Aug 2009
Due to the increasing needs of mobility for global talents, international secondment arrangements have been widely adopted around the world by multinational corporations ("MNCs"). There are no exceptions for China given the shortage of local talents at this stage. Under a typical secondment arrangement, a foreign MNC ("Home Entity") would second its employees ("secondees") to work for its Chinese affiliate ("Host Entity") and the latter would reimburse the former for the costs of salaries, allowances and other fringe benefits (or perks) that the former agrees to pay on its behalf during the course of the secondment with no profit mark-up.
In recent weeks, we have noted that the Chinese local-level tax bureaus in a number of locations, including Shanghai, Beijing, Guangzhou, Dalian, etc., have started to look into the permanent establishment ("PE") issue of the Home Entity arising from the secondment arrangements and conducted surveys through foreign investment enterprises ("FIEs"), which are the Host Entity of the secondees from overseas.
In this Issue of our News Flash, we would summarise the background and current status of this evolving exposure in China, and share our sights and recommendations to tackle such situation.
Background and current status
In more than a decade, the Chinese tax authorities have in general been accepting that the Home Entity assigning secondees to the Chinese Host Entity is a mere salary paying agent. They tended to agree that the Home Entity is not providing services to the Host Entity by virtue of the secondees assigned to China, and hence the Home Entity does not constitute a PE in China. Of course, the secondees, being regarded and reported as the employee of the Host Entity, would be subject to Individual Income Tax ("IIT") in respect of their remunerations under the premise of Chinese employment.
On the contrary, where the secondees are seen as representing the Home Entity to provide services in China to the Host Entity, then the Home Entity might be deemed as constituting a PE in China. The Home Entity, even a foreign corporation, could be exposed to China corporate income tax ("CIT"). For the same token, Business Tax ("BT"), which is imposed on provision of services, would also be imposed on the reimbursement, which is otherwise seen as service fee.
Starting from the second half of 2009, the Chinese local-level tax bureaus have tightened up the tax administration to catch up the considerable amount of shortfall of tax revenues. Secondment arrangements, among other contentious issues, were suddenly falling into their radar screen. They suspected that some MNCs are using secondment arrangements to avoid Chinese taxes for those service projects undertaken by the foreign Home Entities for the Host Entities in China. Some local-level tax bureaus refused to issue tax clearance certificates with "no-tax basis" to the Host Entities when the Host Entities sought to remit the reimbursements of the secondees' costs to the Home Entities overseas.
The survey forms sent and stance taken by those local-level tax bureaus to the Host Entities gave out an impression that the pattern of payments would dictate the China tax consequences. The local-level tax bureaus have formed a general belief that as far as the salary payments are paid by the Home Entity to the secondees offshore and recharged to the Host Entity in China, then the Home Entity should be regarded as providing services to the Host Entity; the reimbursement be regarded as a service fee payment; and the Home Entity be regarded as having a PE in China, and hence subject to China taxes as mentioned above. Some of them did not consider other relevant and important factors in arriving at their conclusions. Most surveys / challenges have targeted FIEs in the manufacturing and service industries, with auto-makers being given special attention. In some locations, the survey period goes back to as early as the year 2006.
Further, a State Administration of Taxation ("SAT") circular issued in late July, Guoshuifa [2009] No. 114, which is aimed at highlighting the tightened tax administration measures in general, has also echoed the actions being taken at the local levels. The SAT put the emphasis to remind the local-level tax bureaus to examine foreign companies' (non-residents) China tax obligations where they assign expatriates to perform management, design, authentication and consulting services in China.
Given all these happenings, PwC China approached the SAT and expressed our concerns about the views and stance apparently taken by the local-level tax bureaus. We shared with the SAT officials our researches and analysis, which are mainly supported by the OECD Model Convention, legislations in other jurisdictions, as well as the previous rulings of the SAT itself on this issue. We understand that the SAT had then sent out an internal notice asking the local-level tax bureaus to hold off the challenges but just to collect more factual information on secondment arrangements of FIEs in their localities before the SAT comes up with a set of clearer guidelines.
