September 2009

For foreign employees looking to work in China an understanding of the common visa, tax and employment practices is significant. It is important for all companies and foreign employees to understand their rights in terms of contractual agreements, hiring, terminating as well as other employment issues, such as the dangers to the individual and company should tax evasion occur.

Visa Application Process

There are three types of visa that apply for foreigners coming to China.

The L-Visa is commonly known as a tourist visa and according to recent regulations can be extended in China twice.

An F-Visa is a business visa which can also be extended in China twice (according to recent regulations). It is available for multi-entry and the individual is permitted to stay for a period of 30 days per stay in China. To extend the visa a notification form is required and it can only be applied for by locally registered companies.

The Z-Visa is a single entry visa which has to be applied for at the individual's home country or in Hong Kong (which has recently permitted such applications as well). The Z-visa is required when an individual relocates to China and will have to apply for a residence visa (and work permit). Within 30 days upon arrival in China the expatriate has to convert his Z-visa into a residence visa. Additionally, the foreign expatriate must also receive a Health Check performed by a specific government hospital in the city of relocation. It takes around 4 weeks to obtain both work permit and visa (including the Health Check process). The FIE has to provide a series of documents for the application.

Should a company wish to hire staff from Hong Kong, Taiwan, or Macao these are considered expatriates as well and have to go through the same application procedure.

When companies relocate their foreign staff to China they should be aware of the fact that an employment contract in China is only valid when the employee holds a proper work permit and residence visa. Otherwise there is no legal relationship and the contract will not protect the employee by law. It is therefore recommended to mention in the work contract that the employment starts on the date when the Chinese work permit and residence visa have been granted.

Red Flags to be aware of when applying for Work Permits and Residence Visas

There are certain criteria which are important to keep in mind when applying for a visa in the PRC, such as:

• The retirement age for expatriate women is 55 years and for expatriate men 60 years. After the employees have reached this age it might become more difficult to receive a visa, if at all.
• The educational degree is important and needed for the visa application. It is important to check whether your employee holds an appropriate degree before relocating them.
• The employment letter must be already in place as this is must be submitted for the application.
• To qualify for a Chinese visa the applicant should have had at least 2 years relevant job experience. Due to this fact it is becoming more difficult for FIEs to hire interns for a temporary or full-time employment, particularly as a "working proof" document is required to be signed by the previous company.

Permanent Residence Permits

The requirements for the application of a permanent residence permit vary from province to province and city to city. The permanent residence permit allows you to have a residence visa for a period of 5 years.

The most basic requirements (among others) are the following:

• The employee must be employed by a Limited Company (it will not be applicable if the employee is working for a Representative Office)
• The person assumes in China the position of a board member, general manager, deputy general manager or a senior title within the company or as an associate professor or researcher.
• The person has held the post for four consecutive years and has lived in China not less than an accumulated three years;
• The person has a good record of tax payment.

Individual Income Tax (IIT)

Foreign individuals residing in China for less than one year are subject to tax only on PRC sourced income. Remuneration from foreign employers to individuals working in China is exempt from tax if the individual resides in China for less than 183 days in a calendar year, provided the remuneration is not borne by an establishment in China (however this does bring in the issue of the secondment assignments - see below).

Individuals who are not domiciled in China but reside in China between one to five years may, with approval, pay tax only on their China-sourced income and non-China sourced income, payment of which is borne by the China establishments. Commencing in the sixth year, their worldwide income will be taxed.

From November 2006, the State Administration of Taxation (SAT) released the "Trial Individual Income Tax Self Reporting Regulation", Guo Shui Fa [2006] 162 (Circular 162). This stipulates that individuals with a yearly income of over RMB 120,000 (USD 15,000) shall "self report" their income tax together with other personal information within three months of the end of the tax year.

Eleven types of taxable income are included when assessing whether an individual has annual income of more than RMB 120,000, thus:

• Income from wages and salaries
• Income from production and business operations by industrial or commercial households
• Income from contractual or leasing operations of enterprises or institutions by individuals
• Income from remuneration for labor services
• Income from remuneration for manuscripts
• Income from royalties
• Income from interest or dividends
• Income from the leasing of property
• Income from sales of property
• Contingent income

Taxpayers with annual incomes of more than RMB 120,000 should complete an annual tax return as well as their routine monthly tax filing, whether via their employer or individually. This annual return should be finished before the end of March each year.

How to structure an Employment Contract for Foreigners

In regards to structuring employment contracts there are three options available to both the company and the employee.

