73ti0635 ho zhao turley by Conrad Turley

Volume 73, Number 7

by Khoonming Ho, Abe Zhao, and Conrad Turley Reprinted from Tax Notes Intâ&#x20AC;&#x2122;l, February 17, 2014, p. 635

How Does Tax Affect International Secondments in China?

February 17, 2014

by Khoonming Ho, Abe Zhao, and Conrad Turley

Khoonming Ho is the tax partner in charge of KPMG Greater China, Abe Zhao is a tax partner and the international tax leader of KPMG China, and Conrad Turley is a tax senior manager of KPMG China. All three authors are based in Beijing. E-mail: khoonming.ho@kpmg.com, abe.zhao@kpmg.com, conrad.turley@kpmg.com Copyright 2013 KPMG LLP. All rights reserved. This article represents the views of the authors only and does not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with a tax adviser.

oreign enterprises with operations in China have always viewed the dispatch of staff members, from head offices and elsewhere overseas, to their Chinese subsidiaries and joint ventures as indispensable to their proper functioning. Under a typical cross-border secondment arrangement, a foreign enterprise (home entity) dispatches its employees (secondees) to work in China at the site of a Chinese enterprise (host entity). The foreign enterprise remains the legal employer of the secondees and may continue to pay part of or all the remuneration to the secondees directly. The Chinese enterprise will in turn reimburse the foreign enterprise. The retention of the secondees’ employment relationship with the foreign enterprise may be important for the preservation of the secondees’ seniority or pension rights or social security entitlements in the home country. If the seconded staff severs an employment

TAX NOTES INTERNATIONAL

relationship with the foreign enterprise, it is often difficult for them to remain in foreign pension plans from a foreign regulatory perspective. Maintaining the foreign employment relationship also makes practical sense for the secondees because their stay in China is usually intended to be only temporary. Seconded expatriates in China serve multiple roles. For example, the secondee may fill a gap for a particular technical or business skill set or expertise that may not be readily available in the local labor market. Such secondments have been at the heart of Sino-foreign joint ventures, in which the Chinese partner provides country access and markets with the foreign partner supplying technology and management skills, delivered essentially through seconded personnel. Beyond this, foreign enterprises often consider it necessary to send senior management personnel to new Chinese operations to inculcate into the locally recruited staff the global group’s business norms and corporate culture. This is required to align the Chinese operations of the foreign enterprise with the wider global strategy, and to establish a social system that can mold newcomers to its procedures. The seconded expat may be relied upon as the ‘‘corporate glue,’’ integrating local operations into the global practices of the firm and, on returning to headquarters, providing firsthand knowledge of local operations to contribute to the development of strategic policy. The importance of seconded staff in China is evidenced by the numbers. According to some estimates,1

1 ‘‘HSBC New Horizons: China — why expats are heading east,’’ The Guardian (U.K.) (Feb. 19, 2013), available at http:// www.theguardian.com/hsbc-new-horizons/china-why-expats-areheading-east.

FEBRUARY 17, 2014 • 635

How Does Tax Affect International Secondments in China?

PRACTITIONERSâ&#x20AC;&#x2122; CORNER

100%

14 22 80%

22 16

Returnees

60% 10

Locally Hired Foreigners

10 13

Asia Pacific

40%

50 20%

Hong Kong/Taiwan Western

45 35

0% Top Executives

Senior Management

Management

Professional

Source: 2008 Mercer China Expatriate Survey.

around 85 percent of China expats work for international firms, with the largest proportions in sales and marketing (30 percent), banking and financial services (25 percent), and engineering (15 percent). The number of foreigners with Chinese work permits reportedly more than doubled from 2003 to 2011 and now exceeds 340,000.2 In the face of relentless market competition and resulting cost pressures, foreign enterprises have been looking to scale back their use of expensive seconded expatriates and pursue a policy of localization. But despite this trend, it is likely that secondments will remain a key feature of the operations of foreign enterprises in China, and consequently will continue to be a major element of corporate human resource planning. This makes it necessary for foreign enterprises, and their HR professionals, to contend with the complex Chinese tax exposures that may arise from secondments. (See figure.)

to subject it to Chinese taxation. If a foreign enterprise is considered to have a taxable presence in China as a result of the activities of its secondees, its active business income, such as trading income or service income, connected with or attributable to such presence will be subject to Chinese corporate income tax at a rate of 25 percent, in addition to various Chinese turnover taxes. Further, the foreign enterprise would have to fulfill several Chinese tax registration and filing obligations.

One possible result of dispatching staff to work in a Chinese host entity is the creation of a taxable presence for the foreign enterprise and hence the potential

The dividing line between having a taxable presence in China and not having one is drawn with reference to whether the dispatched personnel is seen to be actually acting on behalf of the home company in rendering services to the Chinese host entity or whether he truly is working solely for the Chinese enterprise itself. As can be seen from the above outline of the many secondee activities and roles, this can be a rather tricky distinction. Foreign enterprises go to great lengths to draft the secondment documents and operating protocols to ensure that the seconded staff member is seen to be working solely for the Chinese enterprise during the secondment period (that is, that the written contracts and protocols reflect his economic employment relationship despite his retention of a legal employment relationship with the home enterprise).

2 The data are released by the Chinese Ministry of Human Resources and Social Security. The figure of 340,000 includes locally hired expats and secondees.

