. Since Tom’s centre of vital interests are in the United States, Tom may be able to take the position under the treaty that he is not subject to Chinese income tax on his U.S. income. Should China and the United States both take the position that Tom is a resident of their State under Article 4(2) of the treaty, then Tom may present his case to the competent authority of the United States which is the IRS to be taxed only in the United States on his U.S. income and rather than both the United States and China.

For dual-resident corporations, the treaty does not provide a tie-breaker rule. Instead, the tax authorities or competent authorities of the United States and China must determine the entity’s residence.

Business Profits and Permanent Establishment

The way foreign persons are taxed in the United States depends on whether income derives from U.S. sources and whether the income that is taxed derives from the conduct of a U.S. trade or business. If a foreign person is operating a U.S. trade or business, a question arises if a tax treaty is in effect between the United States. Typically, under a treaty, a foreign person’s trade or business income will not be subject to U.S. tax unless the income is attributable to a permanent establishment” of the foreign person in the United States. A permanent establishment includes a fixed place of business, such as a place of management, a branch, an office, a factory or workshop. A permanent establishment also exists if employees or other dependent agents habitually exercise in the host country an authority to conclude sales contracts in the taxpayer’s name. The  United States-China income tax treaty defines a permanent establishment as places of management, branch offices, factories, workshops, and places for the extraction of natural resources. See note 4, at art 5. The treaty specifically excludes certain activities from the definition of permanent establishment. Some of these activities are: maintaining a fixed place of business solely for storing or displaying goods, purchasing goods or collecting information for the enterprise, and carrying on preparatory or auxiliary services.

Personal Services Income

Treaty provisions covering personal services compensation are similar to the permanent establishment clauses covering business profits in that they create a higher threshold of activity for host country taxation. Generally, when an employee who is a resident of one treaty country derives income from services performed in the other treaty country, that income is usually taxable by the host country. However, the employee’s income is exempted from taxation by the host country if the following requirements are satisfied: 1) the employee is present in the host country for 183 days or less; 2) the employee’s compensation is paid by, or on behalf of, an employer which is not a resident of the host country; and 3) the compensation is not borne by a permanent establishment or a fixed base which the employer has in the host country.

Article 13 of the United States-China income tax treaty permits a contracting state to tax the income of a nonresident who provides “professional services” of an “independent character” only when that person is present for a period exceeding 183 days of the calendar year or has a fixed base regularly available to him in the nonresident country for the purposes of performing his services. See art. 13, para 1. Professional services include: Independent scientific, literary, artistic, educational, or teaching activities, physicians, lawyers, engineers, architects, dentists, and accountants. Under Article 14 of the treaty, the income earned by a nonresident employee may be taxed by the contracting state if the employee is present within the state for more than 183 days, he is employed by a resident employer, or his compensation was paid by a permanent establishment of the employer. The treaty provides special taxes and exemptions for directors’ fees, entertainers and athletes, pensions, government services, teachers and researchers, students, and trainees. Under the People’s Republic of China individual income tax law, compensation is exempt from tax if the foreign employees remain in the country fewer than ninety days. The treaty extends this period to 183 days.

Dividends, Interest, and Royalties

Like the United States, most foreign countries impose flat rate withholding taxes on dividends, interest, and royalty income derived by offshore investors from sources within the country’s borders. Tax treaties usually reduce these withholding taxes. Tax treaties usually reduce the withholding tax rate on dividends to 15% or less. The United States-China Income Tax Treaty provides that tax on dividends shall not exceed 10 percent.

The term “dividends” as used in the treaty means 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.

Tax treaties also usually reduce the withholding tax rate on interest to 15% or less. Under the United States-China Income Tax Treaty, 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, the tax so charged shall not exceed 10 percent of the gross amount of the interest.

Most tax treaties provide for lower withholding tax rates on royalties. Typically, the rate is 10%. The U.S.-China Income Tax Treaty withholding rate is also 10%. A royalty is any payment for the use of, or the right to use, the following:

1. Any copyright of literary, artistic, or scientific work (but not including motion pictures, or films or tapes used for television or radio broadcasting);
2. Any patent, trademark, design, model, plan, secret formula or process, or other like right or property;
3. Any patent, trademark, design, model, plan, secret formula or process, or other like right or property;
4. Any information concerning industrial, commercial, or scientific experience, or
5. Any gains derived from the disposition of any right or property described in 1) through 3), where the proceeds are contingent upon the future productivity, use, or disposition of that property.

