The question of paying a non-Chinese employee from the original company established outside China has been making rounds since a long time. Chinese lawyers often face this question from the foreign and parent company. They reply in affirmative because it is legal to pay the non-Chinese employee by the parent organization and also by the Wholly Foreign-Owned Enterprise (WFOE) located in China. However, there are tax hassles regarding this payment issue.
An American employee can pay its American employees from both the USA and also China. That is legal. However, if the American employee stays back in China for over 183 days in a calendar year or is a permanent resident, then that payment comes under tax deductions. Paying taxes and producing a report is obligatory by 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.
The Circular on Questions Concerning Tax Payments for Wage and Salary Income Gained by Individuals without Residence within the Territory of China (Guoshuifa  No. 148), commanded that if the employee is working in China for less than 183 calendar days, then that employee should pay taxes only on a part of the salary received from WFOE in China during his/her tenure in the country. However, if the employee works for over 183 days but less than 365 days, he/she must pay taxes during their stay in China. If he/she was receiving salary from China WFOE, then he/she must pay taxes. This means, whenever employees are paid salary in China, that comes under taxation.
The employee will be taxed doubly, if he/she has stayed in China for over 1 year but less than 5 years. His income will be taxed twice on what he is paid by the original parent company and also on the amount he is paid by the China WFOE. Tax payment must be done by both the employee and the employer. There is no way that this obligation can be avoided by either of the parties. The Chinese business lawyers always advise their clients to comply with these regulations, failing which can lead them being penalized.
There is a loophole in this practice. The problem is that foreign companies have conventionally ignored this rule. On the other hand, the Chinese tax authorities have taken steps to enforce the rules more aggressively. Visa renewal time poses a great challenge for the employees residing in China. In case, the employee has resided in China for over 183 days, the local tax authority demands a copy of the employee’s US tax return documents. In case, the employee fails to provide it, his visa will be denied whereas, if the employee provides the tax return documents, the authorities will assess tax along with penalties and interest.
There have been several instances of visa denial in China after 183 days of sojourn for the WFOE employee. This happens to employees who fail to report their combined salaries. Also, there have been several instances where the Chinese tax authorities penalized the WFOEs aggressively when they failed to report and pay taxes on combined salary for Chinese managers. Therefore, there is a lot of risk involved in noncompliance.
What is then the best practice for WFOE? Whether they should report combined salary and pay taxes or they should make sure that their employees do not stay back for more than 182 days in a year. This will be taken up in the second part of the blog post.