As reported in a recent issue of Tax Notes International, employees of foreign employers temporarily assigned to work in China may face additional tax liabilities with respect to such arrangements after new guidance becomes effective on June 1, 2013.
Foreign Employee Secondments
Foreign companies commonly send “second employees”, especially managers and technicians, to China to support Chinese affiliate companies or other business operations. Foreign companies usually continue the employer-employee legal relationship while the secondees are working in China. The question which surfaces of course, is who should be treated as the real employer for Chinese tax purposes.
Another issue generated by employee temporary reassignments to another country is whether the relocated worker will be subject to income tax and payroll taxes in the jurisdiction of temporary assignment. Where there is a bilateral income tax treaty involved, the issue of avoiding double taxation is capable of a satisfactory resolution. There are also social security tax issues. In avoiding double taxation in this area, totalization treaties are entered into by contracting states. "Totalization agreements," have two main purposes. First, they eliminate dual social security taxation, the situation that occurs when a worker from one country works in another country and is required to pay social security taxes to both countries on the same earnings. Second, the agreements help fill gaps in benefit protection for workers who have divided their careers between the United States and another country. The U.S. does not have a totalization treaty with China. This may be an added rationale for sending over temporary workers to China under a foreign employer secondment arrangement. But, as discussed in this post, there may be an unintended and high cost for using such arrangement.
SAT Bulletin 19 
The new guidance issued in China goes beyond the subject to whether the secondee will be subject to income and social security taxes in China while temporarily working in China. In In Bulletin  19 (Bulletin 19),1 issued by China’s State Administration of Taxation (SAT) on May 6, companies with international secondment arrangements should immediately review their secondment arrangements and policies and make any corrections or tax planning adjustments to minimize Chinese tax risk.
Bulletin 19 provides that a nonresident company or enterprise (“foreign seconding entity”) sends one or more individuals (“secondees”) to China to render services in China, the foreign seconding entity will be deemed to have set up an “establishment or workplace” (a/k/a a “permanent establishment”) in China if the foreign seconding entity assumes part or all of the responsibility and risk associated with the secondees’ work results and normally evaluates their work performance. Where the secondees are the foreign seconding entity’s employees and act for the foreign seconding entity in China, the foreign seconding entity is regarded as having an establishment or workplace in China. Perhaps companies currently engaged in such practices may have felt that such activities did not rise to the level of a permanent establishment in China. Such companies must take an immediate look at this issue.
U.S.-P.R.C. Income Tax Treaty Implications
As far as the U.S.-PRC Income Tax Treaty of 1984, which is currently in effect, is concerned, several articles are worthy of consideration.
“Article 5 (Permanent Establishment)
1.For the purposes of this Agreement, the term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on.
2.The term "permanent establishment" includes especially:(a) a place of management; (b) a branch; (c) an office; (d) a factory; (e) a workshop; and (f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.
3.The term "permanent establishment" also includes:(a) a building site, a construction, assembly or installation project, or supervisory activities in connection therewith, but only where such site, project or activities continue for a period of more than six months; (b)an installation, drilling rig or ship used for the exploration or exploitation of natural resources, but only if so used for a period of more than three months; and (c) the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purposes, but only where such activities continue (for the same or a connected project) within the country for a period or periods aggregating more than six months within any twelve-month period. (emphasis added).
4.Notwithstanding the provisions of paragraphs 1 through 3, the term "permanent establishment" shall be deemed not to include:(a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; (b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; (c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; (d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise; (e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character;(f)the maintenance of a fixed place of business solely for any combination of the activities mentioned in subparagraphs (a) through (e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.
5.Notwithstanding the provisions of paragraphs 1 and 2, where a person, other than an agent of an independent status to whom paragraph 6 applies, is acting on behalf of an enterprise and habitually exercises in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment in that Contracting State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph.
6.An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other Contracting State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise, he will not be considered an agent of an independent status within the meaning of this paragraph if it is shown that the transactions between the agent and the enterprise were not made under arm’s length conditions.
7.The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other Contracting State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other.”
“Article 13 (Services Rendered in Contracting State by Non-Resident)
1. Income derived by an individual who is a resident of a Contracting State in respect of professional services or other activities of an independent character shall be taxable only in that Contracting State, unless he has a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities or he is present in that other Contracting State for a period or periods exceeding in the aggregate 183 days in the calendar year concerned. If he has such a fixed base or remains in that other Contracting State for the aforesaid period or periods, the income may be taxed in that other Contracting State, but only so much of it as is attributable to that fixed base or is derived in that other Contracting State during the aforesaid period or periods. (emphasis added).
2.The term "professional services" includes, especially, independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, dentists and accountants.”
