Chinese Lawyers Clearing the Situation on Payment of Salary and Tax by WFOEs

In the last post regarding payment of non-Chinese employees, we had discussed about the double payment to a non-Chinese employee residing in China for over 183 days. The payment is done by the WFOE or a Wholly Foreign-Owned Enterprise. We had talked at length about the payment being doubly taxed as well. The payment of such employees are taxable under Chinese laws, rules and regulations. On the other hand, the employer will also have to pay tax regarding the same when he/she is maintaining the parent organization as well as the WFOE (Wholly Foreign-Owned Enterprise). When the WFOE is paying salary to a non-Chinese employee, then it becomes taxable. Chinese lawyers often face questions on how to solve this situation from their WFOE clients. However, there is nothing much they can do, because in China the taxation rules are stringent.

Combining the China and US salary for their employees and paying tax on that combined salary is the method followed in China. The methods followed in China are absolutely different from that of other places. Thus, employers and employees get confused regarding the same. This has been mandated 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”. This is also referred to as the Circular No. 241.

Circular No. 241

The Circular No. 241 only applies when the foreign business entity and Chinese entity will be related. Now, the client asks and even others can ask what does the term related mean in this context? This might lead to a confusion because no clear explanation is provided regarding the relation between the foreign and the Chinese entity. This makes the Chinese laws regarding employee payment even more perplexing. Without a proper explanation on the Circular No. 241, nobody understands what could be the possible relationship. However, usually, lawyers treat it as the business relationship between the entities.

The Loophole in the System

Since, there is no clear explanation as to what the relationship between one foreign and one native business entity can be, there are various loopholes which are making way for corruption at different levels. Clients also ask this question whether they can flout the taxation rules and get around those by having Chinese employees work for a US company separate from the regular US company. Though the Chinese lawyers advise their clients against this practice, the clients still seek answer to the same question. However, Chinese law defines the term related but loosely and that too in other contexts. Now, this somewhat half-baked explanation works for the circumstances under which both the parties treat it as business relation between them. Two entities are considered related when:

  • Direct or indirect ownership or control with respect to capital, sales, purchase and business operations.
  • Direct or indirect ownership or control by a third party.
  • Other beneficially mutual connections.

The Chinese tax authorities generally apply this broad definition to define the relationship between two entities. They conclude that the China WFOE and the US company are related enterprises. Now, that they establish the fact in a roundabout manner, Circular No. 241 requires the WFOE to report and pay taxes on the employee’s full salary if they work in China for over 183 days in a calendar year.

China business lawyers have thought about employee dispatching service to tackle the combined salary problem. The lawyers have tried talking to Chinese government employees and they have disagreed the dispatch procedure. They say this is not possible because the foreigners work certificate must specify the employer of the foreigner. Employing dispatch agency will also lay out that the companies are trying to evade taxes.

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