GMT Client Alert Series - 2013/07
Jul 5, 2013
China: Secondments with PE Risk & Changes to Immigration Requirements
China’s staggering & rapid development as the world’s largest market has undoubtedly created gaps in its tax & business practices that their regulators are constantly trying to patch both strategically for China and uniformly across borders. The permanent establishment (aka PE) and immigration matters below are just two more examples of this need to capture tax revenue while conforming, at least in part, with global standards.
Secondment Contracts and Risk of PE Exposure in China
On May 6, 2013, the PRC State Administration of Taxation released Public Notice 19 to address the outstanding issues related to the nature of Secondment Agreements and the conditions that would trigger the creation of an establishment and place (E&P) or permanent establishment (PE) in China and its consequent payment of Corporate Income Tax.
In recent years, Chinese tax authorities have increased inspections of foreign assignments in China to determine whether the assignments were masquerading as a permanent establishment to avoid the payment of Corporate Income Tax and proper registrations with corresponding institutions. Therefore, the issuance of this circular brings clarification on certain points that were often the object of dispute between foreign entities and Chinese tax authorities.
Customarily, employees sign secondment contracts with their foreign employer and continue to receive their compensation from this foreign company. The Chinese entity reimburses the foreign company for the compensation costs related to the Chinese assignment. However, particular care must be taken in considering whether the Chinese company is only reimbursing for the incurred cost or if there are additional fees for services involved, which would imply the establishment of a place of business in China.
Public Notice 19 provides an overriding principle to determine whether an E&P or PE was established. Accordingly, the foreign company will be the economic employer of the assignee if the foreign entity fully or partially bears the responsibilities and risks of the assignees’ work, and evaluates the performance of the employee.
Furthermore, there are five supplementary conditions that will be considered along with the overriding principle in determining the existence of PE or E&P under these PRC rules:
- The PRC company pays management or service fees for the assignee to the foreign entity;
- The PRC company reimburses in excess of the salaries, social security and other costs of the assignee;
- The foreign company keeps part of the reimbursement from the PRC entity that should be paid to the assignee;
- PRC Income Tax (IIT) is not fully paid on income received by the assignee that is borne by the foreign company;
- The foreign company decides the working conditions of the PRC assignee (i.e. number of employees, working locations, qualifications, and remuneration.)
These additional factors help to identify if the foreign company received financial benefits from the assignment.
In addition, the tax circular lays out what documentation will be examined by the tax authorities to discover whether there are transactions or activities that might conceal the existence of the permanent establishment.
Commencing June 1, 2013, foreign employers may be subject to additional tax liabilities related to these employee secondments in China if the above criteria are applied. The tax circular technically doesn't have full legal effect, but local tax authorities could use them as practical guidance.
As such, the above directives taken together present an opportunity for the PRC’s agencies to create additional revenue streams not previously contemplated by foreign companies sending employees to work there. Caution and further analysis is highly warranted of companies in this situation.
China may strengthen the Immigration Requirements for Foreign Individuals
The PRC government is trying to standardize and restrict the types of visas and permits issued to foreign employees in order to control the increase in illegal employment, so the PRC just released a draft for the entry and exit law that will take effect on July 1, 2013.
The proposed changes are:
- Conversion of F visas into M visas: F visas have been issued for foreign citizens that would travel to China for less than six months for lectures, business, research, and exchange in the field of science, technology, education, sports, and culture. The new M visa will be issued to foreign national for business or trade purposes and the F visas will only be issues for non-commercial activities.
- Visa Z that has been issued to foreign nationals employed in China will be subdivided into two categories (Z1 greater than 90 days & Z2 no more than 90 days) considering the length of the assignment. However, visitors holding a Z2 visa will not be able to extend it unless there are exceptional causes such as humanitarian reasons and “force majeure” (extraordinary event/circumstances).
- Introduction of the R visa for senior-level executives and foreign nationals with special skills.
In addition, the Chinese government has issued new regulations effective July 1, 2013 that identifies & defines unauthorized work and overstays resulting in increased penalties and fines for companies and their employees. These visa and work permit breaches are typically defined to be for those not in full compliance with the visa/permit’s intended duration, nature, and stipulations.
GMT recommends the following actions on the part of companies with international assignees in/to the PRC in light of the above legislation:
1. Companies need to review current assignment letters and contracts to verify that there is no risk of creating a permanent establishment especially when they incurred significant costs for assignments that will be reimbursed by the PRC affiliate. Companies need to substantiate all assumptions with valid documentation because they carry the burden of proof.
2. Human Resource & Legal departments need to review their PRC visa program in order to comply with these new regulations that will become effective in July.
3. GMT also recommends companies review their foreign assignment policies to capture the potential tax risks of not accounting for the above changes. Please consult your GMT advisors for assistance with crafting a comprehensive Global Assignment Policy.