September 09 2009
It has been common practice for many multinational companies to assign personnel from headquarters or other foreign group companies to take senior positions in their subsidiaries in China under secondment arrangements. Such expatriates normally continue to be employed and paid by the foreign entity, which allows them to retain their foreign social insurance benefits (eg, a 401(k) plan in the United States). Since no local employment contract is signed, the multinational companies may also avoid the application of employee-friendly employment regulations to their expatriates in China.
By general consensus among tax practitioners - and in the normal practice of the tax authorities - if expatriates work for and are controlled by a Chinese affiliate only while working in China, and if the foreign entity is reimbursed on a cost basis without a mark-up, secondment arrangements should not attract Chinese tax (except individual income tax on the expatriate's salary). However, some local tax bureaux have launched special tax audit programmes targeting multinational companies, especially in the manufacturing and service sectors, that second expatriates to work in their Chinese affiliates. The programmes will focus on completing audits in the next two months.
Local tax officials in Shanghai and Beijing are believed to consider that all secondments of expatriates to China will create a permanent establishment for the foreign employer and that such employers should therefore pay enterprise income tax on a deemed-profit basis - the deemed-profit rate is between 20% and 40%. The enterprise income tax rate is 25%. If a foreign employer is deemed to be providing services in China, a 5% business tax will also apply. This will effectively add a tax burden of between 10% and 15% of the payroll costs of expatriates. There is also a risk that taxes will be imposed retroactively.
If the authorities pursue their programmes, this could significantly change the way in which expatriates are assigned to operations in China. The authorities are on questionable legal grounds if they assert that (i) a properly structured secondment creates a permanent establishment, or (ii) if such a permanent establishment is created, there is actual income attributable to it. Nonetheless, multinational companies may need to consider having their Chinese affiliates pay their seconded expatriates directly to avoid the risk of extra tax.
However, choosing to pay salaries locally may increase the company's employment law risk in China. For example, China does not allow at-will employment. If an expatriate, including a senior manager, is considered an employee of a Chinese company, he or she cannot be terminated unless one of the circumstances expressly provided for by Chinese employment regulations applies. Furthermore, the secondment arrangement must be structured carefully to preserve the expatriate's foreign social insurance benefits. Multinational companies may face a difficult choice between an additional tax burden and the application of Chinese employment law.
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