GUIDANCE ON WHEN STAFF SECONDMENT CREATES TAXABLE PRESENCE IN CHINA

Along with the speedy development of China’s economy and globalization, the need for skilled resources in China is escalating. This has led to an increase in the mobility of human resources to China. Increasingly, multinational companies (“MNCs”) with set up in China are looking for talents within their existing work force from their operations around the world and dispatch them on temporary arrangements to China to assume key technical, management or other positions with the Chinese entity. The employee will continue to show on the payroll of the foreign company and get the salary and other benefits from the company overseas while working at the Chinese entity. The Chinese entity shall reimburse the foreign company for the cost of salaries and other fringe benefits during the course of secondment with no profit mark-up. This type of structure is termed as “secondment arrangement”. This structure is preferred when the overseas employee will be seconded to China for a short term, usually less than 6 months, cumulatively in a year. 

Typically such arrangement is preferred by foreign companies so that they can avoid creating a permanent establishment which can make them subject to tax liabilities in China, such as, business tax and corporate income tax. The seconded employee will continue to be subject to PRC individual income tax (IIT) immaterial of whether the permanent establishment is created or not.

REGULATIONS CONCERNING SECONDMENT ARRANGEMENT

In the recent years, China’s tax authorities, State Administration of Taxation (“SAT”) has been skeptical about secondment arrangement.  SAT considers that some foreign companies are providing services to Chinese entity under the guise of secondment arrangement, and thus avoiding PRC taxes. Therefore, in the recent years, the companies have been facing increasing scrutiny from SAT, where SAT often viewed the secondment of employees to China as extensions of foreign companies to China and regarded it as having a permanent establishment in China.

In 2009, the tax authorities issued an internal notice (Notice 103) requesting the local tax authorities to conduct nationwide investigation on taxation of cross border secondment arrangements. As a result, in many locations, the local tax bureau stopped approval for reimbursement payment.

Following notice 103, in 2010 Circular 75 was issued which provided clearer guidance on this issue, and made it possible for tax bureaus to become more lenient and cease rejection of cost reimbursement applications.  However, its application was limited to the context of parent-subsidiary relationship and double taxation agreement only. Circular 75 did not provide the wider scenario where the foreign company does not directly or indirectly own the company in China.

LATEST DEVELOPMENTS: Announcement 19

In order to fill the regulatory loopholes in Circular 75, on April 19, 2013, SAT came up with further guidance through Announcement 19. The announcement clarifies when the secondment arrangement creates a taxable presence for a foreign company in China. It provides a wider scenario where regulation is applicable to arrangements beyond the one between parent and Chinese subsidiary. It became effective from June 1, 2013. This regulation will have retrospective affect which means any unsettled case of secondment arrangements from the past will be handled as per the new regulations.

Announcement 19 is a welcome development for MNCs with presence in China because it reduces the uncertainty as to when a foreign company may create PE in China under secondment arrangement, and facilitates the process of obtaining the administrations clearance for overseas transfers by a Chinese entity.

I.  Salient features

According to the new announcement, the SAT will take the stand that permanent establishment has been created, if the foreign entity satisfies the following two tests:

Test 1:  Fundamental Criteria:

  • The foreign entity bears all or part of the responsibilities and risk for the work product of the seconded employee; and/or
  • The foreign entity reviews and appraise the seconded employee’s work performance

Test 2:  Reference factors:

  • The Chinese entity pays the management or service fees to the foreign entity;
  • The amount of payment made by Chinese entity to the foreign entity exceeds the salary, social welfare and other costs of the seconded employee initially paid by the foreign entity;
  • The foreign entity does not pass on all the related payments made by the Chinese entity to the Secondee; instead, the foreign entity retains a certain amount of such payments;
  •  IIT on salaries borne by the foreign entity has not been fully paid in China; and/ or
  • The foreign entity determines the number of employees to be dispatched to China,

Please note that a PE is not created if the dispatched employee provides services solely for the purpose of exercising the rights of the foreign entity, the shareholder of the Chinese entity. The service may be provided in the form of investment advice or representation at the board meetings of the Chinese entity.

II.  Tax implications

If the taxable presence in China is determined, the foreign entity must perform tax registration, file tax returns, and pay the following taxes:

  • Corporate Income Tax (CIT) @ 25% of actual profits; if cannot file on profit basis, deemed profit of 15-50%)
  • Business Tax (BT) @ 5% or Value Added Tax (VAT) @ 6%
  • Surcharges - approximately 12% of BT/VAT paid

III. Material to be examined by tax authority:

  • Agreements between foreign entity, Chinese entity and the dispatched employee.
  • Rules for the management of dispatched personnel by foreign entity or Chinese entity including responsibilities, job description, performance appraisal, and risk taking.
  • Payments made by Chinese entity to the foreign entity, accounting treatment, and IIT Filing.
  • Any hidden payments, such as offsetting transactions, debt forgiven, related party transactions.

COMMENTS:

Parties under secondment arrangement should review the existing arrangements and consider restructuring of the arrangement, if necessary. It should demonstrate the relationship of the Chinese entity to the seconded employee as that of an economic employer and should not appear as a service arrangement. Proper documentation is vital for substantiating the genuineness of the arrangement.

Regardless of what the regulations say, based on our experience working with the clients on such issues, we have noticed that the Chinese tax authorities are inclined to regard secondment arrangements as providing services to Chinese entity and the reimbursement of salary payment of the seconded employee being regarded as the payment of a service fee to the foreign entity. This is why, in most cases, the secondment arrangement is viewed as having a PE and thus is subject to PRC taxes. There is no hard and fast rule specifying how the risk of being regarded as a PE can be eliminated. However, it is always advisable to have a more conservative approach while working under secondment arrangements, such as have the Chinese entity directly pay the remuneration to the seconded employee and the seconded employee remit their remuneration back to their offshore bank accounts after deducting their payable PRC IIT.

Announcement 19 reveals the increasing focus from SAT on non-resident tax administration. Therefore, it is important to ensure that your secondment agreement with the Chinese affiliates clearly stipulates that the Chinese entity has full control and supervision over the day-to-day work of the secondee and bears all the related risk and responsibilities and appraise the work performance of the secondee.

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