What is a Permanent Establishment?
An overseas (ie. non-Chinese) company may be deemed by the Chinese Tax Authorities to have a PE if:
1) it has an establishment or a place of business in China; or
2) it has employees working in China for six months continuously or cumulatively in any 12-month period regardless of whether it has a physical office or other fixed place of business in China; or
3) it appoints an agent to conclude contracts or accepts orders in China regardless of whether it has a physical office or other fixed place of business in China.
How to mitigate or manage PE risks if you need employees to work in China?
For overseas companies which intend to transfer overseas employees to work in China for a period of at least 6 months continuously or cumulatively in any 12-month period, there are three options, namely: (i) secondment; (ii) dual employment; or (iii) direct Chinese Employment.
Under a secondment arrangement, the overseas employee continues to be employed by the overseas company but to work with its Chinese affiliate and salary payments are made by the overseas company to the secondees offshore and reimbursed by the respective Chinese affiliate.
However, the Chinese Tax Authorities are inclined to regard such overseas company as providing services to such Chinese affiliate and the reimbursement of such salary payment being regarded as the payment of a service fee to the overseas company and thus, the overseas company being regarded as having as PE and subject to EIT and/or BT.
There are no hard and fast rules for an overseas company to eliminate the risk of being regarded as having a PE, but a more conservative way to avoid the potential PE exposure is to have the Chinese affiliate directly paying the remuneration to the secondees and the secondees remitting their remuneration back to their offshore bank accounts after deducting their payable Chinese Individual Income Tax. Another important issue is to have a proper secondment agreement between the overseas company and the Chinese affiliate in place which clearly states that the Chinese affiliate has full control and supervision over the day-to-day work of the secondees and bears all such associated risks and responsibilities and appraising the secondees work performances.
(ii) Dual Employment
Under a "dual" or "split" employment arrangement, an overseas employee keeps his current employment arrangement with the overseas company, which governs his job duties for the overseas company outside China and is remunerated for such services under the same and also enters into an employment contract with the Chinese affiliate in accordance with the Chinese Labour Law, which governs his role and remuneration for such work in China.
A dual contract arrangement can reduce the risk of the overseas company being deemed to have a PE as the overseas employee is then an employee of the Chinese affiliate while working in China and is paid by such Chinese affiliate, thereby, isolating the overseas company from being involved in any deemed business or provision of services in China.
(iii) Direct Chinese Employment
Under a direct Chinese employment arrangement, the overseas employee has to terminate his existing employment contract with the overseas company. The overseas employee will then enter into a new employment agreement with a Chinese affiliate in accordance with the Chinese Labour Law and be wholly remunerated by the Chinese affiliate.
There will be no PE risk for the overseas company under this arrangement as the overseas employee is an employee of the Chinese affiliated company and is working completely unrelated to the overseas company.
This article is for information purposes only. Its contents do not constitute legal advice and readers should not regard this article as a substitute for detailed advice in individual instances.