Private Pensions and Annuities

Under the United States-China income tax treaty, pensions and other similar remuneration paid to a resident of a Contracting State in consideration of past employment shall be taxable only in the Contracting State. The term “pension and other similar remuneration,” as used in the treaty, means periodic payments. This provision of the treaty provides an excellent opportunity for a non-resident of the United States to utilize the United States-China income tax treaty to reduce or eliminate the U.S. tax consequences associated with an Individual Retirement Account (“IRA”) or 401(k) plan distribution. For example, let’s assume that Tom is a Chinese national that came to the U.S. on an E-3 Visa for a short-term assignment. While working in the U.S., Tom contributed money to an IRA. Tom has returned to China and would like to withdraw money from his U.S. based IRA. However, Tom is concerned about the U.S. 20% withholding tax and the 10% early withdrawal penalty.

Since Tom is a citizen of China, a country that the U.S. has a bilateral income tax treaty, Tom may utilize the United States-China income tax treaty to avoid the 20% withholding tax and the early withdrawal penalty. This is because under Article 17, Paragraph 1, of the United States-China income tax treaty, “pensions and other similar remuneration paid to an individual who is a resident of one of the Contracting States in consideration of past employment shall be taxable only in that State.” The Technical Explanations to the treaty further explain that “paragraph 17 provides that pensions derived and beneficially owned by a resident of one of the Contracting States in consideration of past employment..shall be taxable only in the State [of residency].” This means that under the applicable provisions of the United States-China income tax treaty, the country of residence has the sole taxing rights over pension distributions.

The terms “pensions and other remuneration” is not defined in the United States-China income tax treaty. However, the OECD defines the word “pension” under the ordinary meaning of the word which covers periodic and non-periodic payments. The OECD also provides that a lump-sum payment in lieu of periodic pension payments that is made on or after cessation of employment may fall within the definition of Article 23. See OECD 2014 Commentary, Art 18. Thus, although Article 23 of the United States-China income tax treaty makes a reference to “periodic payments,” the word “periodic” does not preclude Tom from excluding a lump sum IRA distribution from U.S. federal income tax. Even though the OECD or Article 18 of the United States-China income tax treaty does not mention the term IRA, the IRS has clarified that IRAs can be defined as pensions for articles in U.S. income tax treaties. See PLR 200209026. Since Tom is a resident of China, he may potentially be able to utilize the United States- China income tax treaty to avoid U.S. federal tax on the distribution from his IRA.

Disclosure of Treaty-Based Return Positions

Anyone that claims the benefits of a treaty on a U.S. federal tax return that is in conflict with the Internal Revenue Code must disclose the position on the tax return. A tax return position is considered to be in conflict with the Internal Revenue Code, and therefore treaty-based, if the U.S. tax liability under the treaty is different from the tax liability that would have to be reported in the absence of a treaty. A taxpayer reports treaty-based positions either by attaching a statement to its return or by using Form 8833. If a taxpayer fails to report a treaty-based return position, each such failure is subject to a penalty of $1,000, or a penalty of $10,000 in the case of a corporation.

The Income Tax Regulations describe the items to be disclosed on a Form 8833. The disclosure statement typically requires six items:

1. The name and employer identification number of both the recipient and payor of the income at issue;
2. The type of treaty benefited item and its amount;
3. The facts and an explanation supporting the return position taken;
4. The specific treaty provisions on which the taxpayer bases its claims;
5. The Internal Revenue Code provision exempted or reduced; and
6. An explanation of any applicable limitations on benefits provisions.

Conclusion

This article is intended to acquaint readers with U.S.-China income tax treaty. The area tax treaty law is relatively complex and is constantly evolving. As a result, it is crucial that anyone considering utilizing the U.S.-China income tax treaty to minimize their global tax liabilities consult with a qualified international tax attorney.

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.

Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.