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Hiring A Chinese Employee Without A Chinese Entity. Good Luck With That.

Posted in Legal News

American companies are constantly asking us to draft employment contracts between their American company and their Chinese “employee.” One big problem. Such contracts violate Chinese law.

Under Chinese law, only Chinese entities are allowed to have employees based in China. in addition, China does not generally allow for the hiring of independent contractors. If a person (as opposed to a legitimate registered business entity) is going to be performing employment-like services for you in China, that person is your employee and that means you must comply with all Chinese laws that go along with an employment relationship. This means if you are an American company selling widgets you cannot hire someone in China as your employee to sell widgets for you. This means if you are a computer software company, you cannot hire someone in China to do your coding for you.  

We recently received a request from an American lawyer along the following lines:

We have a client that operates a Chinese language school in the United States. It wishes to hire native Chinese speakers in China to write and record dialogue in the Chinese language. The company would like to hire people living in China to do this work. However, the U.S. company does not want to form a company in China. Instead, they simply want to hire people to do the work.

This company has done this in various other countries in the world (with respect to other languages) and it has done so by entering into a contract with the foreign individual. The foreign individual agrees to do the work on a project basis for a fee. On completion of the project, our client wires the fee in U.S. dollars to the bank account of the individual. The individual is treated as an “independent contractor.” The individual is responsible for payment of all taxes on the income received and for arranging social welfare payments and pensions as appropriate.

I have been told that this sort of arrangement is simply not possible under Chinese law and so my questions are:

1. Is this arrangement acceptable under Chinese law?

2. If yes, is there anything we should be particularly concerned with in terms of documentation?

3. If no, how should this work be done if the above will not work?

Our response was along the following lines:

1. The U.S. company could have its proposed employee hired by a Chinese company and then pay the Chinese company the equivalent of the Chinese employee’s wages and taxes, plus an administrative fee. The problem with this is that if the “employee” is not going to be doing at least some work for its Chinese employer, it probably is not legal and if your client gets caught, it may never be allowed to conduct real business in China again. If the “employee” does not actually do work for the Chinese company, it is nothing more than an attempt to get around the laws that require foreign companies that do business at the level at which they need an employee to have a legitimate Chinese entity (be it a WFOE/WOFE, a JV, a Rep. Office, or even one of the new-fangled partnerships). 

And if your client’s goal is to have its own person on the ground for it in China, how much of “its own person” is someone employed by and paid by another. And how will it protect its trade secrets from this Chinese company that has its “employee” in its employ? There are definitely situations where this can work, but not every situation will.

Then there are all the issues for the Chinese company, which is likely going to have to lie to the Chinese government authorities as to why it receives monthly payments in foreign currency from your client, if it is your client that is actually the one paying this employee.

2. Your client can hire the Chinese “employee” directly and just wire that “employee” his or her paycheck every month. Years ago, this sort of arrangement was pretty common, but it is becoming far less so as word is spreading that the Chinese government and tax authorities are very much on to this scheme and are quashing it. The problem with this set-up is that your client’s “employee” is at some point going to have to explain to the Chinese government why it is that he or she is monthly depositing foreign currency into their bank account and why they are not paying taxes on this.

We have received a number of calls in the last year from companies seeking our help in keeping their Chinese “employees” after they were told by their “employees” that the existing relationship must be discontinued. We told them that their best solution would be to form a China WFOE, but that we were very concerned about their WFOE application being rejected because of what they had already done.

3. The third and maybe best option (at least from a legal standpoint) is to have your client’s Chinese “employee” form his or her own domestic Chinese company and then your client simply contracts with that Chinese company for the services you are seeking from this Chinese person. This is going to require a fair amount of initiative by the Chinese employee and the downside of this is that when all is said and done, your client has an independent Chinese company out there with which it is conducting business, and not an employee.  

What have you seen out there?

  • Silva

    We tried #2 for six months and then our Chinese employee came to us and said that if we didn’t form a Chinese entity soon, he would have to go work for someone else. I guess he was starting to get questioned. We wanted to keep him and by that point we had decided we were in China to stay so we went ahead and formed a WFOE without problem.

  • William

    Are the Chinese laws and regulations behind this an example of paranoid/ideologically-based rules which have not been brought up to date, or something connected with the new labor law? Or is it just about tax collection?