Until now, however, the vagueness of existing Chinese tax regulations has made it difficult to ensure that secondment arrangements put in place are sufficiently drafted to eliminate the Chinese tax risk. A 2009 instruction from the State Administration of Taxation

The Chinese Tax Factor

636 â&#x20AC;˘ FEBRUARY 17, 2014

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Profile of Foreign Workers (by Positions) in China

PRACTITIONERS’ CORNER

Who Bears the Responsibility? Announcement 19 provides that the focus in determining which enterprise in substance employs longterm secondees3 will be on who bears the responsibilities and risks for the work products of the secondees and who normally reviews and appraises the job performance of the secondees. Beyond this fundamental factor, the new circular also sets out secondary reference factors. These include: • the label attached to any salary reimbursements paid by the Chinese enterprise to the foreign enterprise (labeling payments as management fees or service fees would be problematic); • a decision by the foreign enterprise to hold on to, and not pay on to the secondees, some part of the reimbursement received from the Chinese host entity (which may result in the foreign enterprise profiting from the arrangement); or • the foreign enterprise getting to decide the number, qualification, remuneration, and working locations of the secondees in China in a way that demonstrates the foreign enterprise’s continuing control over the secondees. In general, satisfaction of the fundamental factor and at least one reference factor would be conclusive evidence that the secondees are employed by the foreign enterprise and that the latter has a taxable presence in China as a result. • This factor-by-factor approach is not too far from the practices adopted by many leading economies, and standard secondment contracts used for send-

3 The term ‘‘long-term secondee’’ here refers to personnel who are seconded to work in China for more than six months.

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ing staff into other jurisdictions will generally be drafted to reflect the above. Note, though, that other jurisdictions would be more relaxed about a foreign enterprise making a small markup on the secondment of employees to cover the administrative costs of making the arrangement. In contrast, overreimbursements are looked on negatively under the new Chinese tax rules. • Another unique aspect of the Chinese rules is that the Chinese tax authorities don’t appear to be concerned if the foreign enterprise pays more to the secondees for their China duties than what they receive as reimbursement from the Chinese affiliate — that is, underreimbursement. This would often be looked on negatively in other countries. This provision can be helpful for when Chinese JV partners do not agree that the full salaries of foreign management personnel should be charged to the JV. However, the quid pro quo is that the Chinese authorities want to see that the secondees settle Chinese individual income tax (IIT) on the full amounts of compensation related to their China duties. • Lastly, a beneficial aspect of the new rules is the ‘‘stewardship exception,’’ which provides that if a foreign enterprise dispatches secondees into China to safeguard its interests as a shareholder of the Chinese affiliate by rendering investment advice or participating in the shareholder meetings or the board meetings of the Chinese affiliate, the activities of the secondees in China will not trigger a taxable presence for the foreign enterprise.

Actions for Human Resource Professionals The clarification of the criteria for determining when a secondment gives rise to a Chinese taxable presence allows HR professionals to review existing secondment arrangements and modify these when they offend against the clarified rules. Because Announcement 19 also sets out the documentation that the Chinese tax authorities will have with regard to making the determination (including secondment agreements, operating protocols and management guidelines for deploying the secondee, information on reimbursement to home entity, and IIT settlement information), HR professionals should put systems in place to collect and retain sufficiently comprehensive documentation to support the foreign enterprise’s tax position. Insofar as the rules do not allow for the home entity to retain any markup, human resource professionals should retain records showing that all the amounts received from the Chinese host entity have been paid to the seconded staff. To the extent that central administrative costs need to be recharged to the Chinese host entity, such recharge should be carried through a separate service agreement (although note that certain complexity in getting tax deductions and foreign exchange clearance for the cost recharge may also be encountered).

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(SAT), China’s central tax administration, to local Chinese tax authorities to step up their scrutiny of secondment arrangements in order to identify and tax the Chinese taxable presences of foreign enterprises put ‘‘the cat among the pigeons’’ for foreign firms and led to widespread calls for the regulations to be clarified. Also, difficulties were encountered with settling the Chinese currency, the yuan renminbi, into foreign currency for the reimbursement of the home company for the compensation costs of the secondees, as the Chinese foreign exchange authorities usually demand to see tax clearance before settling payments, and the tax authorities were frequently unable to decide whether such clearance should be issued. After a long delay, the Chinese tax authorities have now, with the issuance of SAT Announcement 19 (2013) in May 2013, clarified to taxpayers and enforcing tax authorities the factors of relevance in drawing the distinction, thus providing greater tax certainty for the structuring of secondment arrangements as well as potentially clearing up the bottleneck for the tax clearance process.

PRACTITIONERS’ CORNER With the heightened certainty in the new rules, some foreign enterprises may find that they can structure their secondment activities in China in a manner that can help them more effectively manage their tax risks. The human resource teams of multinational enterprises should consider working closely with their counterparts in the management, tax, and legal departments to help achieve a tax-efficient result in China-related secondment arrangements and to develop good documentation to support the desired Chinese tax position, following the principles of Announcement 19. ◆

Conclusion In the coming months, the Chinese tax authorities are expected to enforce the clarified rules vigorously.

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The Chinese tax authorities have clarified that when a secondee to a Chinese host entity continues to fulfill duties and tasks for other group companies outside China, but during the China secondment period, the IIT to be settled to satisfy the ‘‘no China taxable presence’’ requirements is calculated solely on the salary attributable to the China duties. A time apportionment method for determining the taxable salary base may be applied. Nonetheless, care needs to be taken with the drafting of the separate contracts for each set of duties, and documentary support needs to be retained to show that the secondee worked solely on matters unrelated to the Chinese host entity while outside China.