Key Points

  • Clarifies situations where a non-resident company constitutes “permanent establishment” for corporate income tax purposes.
  • Announcement No. 19 clarifies the situations when PE will be established when certain factors are met
  • Also clarifies several documents that the in-charge tax bureau should focus on during its PE evaluation

Background

The Announcement on Corporate Income Tax Relating to Personnel Seconded by Non-resident Companies (“Announcement No. 19”) became effective on 1 June 2013. These regulations clarify various situations where a non-resident company may or may not constitute Permanent Establishment (“PE”) for PRC Corporate Income Tax (“CIT”) purpose.

Under PRC CIT regulations, foreign companies are subject to 25 percent CIT if it has establishment or PE in China and local subsidiaries of multinational corporations are often challenged by local in-charge tax authorities over seconding arrangements. Since 2009, and the introduction of State Administrative of Tax (“SAT”) regulations on PE investigations for nonresident companies, local tax officers have often been aggressive regarding secondment arrangements.

Highlights of the Regulation

Announcement No. 19 – What Factors Would Trigger PE Risk?

Circular No. 75 originally introduced rules where, if a foreign parent company had assigned personnel to work in a PRC subsidiary, certain factors would be taken into consideration to deem that the foreign parent company has created a PE in China. Announcement No. 19 further clarifies these original rules and addresses the specific situations where employees are seconded by foreign parent to the PRC subsidiary.

If the non-resident company assumes some or all of the liabilities and risks for the work results made by the seconded personnel and is entitled to assess personnel work performance, the company may be deemed as having an establishment in China. Under the context of a tax treaty, if the establishment is relatively fixed and permanent the non-resident company will establish PE. Under Announcement No. 19, PE will be established where all the following factors are met:

  1. The domestic company makes payments in the nature of management fees or service fees to the non-resident company which is seconding the employees.
  2. The amount of payments made by the domestic company exceeds the wages, salaries, social security premiums and other costs paid in advance or on a commission basis by the non-resident company.
  3. The non-resident company reserves a certain amount of such payments made by the domestic company instead of delivering all of it to the seconded personnel.
  4. The seconded personnel fail to file individual income tax for the full salary income paid by non-resident company for secondment work.
  5. The non-resident company determines the number of seconded personnel as well as their qualifications, remuneration level and working place in China.

The general rule from the above is that if the employees are deemed to work for the foreign employer, that employer will be subject to the PE exposure.

Announcement No. 19 Standards

When comparing standards, those factors listed in Announcement No. 19 do not necessarily go beyond the standards in Circular No. 75.

One important factor is regarding the individual income tax filing position for such seconded employees. Announcement No. 19 suggests that failure to fully disclose personnel income to PRC tax authority for income tax purposes may demonstrate intent from all parties that part of the salary income is paid for overseas work, meaning that such personnel partly work for the foreign company. In certain cases the individual employees may request the employer does not to fully declare their income for PRC individual income tax purpose. In this instance, the employer should better evaluate the impact and risks of such a proposal – under Announcement No. 19 this may increase the PE risk for the foreign employer.

Announcement No. 19 also clarifies situations where a foreign company dispatches its personnel to China for the sole purpose of exercising the shareholder’s rights. In these instances, the foreign company shall not be deemed as creating a PE. This clarification may be helpful for those venture capital investors worried about their presence in the PRC portfolio and exercising their shareholder’s right.

Announcement No. 19 also clarifies several documents that the in‑charge tax bureau should focus on during its evaluation including:

  1. Secondment agreement.
  2. The company’s internal regulations and rules including specific provisions on seconded employee’s responsibilities, job description, performance evaluation, risk-sharing and other aspects.
  3. Any payment made by the PRC company to the foreign company for such secondment, and the IIT filing record for such seconded employees.
  4. Any agreement between the PRC company and the foreign company regarding offsetting payment, waiving the debt, or any related party transactions and other agreements with similar hidden payment.

Conclusion

Announcement No. 19 supplements Circular No.75 and helps to clarify certain questions regarding PE, particularly relating to the perspective of secondment arrangement.

A benefit of Announcement 19 is that companies can now understand the dos and don’ts regarding the related PE risk so they can plan a more appropriate structure based on their commercial needs. Most importantly, they will now be in a situation to better defend themselves against unreasonable PE claims.