Our China lawyers are often asked whether it is legal to pay non-Chinese employees from both their China WFOE and from a company outside China (usually their home country parent company). The answer is an easy yes, but the tax issues that arise from doing so are where things get really difficult and why we seldom recommend our clients do this.
By way of an example, it is perfectly legal for a United States company to pay its employees from both China and the United States. However if a U.S. employee is a resident in China for more than 183 days in any calendar year, the U.S. employer must pay taxes in China on the combined U.S.-China salary of that employee. This obligation to report and pay taxes is set forth in the Circular of the State Administration of Taxation on Income Tax Paid by the Enterprises with Foreign Investment and Foreign Enterprises for Their Employees on Behalf of Their Enterprises Abroad (Guoshuifa [1999] No. 241).
The Circular on Questions Concerning Tax Payments for Wage and Salary Income Gained by Individuals without Residence within the Territory of China (Guoshuifa [1994] No. 148), mandates that if your employee works in China for less than 183 days in a calendar year, he or she is obligated to pay taxes only on that portion of salary received from the China WFOE when he or she was in China.
But employees that work in China for more than 183 days and did not live in China for a full year prior to this year must pay China taxes on the salary paid by the China WFOE and on the salary paid by the U.S. entity during the period the employee is in China. In other words, your employee must pay taxes on whatever salary was earned in China, no matter who pays it.
If your employee works in China for more than one year, but less than five years, your employee must pay China income taxes on the salary received from the China WFOE and on the salary received from your U.S. entity during the time your employee is in China.
Working in China for 183 or more days in any calendar year triggers the requirement that both the employer and the employee pay taxes on the combined U.S.-Chinese salary. There is no way around this obligation and we advise our clients to take these tax obligations seriously because failing to comply can result in penalties for both the WFOE and the employee.
Many foreign companies have ignored this rule and Chinese tax authorities have become more aggressive in enforcing it. We often see the employer and employee get caught not paying these mandatory taxes when the employee applies to renew his or her China visa. If the employee has resided in China for more than 183 days, the local tax authority will request a copy of the employee’s US tax return. If the employee fails to provide the U.S. return, that employee’s visa gets denied. If the employee does provide the U.S. tax return, the tax authorities assess the tax, along with interest and penalties.
We also often see the employer and employee get caught not paying these taxes soon after some other employee in the WFOE gets terminated. No surprise there as employee unhappiness is what triggers all sorts of problems for WFOE employers in China and is why we so strongly advocate for foreign companies to conduct yearly audits of their China employment situation. See How to Avoid China Employment Law Problems: Employer Audits.
Our China attorneys are aware of many instances where foreign employees were denied entry into China after 183 days of residence for failing to report their combined salaries. We also are aware of multiple cases where the Chinese tax authorities pursued penalty actions against WFOEs for failing to report and pay taxes on the combined salary of their high level China company managers. The risk of noncompliance is significant.
So what should your WFOE do? It should report the combined salary and pay the full tax, or ensure that your employees reside in China for no more than 182 days in any calendar year.
Circular No. 241 applies only when the Chinese entity and the foreign entity are “related.” That of course leads to the question of what “related” means in this context. Because the term is nowhere defined, is it possible to get around the taxes by having “your” China employees work for a U.S. company separate from your regular U.S. company? We advise against even attempting this because Chinese law defines the term “related” companies quite broadly. Specifically, two entities are considered “related” if (1) there is direct or indirect ownership or control with respect to capital, business operations, purchases and sales, (2) there is direct or indirect ownership or control by a third party; or (3) there are other kinds of mutually beneficial connections. The Chinese tax authorities will almost certainly apply this broad definition to conclude that your China WFOE and the U.S. company that is also paying your employee are related enterprises. Indeed, the mere fact that an employee is being paid by a Chin4a WFOE and some other foreign company will alone likely be enough for them to conclude those two companies are related. Once it finds this relationship it will then find that Circular No. 241 requires the WFOE report and pay taxes on the full salary of any employee that works more than 183 days in China in a calendar year. The Chinese tax authorities will also likely be unhappy with your attempt to circumvent its taxes and that will increase your chances of getting hit with a penalty and interest it may also influence the penalty amount as well.
What about using an employee dispatch service/third party hiring agency to try to get around the combined salary problem? Our China employment law attorneys have discussed this with multiple China government officials and each time we have been explicitly told that dispatch agencies are not allowed to dispatch foreigners because a foreigner’s work certificate must specify the employer of the foreigner, and when using a dispatch agency no employer can be specified. Using a third party agency also risks the Chinese authorities concluding you did so to evade taxes, which will then lead to their imposing taxes owed, plus interest and penalties.
There is no good or legal way around the fact that if your employee resides in China for 183 or more days in a year, both you and your employee must pay taxes on that employee’s combined Chinese/foreign salary.
