It has been a common practice for many multinational companies ("MNCs") to assign personnel from headquarters or other offshore group companies to take senior positions within their subsidiaries in China under secondment arrangements. In most cases, expatriates will continue to be employed and paid by the offshore entity. Such secondment arrangements allow the expatriates to keep their offshore social insurance benefits (e.g., a 401k plan in the United States). Because no local employment contract is signed, the MNCs can also potentially avoid the application of employee friendly employment regulations to their expatriates in China. Moreover, it has been a general consensus among tax practitioners and also a common practice of the tax authorities, that if the expatriates work for and are controlled by the PRC affiliate only while working in China, and the offshore entity gets reimbursed on a cost basis without any mark-up, secondment arrangements should not attract any PRC tax except individual income tax on the expatriates' salary income.
Recently, some local tax bureaus have launched special tax audit programs targeting MNCs (especially in the manufacturing and service sectors) that second expatriates to work in their PRC affiliates. The program is to focus on completing audits over the coming two months. Based on no-name discussions with local tax officials in Shanghai and Beijing and work with our contacts on the same, the local tax authorities hold the opinion that all secondments of expatriates to China will create a Permanent Establishment ("PE") for the offshore employers, and the offshore employers should pay enterprise income tax ("EIT") on a deemed profit basis (the deemed profit rate is between 20% - 40%). The EIT rate is 25%. Furthermore, if the offshore employers are deemed to be providing services in China, 5% business tax ("BT") would also apply. This will effectively add a tax burden ranging from 10% to 15% of the payroll costs of expatriates. There is also a risk that taxes will be imposed retroactively.
If the PRC tax authorities follow-through on these audits, this could represent a massive shift in the way expatriates can be assigned to operations in China. Depending on how this develops, MNCs may need to adjust their existing secondment arrangements as well in order to manage the tax burden going forward. The tax authorities are on questionable legal grounds if they assert that a properly-structured secondment actually creates a PE, and further that if a PE is created, there is actual income attributable to that PE.
Nonetheless, if the PRC tax authorities continue to impose EIT and BT on all reimbursement payments, MNCs may need to consider having the PRC affiliates pay the seconded expatriates directly to avoid the risk of these taxes applying.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