“Article 14 (Income from Employment)
1.Subject to the provisions of Articles 15, 17, 18, 19 and 20, salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that Contracting State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other Contracting State. (emphasis added).
2.Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if: (a) the recipient is present in the other Contracting State for a period or periods not exceeding in the aggregate 183 days in the calendar year concerned; and (b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other Contracting State; and (c) the remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other Contracting State.”
Bulletin 19 Issued by the PRC State Administration of Taxation (SAT)
Consistent with issued guidance by the PRC’s SAT, under Article 15, ¶2 of the Guoshuifa  75 (Circular 75), Bulletin 19 determines a secondee’s real employer by looking at who takes the responsibility and risk for the secondee’s work results. Bulletin 19 sets out five scenarios in which the tax authorities will determine that a foreign seconding entity is a real employer and consequently constitutes an establishment or workplace in China: (i) the Chinese enterprise that receives secondees pays the foreign seconding entity management fees, service fees, or similar fees; (ii) the Chinese enterprise pays the foreign seconding entity more than the compensation (for example, salaries and social insurance expenses) that the latter pays the secondees; (iii)the foreign seconding entity pays the secondees less than the amount it receives from the Chinese enterprise, withholding a portion of that amount; (iv) the secondees fail to fully pay Chinese individual income tax (IIT) on their employment income borne by the foreign seconding entity; and (v) the foreign seconding entity determines the number of secondees, their job titles, compensation standard, and work location in China.
Commencing June 1, 2013, foreign employers will be subject to additional tax liabilities from employee secondments in China. Where a foreign seconding entity assumes part or all of the responsibility and risk for secondees’ work results, such liabilities will be triggered by the “foreign seconding entity” generally will be viewed as having establishment or workplace in China. The written comments technically don’t have legal effect, but local tax authorities could use them as practice guidance.
Article 5, paragraph 7 of Circular 75 contains similar treaty interpretation rules with respect foreign parent-Chinese subsidiary cases. Under these rules, nonresident individuals who are seconded by a foreign parent company to a Chinese subsidiary under an applicable tax treaty are treated as working for the parent company if any of the following conditions is met: (i) the parent company can direct the secondees for work and takes the risk and responsibility for the secondees’ work; (ii) the parent company determines the number and standards of the secondees; (iii) the parent company bears the secondees’ salaries; or (iii) the parent company makes profits from the subsidiary for the secondment.
Under Article 3 of the Enterprise Income Tax Law (EIT), a nonresident enterprise with an establishment or workplace in China is subject to EIT on Chinese-source income derived by the establishment or workplace and on overseas income that is effectively connected with the establishment or place. Therefore, if a nonresident enterprise is located in a foreign jurisdiction that does not have a tax treaty with China and is deemed to have set up an establishment or workplace in China from an international employee secondment, it may be subject to Chinese EIT on the employee secondment arrangement, regardless of how long the secondees carry out activities on its behalf in China.
Permanent Establishment Implications
Many foreign seconding companies, such as those resident in the United States, will have the protection of avoiding taxation in China under the permanent establishment provision, i.e., Article 5 of the U.S.-PRC Income Tax Treat (1984). Bulletin 19 provides that a foreign seconding entity’s establishment or workplace in China will constitute a permanent establishment in China if a tax treaty is available and the establishment or workplace is "relatively fixed and permanent." (emphasis added) . Therefore, the foreign secondment entity with a permanent establishment in China is subject to the 25% Enterprise Income Tax (EIT) on Chinese-source income derived by the permanent establishment located in China and associated profits effectively connected with the permanent establishment situated in China. Where the establishment or workplace is not considered a permanent establishment, the foreign seconding entity will not be liable for the EIT in China.
As further background for the EIT law, it provides that enterprises established outside of the PRC whose “de facto management bodies” are located in the PRC are considered “resident enterprises” and are generally subject to the uniform 25% enterprise income tax rate as to their worldwide income. Under the implementation regulations for the EIT Law issued by the PRC State Council, “de facto management body” is an organizational branch or division that has material and overall management and control over the manufacturing and business operations, personnel and human resources, finances and treasury, and acquisition and disposition of properties and other assets of an enterprise.
China’s EIT Law and its implementing rules are relatively new and considered by international tax practitioners to suffer from ambiguity. This is certainly the case with respect to certain definitions, requirements and detailed procedures, and currently no official interpretation or application of the “resident enterprise” definition is available from the SAT, at least not until this new guidance on secondments. Overall, it is unclear how PRC tax authorities will determine the tax residency of each company based on the facts and circumstances of the specific company.