PwC observations
Based on our researches and analysis, a secondment arrangement should clearly be distinguished from a service arrangement (which would lead to a PE for tax purposes). Under a secondment arrangement, the secondee normally works under the control and supervision of the Host Entity, which controls and benefits from the secondee's day-to-day work and bears the risks and responsibilities associated with it. Whereas, under a service arrangement, the secondee usually continues to work under the control and supervision of their overseas Home Entity to fulfil a service contract entered between the Home Entity and the Host Entity. The pattern of how the service are rendered by a secondee under a secondment arrangement (as an employee of the Host Entity) and a service arrangement (as an employee of the Home Entity) should not be mixed up.
We are also of the view that a distinction must be drawn between the "legal employer" and "economic employer" of the secondee and each case must be reviewed on its own merits. For example, if the Home Entity (also the overseas "legal employer"), merely acts as the payment agent of the secondee's salaries, allowances and fringe benefits and will recover the payments at cost from the Host Entity (also the "economic employer"), then the Home Entity should not be regarded as having created a PE in China simply by reason of making payments directly to the secondee.
Other relevant factors to be taken into consideration should also include:
- Which entity receives the benefits arising from the secondee's work?
- Which entity gives day-to-day instructions or has authority over the secondee's work?
- Which entity bears the risks, costs, and responsibilities of the secondee's work?
- Which entity reviews and appraises the secondee's work performance?
- Whether the secondee's work constitutes an inseparable part of the Host Entity?
- Does the Home Entity (also "legal employer") recover only the actual secondee's costs or is a profit mark-up also charged?
- Which party(ies) has the right to determine the remuneration of the secondee?
Our researches and analysis presented were largely agreeable to the SAT officials whom we visited. They emphasized that the fact patterns of secondment arrangements vary among MNCs and it is unrealistic to provide hard and fast rules as to what type(s) of secondment arrangement would or would not create a PE of the Home Entity in China. The facts and circumstances of each secondment arrangement should be examined carefully in order to determine the appropriate tax treatments.
We understand that the SAT is inclined to take a more sophisticated approach in assessing the PE implication arising from secondment arrangements. They are considering issuing a policy circular to give local-level tax bureaus more specific guidelines in examining secondment arrangements. We will monitor the progress of such policy circular and keep you posted.
We are also pleased to see that one of the Guangzhou tax bureaus last week issued a revised survey form with the information required along the same line.
Impacts and suggestions to Host Entity and Home Entity
- FIEs (also the Host Entities) will be the first party to face the potential tax surveys / challenges from the Chinese tax authorities on the secondment arrangements for their secondees. They may wish to review or revisit the current secondment arrangements, jointly with the Home Entity and the secondees, to ensure that they are in line with relevant factors as discussed above. This would help form the first line of their defence. Upon request by the local-level tax bureaus, FIEs should fill out the survey forms properly to avoid providing incorrect information to the local-level tax bureaus. Documentation is the key of success in the defence for challenges or disputes from the Chinese tax authorities. There is no point to wait until the SAT really issues more guidelines to the local-level tax bureaus.
- FIEs should notify the secondee's Home Entity of the potential tax exposures in China. The Home Entity may be able to lend supports to the FIEs by providing strong evidence to substantiate the genuine nature of the secondment arrangements. Also the Home Entity should be made aware that the current surveys / challenges on secondments would very likely cause delay in settling the remittance of secondment costs.
- Where appropriate, the FIEs and Home Entity may also engage professionals for assistance in collating the relevant documentation, or even in dispute resolutions in the course of tax investigations / audits.
- As an alternative to the typical secondment arrangement as we mentioned at the beginning of this Issue, a more conservative way to avoid the PE exposure is, where practical, to have the Host Entity pay the remuneration directly to the secondee in Chinese currency in China, and the secondee can then use their Chinese IIT payment certificates to remit the income to their overseas personal bank accounts. There should, of course, be a proper secondment agreement and other clear documentation in place. However, this may create confidentiality issue and process difficulties for the secondee. MNCs may consider using professional firms to assist with the salary payment and remittance matters going forward.
- Another alternative solution that some MNCs are exploring is for the secondee to enter into local employment contracts with the Host Entity which would then pay salaries and related employment benefits directly to the secondee. The potential consequences of restructuring secondment arrangements in this way should be carefully considered. In particular, the Chinese Labour Contract Law which has specific legal provisions governing sick leave and other leave entitlements, as well as termination procedures and other matters.
We will continue to monitor the development of the PE exposure to the Home Entity arising from secondment arrangements and share with you our insights, observations and recommendations on a timely basis.
