ByTony Dong, Daisy Duan and Jiang Junlu King & Wood Mallesons Corporate Group
Over the years, it has been a common practice that multinational companies (“Home Entity”) dispatch expatriate employees (“Secondees”) to the affiliated enterprise in China (“Host Entity”) to hold post as senior management or other technical position. Usually, the Home Entity and the Secondees would retain the employment relationship and the Home Entity continues to pay the salaries and social security contribution for the Secondee in the home country, which would be reimbursed by the Host Entity. Since the tax clearance certificate issued by Chinese tax authority is required when the Host Entity makes remittance overseas for the reimbursement payment, the tax authority needs to determine whether the Home Entity constitutes the establishment/place of business (“taxable presence”) or permanent establishment (“PE”) under the relevant tax treaty under the secondment arrangement, which may result in PRC Enterprise Income Tax (“EIT”) consequence for the Home Entity. Nevertheless, there are often disagreements between tax authorities and the Host Entity due to the ambiguity of tax regulations in the assessment of taxable presence or PE under cross-border secondment arrangement, and consequently Host Entity has difficulty in obtaining the tax clearance certificates and cannot remit the payment to the overseas Home Entity. There will be a change from June 1st, 2013.
On 19 April 2013, the State Administration of Taxation issued the “Announcement on Issues Concerning Enterprise Income Tax on Services Provided by Non-resident Enterprises through Seconding Personnel to China” (“Announcement 19”) which provides clearer guidance in determining whether the Home Entity under the secondement arrangement will constitute taxable presence or PE in China. Announcement 19 is rooted on the tax circular Guoshuifa  No.75 (Circular 75) and a further development in respect of the assessment of PE in China under international secondment arrangement. Where the Home Entity constitutes taxable presence or PE in China, apart from the Individual Income Tax (“IIT”) which shall usually apply to the Secondees, EIT will be imposed on the Home Entity. This new policy will bring significant impact on the tax cost of Home Entities and the structuring of international assignment arrangement.
Based on the salient points of Circular 75 and the latest Announcement 19, we would like to summarize the issues related to the determination of taxable presence and PE under secondement arrangement as below for your reference.
Criteria determining the constitution of taxable presence or PE in China
According to Circular 75, if at the request of PRC subsidiary, the overseas parent company dispatches personnel to work for the subsidiary, and such personnel enters into formal employment relationship with the PRC subsidiary which has command over his/her work, and the work responsibilities and risks are entirely assumed by the subsidiary, instead of the parent company, then the activities of such personnel shall not trigger taxable presence or PE of the parent company in China. In this case, the fees paid, directly by the PRC subsidiary or indirectly through the parent company to such personnel, shall be deemed as the payroll expenses paid to the PRC subsidiary’s employees.
Moreover, Announcement 19 clearly states that, where the Home Entity dispatches personnel to render service in China, if the Home Entity bears all or part of the responsibilities and risks in relation to the work of the Secondees, and normally reviews and evaluates the job performance of the Secondees, the Home Entity shall be deemed as having taxable presence in China.If the Home Entity is a tax treaty resident enterprise, such establishment and place of business may create PE in China.
When making the above assessment, the following factors shall be taken into consideration:
- The Host Entity makes payment to the Home Entity in the nature of management fee or service fees;
- Payment from the Host Entity to Home Entity exceeds the Secondee’s salaries, bonus, social security contributions, and other expenses as advanced by the Home Entity;
- Not all related expenses reimbursed by the Host Entity is paid to the Secondee; instead, the Home Entity retains a portion of such payments;
- PRC IIT is not paid on the full amount of the Secondee’s salaries borne by the Home Entity; and
- The Home Entity is the decision maker in terms of the number, the qualification, the remuneration and the working locations of the Secondees in China.
Generally speaking, if one of the above factors is satisfied and the work of Secondees has substantial connection with the Home Entity, the Home Entity is likely to be assessed as having taxable presence or PE in China.
In addition, Announcement 19 also provides that, if the Home Entity constitutes taxable presence or PE in China, both the Host Entity and the Home Entity shall perform tax registration or record-filing and shall calculate the income accurately, declare and pay EIT on such income. If it is not feasible to accurately calculate the taxable income, the tax authority is empowered to deem the taxable income in accordance with the relevant regulations.
1． With the release of Announcement 19, it is expected that the tax authorities will strengthen the tax administration on international secondment arrangement between MNCs and their subsidiaries in China. Enterprises concerned are suggested to conduct self-examination on the existing secondment arrangement and assess the underlying tax risks. The bright side of Announcement 19 is that it provides greater certainty of the tax treatment under secondment arrangement, and will facilitate the Host Entity to obtain tax clearance more smoothly when making the remittance overseas on reimbursement payment.
2． In case PRC IIT is paid on the full amount of the Secondee’s salaries, even if the Home Entity bears part or full of the expenses, since the Home Entity does not bear Secondee’s salaries and does not derive profit through the secondment arrangement, it is not likely to create taxable presence or PE for the Home Entity.
3． This Announcement clarifies that where the Home Entity assigns its expatriate employees to China solely to exercise the shareholders’ rights and safeguard the shareholders’ interest, the Home Entity would not be deemed as having taxable presence or PE in China.
4． Enterprise shall build up the facts patterns to substantiate the connection between the work of Secondees and the Host Entity. It is of vital importance to put in place sufficient documentation with respect to the work reporting requirement, evaluation on job performance, and etc., and the documentation shall include the following: (1) relevant contracts or agreements regarding employment or secondment arrangement; (2) job description on the Secondees of the Home Entity or the Host Entity, including the job responsibilities, job description, performance evaluation and assumption of risk of the Secondees etc. ; (3) the conditions on the payments made by the Host Entity to the Home Entity and the relevant accounting treatment, and the IIT filing and payment records of the Secondees in China; (4) information regarding whether the Host Entity makes the expenses related to the secondment arrangement by means of offsetting inter-company accounts, waiver of creditor’s right, related party transactions and other means, in lieu of reimbursement arrangement.
Announcement 19 will become effective as of June 1, 2013, and it also applies to the secondment arrangements made previously but tax treatment has not been confirmed or reimbursement has not been effected for overseas remittance. As such, it is suggested that our clients shall assess the tax implications of Announcement 19 on the current international secondment arrangement and, where needed, shall consider restructuring the international secondment arrangement and put in place proper documentation with a view to safeguard the parent company’s tax position and mitigate the PRC tax risks.