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Last week I wrote a post on how our China lawyers have been receiving a steady onslaught of calls from American companies with “employees” or “independent contractors” in China, but no China business entity. The onslaught has continued, and now I know more about why.
China banks (owned by the Chinese government) are providing information to China’s tax authorities regarding account-holders who consistently receive money from foreign companies. China’s tax authorities are apparently going to these individuals and pressuring them into spilling the beans on why they are receiving their funds from overseas. Upon learning of a foreign (usually American) company that has “employees” or “independent contractors” in China, the Chinese government pounces.
If you are a foreign company operating in China without a China WFOE and you are trying to figure out what to do, your choices are relatively simple and stark.
But before I talk about your limited choices, I feel compelled to explain again why it is that so many foreign companies are still operating illegally in China. Chinese law limits hiring China-based employees to only Chinese legal entities. This means that if you are an American software company, you cannot hire someone in China to do your coding or to provide your support services. This means that if you are a Australian company selling widgets, you cannot hire someone in China to sell widgets for you. This means that if you are a British company that has your products manufactured in China, you cannot hire someone in China to do your quality control for you.
Any person (as opposed to a registered China business entity) performing employment-like services for you in China is your employee because China does not recognize independent contractors in anything other than extremely limited circumstances (and your circumstances do not qualify!). And Chinese law requires you pay both employer taxes and benefits on that employee. These employer taxes and benefits vary from city to city, but they usually total around 40 percent of an employee’s salary. China also mandates employers withhold around 15 percent of their China-based employees’ wages for individual income taxes. But those companies that do not realize they have employees in China are not doing that withholding either. Then on top of the employer and employee taxes, the foreign companies with employees in China are almost always going to be viewed by the Chinese tax authorities as “doing business in China” and that is because they almost always are. The foreign company is now almost certainly liable for having failed to pay its corporate taxes as well.
So when all is said and done, the foreign company owes a heck of a lot of taxes to the Chinese government, plus steep penalties, plus interest. Needless to say, the Chinese tax authorities salivate over collecting these taxes and interest and penalties.
In my previous post, I noted two common ways companies operating in China without an entity get caught:
One, we are hearing of long loyal “contractors” going to their employers and saying that if their employer does not double or triple their pay, they will report the foreign company to the Chinese authorities because their doing so will get them a tax amnesty (and perhaps even a portion of the taxes collected?). We are also hearing of vendors with whom the foreign company has no beef making essentially similar threats. Two, and most importantly, we are hearing that the Chinese government is poring over bank records and questioning people (your “employees”) who regularly receive funds unreported funds from overseas.
It is the second way of getting caught that is steeply rising.
What then should you do if you are right now operating in China without a Chinese company. You have essentially the following three choices:
The above three options are your only reasonable choices, but we have twice heard of an additional option from potential clients, which really is not an option at all. Two companies under extreme pressure from their vendors/employees have made clear to us that none of the above three options are acceptable to them and they want our China lawyers to engage in what they call the “political” or “guanxi” option. Are you kidding me? Are we supposed to do the following:
Hi, we represent Company A. Company A is an American company that has been operating 100% illegally in China for the last _____ years. Despite having _____ [number] of employees in China, Company A has never paid an RMB in employer taxes nor has it ever contributed even one single RMB in employer benefits. On top of this, it has failed to withhold employee taxes and it has not paid anything in income taxes either. But despite these criminal law violations and despite it having no intention of even trying to get legal, we think it makes sense for you to not only allow Company A to continue flaunting Chinese law, but to lean on the vendors/employees with which Company A is having disputes.
Perhaps what they mean by politics/guanxi are bribes, but we will not even go there with them. There is no way any of my firm’s lawyers are going to risk jail time in China and the United States for anyone. Just no way. And of course, they shouldn’t either.
Oh, and note that a Hong Kong company is NOT the equivalent of a PRC company. For purposes of the above, it is the equivalent of having a United States company and having a Hong Kong company will NOT help you avoid the above problems, not even in the slightest. See Having A Hong Kong Business Does NOT Make You Legal in Mainland China and A Hong Kong Company Is NOT a Mainland China Company and a Hong Kong Trademark is NOT a Mainland China Trademark.
Bottom Line: If you are a foreign company operating in China but you are not on the gird there, get legal or not, but don’t be stupid.
We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.