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Foreign companies must be aware of the tax implications of sending employees to work in Chinese affiliates, reports Charles Gong

This article was first published in the June 2012 International edition of Accounting and Business magazine

China’s continuously booming market continues to attract foreign investors to the country to explore potential growth for their businesses. Recent years have seen the evermore common practice of foreign companies sending their employees to their Chinese affiliates to perform functions such as management, supervision and consulting under cross-border arrangements.

For a foreign company whose country of origin has signed a double tax agreement (DTA) with China, whether a China Permanent Establishment (PE) is deemed created is crucial in judging whether or not such foreign company has a taxable presence in China. As the Chinese tax authorities have stipulated more comprehensive laws and regulations applicable to crossborder employee assignments and tightened the scrutiny over such arrangements, the related China PE exposure is becoming a growing concern for either the foreign investors or their Chinese subsidiaries.

Overseas expat arrangements

Under current business practices, there are three main approaches for foreign companies when implementing an overseas assignment arrangement in China, namely:

  • Sole Chinese employment: the overseas expat employee under a sole Chinese employment arrangement is obliged to terminate his existing employment contract with the foreign company and enter into a new employment contract with the Chinese subsidiary subject to Chinese laws.
  • Dual/split employment: if a ‘dual’ (or ‘split’) employment arrangement is adopted, the assigned employee is able to keep his employment relationship with the foreign company under his existing overseas employment contract while at the same time conclude a new employment contract with the Chinese affiliate in line with Chinese laws.
  • Secondment: under a secondment arrangement, the assigned employee can work in the Chinese subsidiary under his existing employment contract with the foreign company.

Key factor

The key factor for determining whether the three arrangements for overseas employee assignment will give rise to the existence of a China PE lies in the judgment over the ‘real employer’ of the expatriate employee. China has adopted the ‘substance over form’ principle under an approach consistent with the 2010 OECD Model Tax Convention.

If a foreign parent company assigns an individual to its Chinese subsidiary and one of the following conditions is met, the parent company is most likely to be considered the ‘real employer’ of the individual:

  • The parent company has the right to direct the individual’s work and undertakes the relevant risks and responsibilities of the assignment.
  • The parent company decides the number and the grade of the assigned individual.
  • The salary of the individual is borne by the parent company.
  • The parent company earns profits from the subsidiary by virtue of the assignment.

In light of the ‘substance over form’ principle, even under the above assignment arrangements where an employment contract is concluded between an expatriated employee and the Chinese subsidiary, or the employee’s remuneration is borne by the Chinese subsidiary, once the foreign parent company has control over the employee’s work in China and undertakes the related risks and responsibilities for the assignment, the foreign parent company is still deemed the ‘real employer’ of the employee. When certain other conditions are also met (as mentioned later in this article), a China PE is very likely to be constituted by the parent company with regard to the employee assignment.

On the other hand, if a foreign parent company assigns an individual to work for its Chinese subsidiary and the subsidiary has the right to control the work of the individual and undertakes the risks and responsibilities for such work, the Chinese subsidiary is regarded as the ‘real employer’ of the individual. The remuneration paid to the individual is then regarded as compensation reimbursement paid to the subsidiary’s own employee, no matter whether the payment is made directly by the subsidiary or indirectly via the parent company’s account. Thus, the foreign company is not in this situation deemed to constitute a PE in China in connection with such individual work.

Moreover, it is notable that, although the current related Chinese laws and regulations only cover PE determination with respect to crossborder assignments of employees between a foreign parent company and its Chinese subsidiary, it is believed that the principles shall also apply to any similar assignment between any foreign company and a Chinese company.

Other factors

If a foreign company is regarded as the real employer of its employee assigned to China, there are two more conditions, as described below, which if either is met, such foreign company is deemed to constitute a PE in China under an overseas expatriation arrangement:

  • The assigned employee provides services wholly or partly through a fixed place of business in China
  • The definition of ‘a fixed place of business’ when deciding on the existence of a China PE comprises the following three features:
  1. a physical existence, referring to a certain space at the disposal of an enterprise, regardless of whether the enterprise owns or leases the space
  2. relatively fixed, with a certain degree of permanence – for example, a representative office, a branch or an office provided by service recipients for the individual’s exclusive use
  3. a place at which the business of an enterprise is wholly or partly performed.
  • The assigned employee has stayed within the territory of China for a period or periods aggregating more than 183 days/six months within any 12 months for the purpose of providing their services.

There is a strict calculation of 183 days (or six months under certain DTAs) for the determination of the existence of a China PE. The duration of the crossborder assignee’s stay in China for providing their services is calculated from the assignee’s arrival date in China until the date of the completion of their service in China, with days outside China excluded but holidays, weekends, vacations or other off-duty days in China most likely included.

OECD commentary coherence

A China PE of a foreign company related to its crossborder assignment of employees to China may be much more easily exposed than previously. The current interpretations of a China PE are generally based on the OECD commentary, which suggests that a taxpayer is able to invoke the OECD commentary for application to its case where the existing laws and regulations do not specify otherwise.

China tax liabilities and the PE

If a China PE is determined to exist due to overseas expatriation arrangements of a foreign company, the relevant income that the foreign company extracts from its Chinese subsidiary due to the expatriation is regarded as the PE’s revenue, including but not limited to management service fees and the expatriate individual’s remuneration, etc. Corporate income tax (CIT) at 25% shall be levied on the total income attributable to the PE. If the PE’s revenue is significantly low or the attributable income cannot be verified to the tax authority’s satisfaction, the tax authorities may levy CIT on a deemed profit basis, ie the tax authorities would deem a margin based on the PE’s costs and expenses according to the following formula:

Taxable income = costs and expenses / (1 – deemed profit margin) x deemed profit margin

The above costs and expenses of the PE include the individual’s remuneration attributable to the PE and other expenses of the individual such as travel and accommodation, office rent, etc. Pursuant to the relevant Chinese tax laws and regulations, the deemed profit margin shall be determined based on the following criteria:

  • for construction projects, and design and consulting services, the deemed profit margin shall range from 15% to 30%
  • for management services, the deemed profit margin shall range from 30% to 50%
  • for other services or business activities, the deemed profit margin shall not be less than 15%
  • if the competent tax authority is aware of evidence indicating that the actual profit margin of the PE is significantly higher than the above standards, the applicable deemed profit margin can be raised to a higher level.


Charles Gong is tax CEO, RSM China Certified Public Accountants, and managing partner, Zhongrui Yuehua Tax Advisory Company Ltd

Last updated: 19 Mar 2014