Independent Contractors in China and Available Alternative Options
By Eunice Ku & Adam Livermore
Posted: 24th July 2013 10:06It is not (as has been suggested elsewhere online) illegal to use independent contractors in China, however, care must be taken when assessing the relevant employment law. Engaging independent contractors can be a useful strategy for foreign investors in China, especially when involved in specific project work that does not call on the need for permanent workers. The use of them can essentially be broken down as an “employee vs. independent contractor” debate, and it is important to be aware of the distinctions between the two.
Most employees in China are hired directly by their employers, with this trend having been accelerated considerably by the recent implementation of the “Decision on Revising the Labor Contract Law of the People’s Republic of China (Order No.73 of the PRC President).” Under this order, companies may only utilize “dispatched” or “paiqian” employees when the nature of the work that they will carry out is temporary, auxiliary or backup.
Employees working for representative offices (ROs) in China are an exception to this rule, as the RO does not have the ability to hire them directly. Such employees working under a “paiqian” relationship will have a labor contract in place with the agency to which they are affiliated, and then the agency will put a service contract in place with the ultimate employer. This effectively shifts the legal onus concerning employment onto the service contract between the ultimate employer and the labor dispatch company – care and advice must be taken to fully understand the implications.
It is generally a challenge for companies to negotiate preferential terms into the service contracts they sign with labor dispatch companies, especially when they are only looking to employ a few staff. Many of these contracts pass all risk onto the ultimate employer, and terms of these contracts should be closely inspected to see whether there are, in fact, any tangible benefits to be gained. Some agents also charge substantial amounts for the service they provide, which can often negate or exceed any potential benefit that can be gained by the ultimate employer.
There are other circumstances under which individuals can be engaged in China. One is under a relationship of a nature that can be considered a kind of independent contractor. Such relationships will normally be project based, and a company initiating any such relationship should be careful that the relationship cannot be interpreted as a normal employee/employer relationship.
Under such a relationship, the individual works in a similar way as a sub-contractor providing a service to the company. The individual is required to obtain a “laowu” invoice from the tax bureau and provide it to the company as evidence that their taxes (including business tax, surcharges and individual income tax) have been paid, such that the company can include the cost into its expenses and deductions for purposes of corporate income tax. This tax rate is generally higher than that of a company employee, and higher than the amount of tax a subcontracting company would expect to pay when delivering a service.
In this sense, the use of such relationships is generally avoided by both companies and individuals, despite the advantage to the company in that mandatory benefits do not need to be paid to such individuals and that Chinese Labor Contract Law does not apply to such relationships.
It is also possible to employ individuals in China from overseas under certain circumstances – there is nothing inherently illegal about this, they just can’t be employed under Chinese law in this way. This means that such employees effectively enjoy zero legal protection under the contract that they have signed, and it is difficult to persuade potential employees to accept this situation. Such a method also necessitates the individuals to calculate and pay their own tax each month, and make their own social insurance contributions. Employers will also have concerns relating to the creation of a permanent establishment (PE) in such circumstances (referred to in more detail below).
An alternative method companies will sometimes use to employ individuals in China from overseas is to utilize a HR agent in China, paying that company a service fee from overseas and having the agent put in place an employment contract with the individual. Such a method can also work, although the fee payable to the agent is normally relatively high, and a large upfront deposit required. Please note that entering into such a relationship does not provide much protection against the risk for the company to create a PE in China based on the employment of that individual.
A typical double taxation avoidance agreement (DTA) contains clauses related to the PE concept, and this can significantly impact upon the total investment needed to enter a particular market. Once an enterprise triggers PE status in China, it becomes subject to China’s business taxes. Furthermore, any qualifying staff will be subject to individual income taxes, and if Chinese, for social welfare payments from the foreign entity. As such, it is critical for overseas based businesses engaging in activities in China – even while working with labor dispatch companies – to be fully aware of their PE applicability. Although the precise definitions for the creation of a PE need to be judged on a case-by-case basis, because the nature of these agency contracts still leaves the ultimate employer in effective control of the individual’s employment, it is unlikely that much risk can be defrayed through this method. We suggest that any such relationships entered into should be as short-term as possible.
Of course, the most obvious method of achieving the objective of having a project completed in China is to hire a company to do the work, and have that company employ individuals. This method is becoming more popular now that China is implementing its transition from a business tax (transactional tax) system to a value-added tax system.
This article was first published on China Briefing.
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