Bulletin 19 does not provide details on the term "relatively fixed and permanent." When a foreign seconding entity is treated as providing services to a Chinese company through secondees, tax treaty rules apply to determine whether the service activity constitutes a PE in China. Under most of China’s tax treaties, the furnishing of services, including consultancy services, by an enterprise of a foreign jurisdiction through employees or other engaged personnel in China is generally considered to have a permanent establishment in China if the service activity continued for the same project or a connected project for more than six months or 183 days.
Individual Income Tax
As long as a foreign seconding company constitutes a permanent establishment in China, the secondees, in general, will be subject to the individual income tax in China (ITT) on employment income derived from the performance of the work in China regardless of the length of their stay in China. This is because they generally cannot meet the third tax-exempt requirement of Chinese income tax treaties in accordance with the treaty interpretation rules provided by article 15, paragraph 2 of Circular 75. Chinese-source employment income derived by those secondees is deemed to be borne by the foreign seconding company’s permanent establishment in China regardless of the length of their stay in China and of the payer of the employment income. The secondees are therefore disqualified from the tax exemption unless their work is limited to temporary inspection, examination, or assistance for the Chinese permanent establishment.
Where no applicable tax treaty is involved, a nonresident individual will be exempt from IIT on Chinese-source employment income provided she is present in China for no more than 90 days in a given tax year and the employment income is paid by a foreign employer and is not borne by the employer’s establishment in China, according to Guoshuifa . Thus, if a foreign seconding company is deemed to have an establishment in China, the secondees’ Chinese-source employment income could also be deemed to be borne by the establishment in China under the tax principle, thereby disqualifying the secondees from the IIT exemption no matter how long they stay in China.
The PRC’s GAAR. General Anti-Abuse Rule)
The corporate Income tax law, as revised, in China (CITL) has included several GAAR rules. Such anti-avoidance provisions permit the taxing to make adjustments when enterprises enter into business arrangements that give rise to a reduction of taxable income and are not supported by a reasonable business purpose. Under Chinese tax regulations, business arrangements without a bona fide business purpose refer to arrangements the primary purpose of which is to reduce, avoid, or defer tax payments. Guidance in this areas has been issued by the Chinese tax authorities which are very broad and cover a variety of contexts, including abuse of tax incentive policies, tax treaty provisions, legal vehicle forms or structures, tax havens, and other arrangements without bona fide business purposes. The Chinese have also adopted principles tax lawyers in the States are familiar with including, step transaction, substance over form, and book-tax differences.
The GAAR rules provide the Chinese tax authorities with the power to make adjustments to certain transactions or deny tax benefits, and allow local tax bureaus to disregard legal entities that are deemed to lack substance. These rules are being used to examine back-to-back loan or financing structures made by off-shore investment funds.
China Treaty Circulars: A Brief Summary
In Circulars 601 and 698 the Chinese taxing authorities will attack structures that exploit tax treaties, such as prohibited treaty shopping, and tax avoidance. These Circulars were preceded by some high-profile cases (citations omitted)and the issuance of other guidance aimed at strengthening the taxation of nonresidents.
In Circulars 124, the Chinese tax authorities introduced detailed administrative rules for treaty residents to claim treaty benefits, with an effective date of October 1, 2009. The rules provide that nonresidents will not be automatically granted the benefits under DTAs, and will be required to comply with administrative rules to receive them. Income derived by nonresidents is divided into two categories and is subject to different procedures for claiming treaty benefits.
For benefits attributable to passive income, including dividends, interest, royalties, and capital gains, nonresidents must adhere to an "application-approval" procedure. For active income, such as business income of permanent establishments, independent personal services, and dependent personal services, nonresidents must satisfy the "record-filing" procedure.
Different documentation is required with respect to the two procedures. Once the application for treaty benefits is approved, the nonresident does not have to reapply to the tax authority to be entitled to benefits for three calendar years (including the year in which the initial application is made) with respect to (1) dividends derived from the same equity investment in the same enterprise; (2) interest derived from the same debt and due from the same debtor; and (3) royalties derived from granting the same right to the same person or enterprise. Eligible nonresidents under the DTAs that fail to apply for approval may cure this failure by filing an application within three years from the date of the tax payment to obtain a refund. Approval may be revoked by the Chinese tax authorities in certain circumstances and the nonresident may be required to pay the taxes plus surcharges, interest, or penalties. Query, how would a US based company issuing GAAP financials set up appropriate reserves under FIN 48 (FAS 5) for such procedures and the risk of facing tax assessments in China?
