Independent Contractors in China and Available Alternative Options

Posted by Reading Time: 6 minutes

By Eunice Ku & Adam Livermore, Dezan Shira & Associates

Jul. 18 – It 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.

Dezan Shira & Associates has been established in China since 1992 and provides business advisory, corporate establishment, tax, payroll and HR services to foreign investors in China. The firm has its own Payroll Services Division, headed up by Adam Livermore, which can advise on employment law and employee social welfare in China, pertinent double tax treaties, and the likelihood of triggering permanent establishment status.

The firm also provides such services throughout Asia, including India, Vietnam and Singapore. For further information please contact payroll@dezshira.com or visit www.dezshira.com.

Related Reading

Human Resources and Payroll in China (Third Edition)
A firm understanding of China’s laws and regulations related to human resources and payroll management is essential for foreign investors who want to establish or are already running foreign-invested entities in China. This guide aims to satisfy that information demand, while also serving as a valuable tool for local managers and HR professionals who may need to explain complex points of China’s labor policies in English.

Understanding Permanent Establishments in China
This issue of China Briefing Magazine casts some light on permanent establishment status in China by discussing the circumstances triggering a PE in China, focusing on Service PEs. We also discuss the tax implications for a non-resident enterprise where its activities in China constitute a Service PE in the country, and address the taxation of representative offices.

Social Insurance and Payroll
In this issue of China Briefing Magazine, we take a “back to basics” approach to China’s mandatory benefits. Where, exactly, is that extra 35-40 percent on top of an employee’s salary going? What are social insurance contribution rates, base amounts, and tax exemptions? How does all of this figure into the payroll process? We next look at mandatory benefits as a piece of the larger payroll puzzle, with highlights on two very China-specific pieces: FESCOs and hukou, China’s “domestic passport.”

China Issues Q&As on Labor Dispatch Licensing

China Releases Implementing Rules on Labor Dispatch Licensing

China Releases Administrative Measures for Labor Dispatching Licenses

China Revises Labor Contract Law

3 thoughts on “Independent Contractors in China and Available Alternative Options

    Tim says:

    Interesting commentary, in particular the PE risk you discuss as this is something I believe many people neglect when looking at these types of arrangements.

    A couple of questions: if you are using an intermediary such as an HR outsourcing company, does the individual still remain an independent contractor? After all, the foreign company’s contractual relationship is now with a 3rd party and not the person himself.

    Having recently spoken to one of the larger HR services firms in China, my understanding is that when they hire someone on behalf of a non-resident company, they call this ‘outsourcing’ and not ‘dispatching’ as they are not hiring the employee under their dispatching license but rather as a direct employee then ‘outsourcing’ the employee to the non-resident company. What’s your take on the legality of this?

    @Tim: In most circumstances the employee would be affiliated to the agency and would pay taxes (and make social insurance contributions etc.) via this agency. In this sense, they would not be an individual contractors.

    Concerning this “outsourcing” concept, that would suggest to me that they are providing not an employee to the overseas company, but rather a service. I think the difference would be that with dispatch, the contract signed with the client will relate specifically to the hiring and employment of the employee, and how to deal with various circumstances that arise in respect to that specific employee. Under such a dispatch contract, the agent will only charge tax (VAT) on the fee that they are charging for the service they are providing, and not on the full amount paid by the client to them (which includes the salary and social insurance of the specific employee.

    In contrast, if they are providing an outsourced service I would expect the nature of the contract to be different and tax to be levied on the entire amount. The key point would be that the HR company would be responsible for provision / completion of the work allocated to it, not specifically responsible for managing the employment relationship with the individual selected by the foreign company.

    Best regards,
    Adam

    Sidney Chow says:

    Very good article amongst all the blog noise.

Leave a Reply

Your email address will not be published. Required fields are marked *