How you should second employees to your PRC Affiliate

Published 09 February 2010

Secondment arrangements have often been considered an effective way for multi-national companies (MNCs) to avoid Permanent Establishment (PE) exposure and thus avoid hefty Enterprise Income Tax (EIT) and Business Tax (BT) payments in China. Under a secondment arrangement, an employee of an MNC is dispatched to its Chinese affiliate, providing services to the Chinese affiliate, while remaining an employee of the MNC, and retaining employee benefits under the employment contract with the MNC. Under the secondment arrangement, the dispatched employee reports directly to, and remains under the payroll of the MNC. The Chinese affiliate then reimburses the MNC for the employee’s salary without any mark up. Effectively, this meant that the MNC does not accrue any onshore income in China, and the dispatched employee’s presence would not be deemed as establishing a PE in China.

However, as the Chinese saying goes, “the song can no longer be sung”.


The issuance of Circular 103 by the State Administration of Taxation (SAT) is a red alert to
MNCs on the SAT’s mission to tighten up tax administration, and to catch up on tax revenue
shortfalls from disguised secondment arrangements. Circular 103 empowered local tax
authorities to investigate secondment arrangements between a foreign entity and the Chinese affiliate, allowing the authorities to request information relating to the secondment agreement, such as the service contracts, travel records, and evidence of the payment from the Chinese
affiliate to the foreign entity.

Where, after investigations, the secondment arrangement is considered to be a “service
arrangement”, the foreign entity will be deemed to have established a PE in the PRC. The
reimbursement by the Chinese affiliate to the foreign entity will hence be considered as onshore income of the foreign entity, which is subject to EIT and BT.

The tax authorities’ investigations came to a close at the end of August 2009. Some foreign
entities that benefited from secondment arrangements may have suddenly found themselves being requisitioned by local tax authorities for unpaid taxes and penalty interest on the reimbursement of the seconded employee’s salary.


The SAT continued its mission to seek out and scrutinize foreign entities attempting to escape
tax payment obligations by introducing Circular 19 in February 2010.

In a nutshell, Circular 19 requires foreign entities to maintain complete and accurate accounting records for tax assessment purposes, failure of which will empower the local tax authorities to
assess the foreign entity’s taxable income on a deemed profit rate basis, being:

• 15-30% for provision of contract engineering, design and cons ulting services; or
• 30-50% for provision of management and administrative service s; or
• No less than 15% for other services or non-services activitie s; or
• A rate higher than the above deemed profit rate if it believes that the actual profit rate is
obviously higher than the prescribed rate above.

In other words, a foreign entity which has been deemed to have established a PE in the PRC
through providing services to its Chinese affiliate, and have obtained ‘onshore income’ for
providing those services will be subject to EIT and BT at the above tax rates (as opposed to the
usual 25%) if it fails to provide relevant proof of the amount of taxable income.

To take things further, if a foreign entity provides services both inside and outside of the PRC, and it fails to provide accurate accounting records to prove that income derived from services provided inside the PRC is separate from income derived from services outside the PRC, the tax authority may deem all service income derived from both inside and outside of the PRC as income derived within the PRC.

Taking the above into consideration, secondment may no longer be an optimum solution for MNC’s HR deployment.

Taking the above into consideration, a secondment arrangement may no
longer serve as a solution for MNC’s for tax reduction purposes.


Foreign companies are advised to conduct an internal review on their existing arrangements
involving the employment of foreign nationals in the PRC.

Alternatively, foreign entities may consider having a dual employment arrangement, whereby the foreign company arrange expatriate “secondees” to enter local employment contracts with the Chinese affiliate. This will also avoid tax on attributable income in the home country. The Chinese affiliate will then pay salaries and related benefits directly to the secondee.

This arrangement allows clear separation of pay packages for the employees’ work done inside
the PRC (which is subject to Individual Income Tax (IIT)) and work done outside of the PRC
(which is not subject to IIT).

When structuring dual employment, the foreign entity should include a statement in the
employment contract to show that there is a reasonable business justification for two separate
contracts. They should also set out distinct roles and responsibilities under each contract; as well
as clear and distinguishable lines of control and reporting of each position. It is also important to
set out reasonable split of remuneration between the two contracts, (for example, reasons reflecting the respective duration, status and difficulty of work inside and outside of the PRC)
especially if the two employers are affiliates or have other business relationship. Further, the
Chinese affiliate must not bear (directly or indirectly) the cost of the foreign entity’s remuneration of the employee for their foreign work portion unless it is a justifiable administrative cost.

The above may assist in a defence against challenges from the PRC State Administration of
Taxation. Therefore, think twice and seek advice before you second.