Structure One - Compensation Split

The expatriate can receive compensation from both the parent company and the China entity as there may be certain benefits which the expatriate will want to continue to receive in the home country such as Social Security. Having the parent company continue to pay the expatriate a salary for services rendered outside China would be reasonable. At the same time, the China entity will require that the expatriate receive some compensation within China, where the expatriate will actually be rendering services. The separation of compensation into the parent company and China components must have substance and be based on the reality of the expatriate and his services. The parent company can either declare the "parent company portion of the Salary" or the entire compensation (i.e. the parent company and China Salary together) and in China only the "China Salary" would be declared.

While physically in China, the expatriate only provides the types of services outlined in a simple contract that are appropriate for the China entity. The China entity will then compensate the expatriate for those services in an amount that is comparable to what someone who provides similar services in a similar market (i.e. China) would receive. It is important to provide an appropriate salary amount. While physically working abroad, the expatriate only provides services to the parent company. The parent company then compensates the expatriate based on those services. The idea is to have the expatriate only conduct China business while in China and only conduct parent company business while overseas.

The tax bureau in China may want to see the resume of the individual. The reason is to understand whether the salary declared is reasonable compared to the individual's age, work experience and what is being currently offered on the market.

Structure 2 - Declaration of the entire Salary in China

Many foreign employees also "shut themselves down" in their home country tax bureau stating they will live abroad. Hence they declare their full salary in China and no taxes will need to be paid in the home country. A disadvantage would be that no benefits would be provided in the home country either.

Structure 3 - Declaration of the Total Salary in both China and Home Country

As there is a double taxation treaty between many overseas countries and China, it is possible that you can declare the full salary in China, provide the tax receipts to the home country's tax authorities upon your return and you should not be liable to pay taxes then in the home country.

It is highly recommended that further information should be asked for by tax advisors in the home country.

Secondment Arrangements

Recently China's local level tax bureaus started to pay much closer attention to secondment arrangements of FIEs. Multinationals in the service as well as in the manufacturing sector have been investigated by the Chinese authorities who suspect the companies to have established Permanent Establishments (PEs) which would have different tax implications.

Up until now secondment arrangements were not questioned in China. Generally, an overseas Company would send its employees (secondees) to work for its affiliate in China. The Chinese affiliate would reimburse the foreign entity for the cost of salaries, allowances and other benefits of the seconded employee with no profit mark up (through management contracts). In the past, the Chinese authorities had accepted that the foreign entity assigning secondees to the Chinese subsidiary is a mere salary paying agent. They would agree that the foreign entity does not provide services to its affiliate and hence does not establish a PE. The secondees were regarded and reported as employees of the subsidiary and would pay IIT on their income according to Chinese law.

In case secondees are seen as representatives of the foreign entity providing services for their sister company in China, the foreign company might be deemed as constituting a PE in China. If the authorities see a PE as established, the foreign company would have to pay corporate income tax as well as business tax on all services, including the reimbursement payments.

The Chinese tax officials seem to judge these arrangements purely by identifying the party that pays the salary to an employee in China. If the foreign company pays the salary to the staff to an offshore account and recharges the amount to the subsidiary in China, the foreign entity is considered to provide services to the Chinese subsidiary and therefore is a PE. The reimbursement would be regarded as service fee payment and incur 5% business tax.

However, service and secondment arrangements should be distinguished as under a secondment arrangement the foreign employee is usually under the control and supervision of the Chinese entity and it is this entity that benefits from the employees work and not the foreign entity. Under a service agreement, the employee would rather report to the foreign entity and fulfill services laid out in a service agreement between the foreign company and its Chinese affiliate.

It is very important for all FIEs that have such arrangements to be prepared and have proper documentation in place proving the nature of the arrangement to the authorities. This should be done in close cooperation with the foreign company which might also be able to provide evidence to substantiate the nature of the secondment arrangement.

Conclusion

Prior to relocating foreign employees to China or hiring foreign employees on the ground it is important to check with the overseas tax advisors on how to best structure their employment contracts so that the employees can gain all benefits when going back to their home country.

Structuring your expatriate employee's salaries and ensuring they are in compliance is a major part of any corporate planning for companies in China. Should the employee not be in compliance then neither will the employer and this could result in the possibility of high fines and future audit problems. Companies should frequently review arrangements (legal form and economic substance) with their foreign employees to make sure all issues are within accordance to PRC requirements.

If you require assistance with the above subject, please contact us at This e-mail address is being protected from spambots. You need JavaScript enabled to view it with your detailed questions.

All information in this report is verified to the best of our ability and is assumed to be correct at time of release; however, Klako Group does not accept responsibility for any losses arising from reliance on the information provided within.