In Circular 290, supplementary rules pertaining to local PRC tax authorities were promulgated including subjects on the timing of internal review procedures, tax filing requirements, and tax residency certificates for nonresidents seeking tax benefits under DTAs. Circular 290 requires a withholding tax agent to complete tax filing procedures regardless of whether the taxpayer has submitted related documents to the tax authority. Circular 290 clarifies that to obtain DTA benefits, a tax residency certificate must be issued exclusively for that purpose or in accordance with the requirements of Circular 124. Additional Circulars were issued by SAT after 2008. See, e.g., Circulars 601 (“beneficial owner”), 698 (capital gains). Each of these additional Circulars announces that substance-over-form determinations will extend to capital gains derived indirectly by nonresidents on share or equity transactions and highlights the willingness of the The SAT will disregard certain entities under GAAR if they were established to avoid tax and lack a business purpose and commercial rationale. See Federal Tax Developments Blog Post in April 22, 2011 by Jerald David August Tax Strategies for Funds Investing In China: China Tax Authorities Aggressively Enforcing GAAR (General Anti-Avoidance Rules)
Back to SAT Bulletin 19
Bulletin 19 instructs local tax authorities to focus on the economic substance of international employee secondment to China. Apparently, Bulletin 19 has applied the Chinese general antiavoidance rule to international employee secondment, giving local tax authorities express guidance to investigate foreign companies’ tax avoidance associated with international secondment. Foreign seconding and Chinese receiving companies that conceal international secondment arrangements through related-party transactions, the elimination of transactions, or the waiver of debt may be subject to GAAR investigation.
Where a secondment period is of a shorter period than the minimum period for invoking a deemed service permanent establishment (6 months or 183 days in most of the PRC’s income tax treaties), a foreign seconding company wishing to continue the legal employment relationship with secondees will continue to pay the secondees’ salaries during the secondment. In that case, the foreign seconding company and nonresident secondees may be exempt from Chinese income tax liability based on the availability of an applicable tax treaty. Note that the secondees’ salaries cannot be paid or borne by any Chinese entity for IIT exemption purposes. To qualify for the tax exemption, each of them is required to file with the Chinese competent tax authorities in accordance with Guoshuifa  124.
Where the anticipated secondment period will be of sufficient duration to implicate a “deemed permanent establishment”, the foreign seconding company will likely be subject to Chinese EIT arising from the secondment if it is the real employer of the secondees, i.e., undertaking part or all of the responsibility and risk for the secondees’ work results. In order to minimize or avoid the EIT in this situation, the foreign seconding company may be advised to have the secondees hired and paid by the Chinese receiving company if commercially practical. If the secondees perform technical work for the Chinese company and the foreign company also wants to use the technical results, then the Chinese company may license the technology to the foreign company in exchange for arm’s-length royalties. The Chinese company may claim foreign income taxes paid on the royalties as a credit against Chinese EIT.
Transfer Pricing Considerations
Where it is undesirable or otherwise impractical for a Chinese company to hire long-term secondees (or short-term secondees as well), a foreign seconding company will need to employ an arm’s-length price for the provision of services to the Chinese company, using a cost-plus method for example. The foreign seconding company must maintain accounting records for computing Chinese taxable income on an actual basis. Failure to compute the actual taxable income may result in the application of a deemed profit rate between 15 and 50% or higher. Also, those service activities are generally subject to Chinese VAT or business tax, depending on when and where the services occurred in China.
Secondees in certain instances may be working for a Chinese Company as well as a foreign seconding company. Under SAT Bulletin 19, where the foreign seconding company assumes a portion of the responsibility and risk associated with secondees’ work results, it may be regarded as having an establishment or workplace in China. This outcome should be avoided if possible.
Individual Income Tax Payment
Foreign sending companies should make sure that their secondees are paying the full amount of applicable IIT in China. For many U.S. secondees the tax will be creditable under Section 901. But see also Section 911 for U.S. individual taxpayers (U.S. citizens or residents working in the PRC). In this regard, Bulletin 19 provides that where a secondee underpays her Chinese IIT on taxable income, the foreign seconding company faces a greater risk of triggering an establishment or workplace or a PE in China. Imagine that claim being made by our own IRS!
In this regard, U.S. tax law imposes responsibility for the employer to properly withhold on wages but not to guaranty that the employee will pay all taxes owed to the U.S. Bulletin 19 imposes a tax rate penalty on the foreign seconding company that doesn’t make sure that the IIT is properly computed and timely paid. Substantive due process does not appear to be alive and well with our neighbor to the West.
CAVEAT: The comments set forth in this post are intended for informational purposes only. This author is not licensed to practice law in China. For companies and individuals having further questions on Bulletin 19 and the China EIT and ITT, consult with an attorney licensed to practice in China who is knowledgeable in income taxation.