But with the clarity come some rules that are more onerous

Clarifications on rules for seconded staff to the Chinese mainland could result in significant cost savings for multinationals. A recent circular issued by the Chinese State Administration of Taxation has clarified the circumstances in which secondment arrangements will give rise to a taxable presence in China for foreign enterprises. This will affect a large number of overseas companies that have seconded staff to the Chinese mainland.

The Ministry of Human Resources and Social Security says the number of foreigners with Chinese work permits more than doubled between 2003 and 2011 and now exceeds 340,000. Many of these foreign employees are expatriates employed by foreign investment enterprises in China under secondment arrangements. While working on the premises of foreign investment enterprises in China, those seconded retain their employment contract relationship with the home company overseas, and often continue to receive compensation from it directly. It in turn is reimbursed by the Chinese foreign investment enterprises for any compensation costs incurred in relation to those seconded during the period of assignment. Maintaining the contractual relationship between those seconded and the foreign enterprise is important for the former to preserve their seniority or pension rights, and makes practical sense in any case where the stay of those seconded in China is only intended to be temporary.

However, a consequence of dispatching staff to work in foreign investment enterprises under secondment arrangements is the potential to subject the home company to Chinese taxation. This is an exposure that foreign enterprises with Chinese operations have always sought to manage. As the Chinese tax authorities have recently stepped up their enforcement efforts in taxing non-residents, such tax risks have preoccupied foreign enterprises more than ever before. Nevertheless, the vagueness of existing tax regulations has made it difficult to ensure that secondment arrangements put in place are sufficiently well drawn to eliminate the Chinese tax risk.

It is in this context that the new circular clarifies the issues related to secondment of staff. It represents a serious effort by the Chinese tax authorities to tighten up tax enforcement against non-residents. Meanwhile, it also clarifies a number of ambiguities in tax administration and may be viewed as a welcome development by multinational companies who want greater tax certainty in structuring their secondment arrangements.

What does a taxable presence mean?

Foreign enterprises clearly have an incentive to avoid inadvertently creating a taxable presence in China. Basically, if a foreign enterprise does not have a taxable presence in China, income from active business activities of the foreign enterprise, such as trading income or service income, will not be subject to Chinese corporate income tax. By contrast, if a foreign enterprise is considered to have a taxable presence in China, its active business 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 turnover taxes. Furthermore, the foreign enterprise would have to fulfill a series of Chinese tax registration and filing obligations.

There are several ways for a foreign enterprise to create a taxable presence in China. One of them is to have its foreign employees stationed in China and carry out business activities. In the case of personnel assignment from a foreign enterprise to China, the key to the existence of a taxable presence in China is whether the seconded personnel are really the employees of the foreign enterprise or the Chinese foreign investment enterprises. Despite the tax significance of this matter, previously there have been no clear rules on when those seconded are viewed as continuing to act for the foreign enterprise which seconded them to China, as opposed to being considered to work solely for the Chinese foreign investment enterprises to which they have been seconded.

When does a taxable presence arise?

Announcement 19 provides that in determining which enterprise employs those seconded in substance, the focus will be on who bears the responsibilities and risks in relation to the work products of the those seconded and who normally reviews and appraises the job performance of those seconded. Beyond this fundamental factor, the circular also sets out certain secondary reference factors. These include: The label attached to any salary reimbursements paid by the Chinese foreign investment enterprises to the foreign enterprise (labeling payments as management fees or as some kind of service fee would be problematic); a decision by the foreign enterprise to hold on to, and not pay on to the person seconded, some part of the reimbursement received from the Chinese foreign investment enterprises (which may result in it making a profit from the arrangement); or the foreign enterprise getting to decide the number, the qualification, the remuneration and the working locations of those seconded in China, in a way that demonstrates the foreign enterprise's continuing control over those seconded. In general, satisfaction of the fundamental factor and at least one reference factor would be conclusive evidence that the foreign enterprise has a taxable presence in China.

The factor-by-factor approach above is not too far from the practices adopted by many leading economies and that advocated by the OECD, though other jurisdictions would be more relaxed about a foreign enterprise making a small mark-up on the secondment of employees to cover the administrative costs of making the arrangement. Under the new Chinese rules, if the foreign enterprise gets over-reimbursed by the Chinese foreign investment enterprises regarding the compensation costs of those seconded, that is viewed as proof that the foreign enterprise derives profits from and has a taxable presence in China.

Another interesting quirk of the Chinese rules is that the Chinese tax authorities appear not to be concerned if the foreign enterprise pays more to those seconded for their China duties than that received as reimbursement from the Chinese foreign investment enterprises, i.e. under-reimbursement. Many other countries might view this as evidence that those seconded at least partially work for the foreign enterprise, thereby creating a taxable presence of the foreign enterprise in China. In this situation, the Chinese circular emphasizes that as long as those seconded settle Chinese individual income tax on the full amounts of compensation related to their China duties, under-reimbursement does not suggest the existence of a taxable presence for the dispatching foreign enterprise. This rather unique criterion could work in favor of the foreign enterprise or against it, depending on the circumstances.

Finally, a new sweetener in the Chinese circular is the "stewardship exception". According to this provision, if a foreign enterprise dispatches those seconded into China to safeguard its interests as a shareholder of the Chinese foreign investment enterprise, by rendering investment advice or taking in shareholder meetings or board meetings of the foreign investment enterprises, the activities of those seconded in China will not trigger a taxable presence for the foreign enterprise. This position is generally consistent with international common practice, and recognizes the fact that stewardship activities do not directly lead to the generation of business profits and should be treated more leniently compared with regular business activities.

How are foreign enterprises affected?

The new Chinese circular on secondment can be looked at as a bit of a mixed bag. First, the greater clarity in the determination criteria for a taxable presence is welcome. Under the new rule, assessment of a taxable presence can now be carried out on a more consistent basis in China, with greater efficiency and fewer controversies. Second, some of the provisions will be regarded as more onerous and restrictive than the approaches taken elsewhere while other provisions will be seen as more generous. So the new rules create both risks and opportunities for multinational companies doing business in China.

In light of the above, foreign enterprises will have to work quickly to review their existing secondment arrangements and modify these where they offend against the clarified rules. They will need to put systems in place to collect and retain sufficiently comprehensive documentation to support their tax position. This is particularly the case given that, with the release of the circular, tax authorities will be expected to enforce these clarified rules more vigorously, and are in fact urged in the circular to work towards greater co-ordination between administrative units in charge of different types of tax. Well prepared foreign enterprises are likely to find the clarifications helpful and would do well to consider whether the new rules allow them to arrange their activities in China in a manner they may have previously feared to do on account of perceived tax risks.

On a broader note, as China further clarifies its rules on taxing non-residents, it has shown quite an independent streak in devising provisions that depart, at least partially, from international tax norms. This clarified approach to determining the existence of a taxable presence in China contains aspects that may be regarded as innovative, in the same way as Chinese rules on indirect offshore equity disposals and on access to tax treaty benefits differed from the globally accepted approach. It remains to be seen how the Chinese innovations in international tax law, and those of other BRICS nations, will affect standard accepted international tax practice, which for so long was dominated by the interests and preferences of Western nations.

Khoonming Ho is the tax partner in charge at KPMG Greater China. Abe Zhao is the international tax leader at KPMG China. Conrad Turley is the tax senior manager at KPMG China. The views do not necessarily reflect those of China Daily.

(China Daily European Weekly 06/14/2013 page12)