  • Jay in China

    William:
    There is a general hostility to private enterprise in China and lots of laws and regulations that effectively prohibit freelance work.

  • Douglas McCarroll

    Dan
    I’m curious where the Chinese goverment draws the line. If I hire an individual in China – through a site like iTalki.com – to tutor me in speaking Chinese for a few hours a week, does the Chinese government consider this to be illegal? What if I’m in China and I want to hire someone to walk my dog once a day? A complete ban on people paying other people to do things seems, well, impractical. Is this really technically illegal in China?
    Douglas

  • Twofish

    William: Are the Chinese laws and regulations behind this an example of paranoid/ideologically-based rules which have not been brought up to date, or something connected with the new labor law? Or is it just about tax collection?
    Chinese labor laws and regulations are not very unusual by global standards, and they require certain procedures to be followed to make sure that taxes, social security, and general labor standards are being followed. It’s not that China has usually strict regulations with regard to labor, but that the United States has unusually loose regulations and makes distinctions that most other countries do not make. In particular the employee/contractor distinction is an artifact of US tax law, and in most other places, if someone works for you, they are an employee. Period.
    Also it’s not that difficult for a local person to create proprietorship in China and hire people. The important thing is that anyone they hire needs to comply with various labor regulations.

  • Twofish

    What should happen is that in order for a local person create a business in China, you need to go to the local government and create a “ge ti hu”. It’s a relatively quick and painless process, and you just basically go to the local government, pay a small fee and get a small business license, and forming a small business in China isn’t worse than forming one in the US.
    At that point it’s legit. The crucial thing for this discussion is that foreign companies can’t get a “small business license.” For locals they make it easy, because they rather people do things above ground than under ground.
    A complete ban on people paying other people is something that *can* be done, but it totally wrecks your economy. The fact that people were banned from starting their own businesses explains why China was an economic mess before from 1952 to 1978 and why the Soviet Union fell apart.
    I should point out that in the United States, there are a lot of people are required to pay for social security every time they hire a tutor or a dog walker, but most people don’t.

  • Jacky in China

    Such without registration American companies in China very much, Belong to trading company.
    China’s law is not allowed in this mode of operation, but the American companies are evading Chinese laws.
    These illegal business in many big companies.
    Their purchasing goods in China’s exports to the United States and other countries, the employment of employees.

  • Twofish

    The big problem that you will have is currency controls. If you want to wire US dollars to a Mainland Chinese national, then they are going to have to have a USD account in China. It’s possible for a PRC national to open such an account, but they are going to provide the bank with their ID and a reason why they need to open such an account, and “so I can get paid by a foreign company in violation of Chinese employment law” isn’t something that I don’t see people putting into their banking form. If the client lies and tells the bank that they getting money from a rich uncle in the US, then the money is being deposited in violation of foreign exchange controls, the government can seize the account. At this point, all the bank has to do is to *ask* why that money is there, and your potential employee is likely to quit rather than risk getting into further trouble (and losing whatever money they have already made.) Theoretically, you can go to jail for violating currency restrictions. I don’t know of anyone who has, but the fact that the big stick is out there means that people are going to totally stop doing what they are doing once they realize that they are not “off the radar.”
    One other thing is that it’s quite interesting to see how the enforcement structure is set up for companies on the ground. What normally happens when things get done under the table is that A pays B both A and B are happy so when the tax officials start asking questions both A and B team up against the tax officials.
    The way that employment law in China is set up is designed to keep things from happening. When you pay an employee in China, you are required to contribute money into an individual pension account controlled by that employee in addition to the general pension fund What will happen if you try to pay someone under the table is that once the contract is finished, then that person will go to the local labor bureau and demand that you pay money into the account. Also, if you fired said person without going through the proper procedures, they can also go to the labor bureau and force you to pay back wages. At this point, you are stuck, because either you pay the money, or you get shut down and kicked out of the country.
    If you are doing things virtually, then you don’t have to worry about getting kicked out since you are not already there, but the problem that you have is that none of the agreements that you are signing are going to be enforceable anywhere, so at that point you just figure out a way of doing things by cash, and there’s no point in getting a lawyer to draft anything.
    Also, it is legal for a foreign company to contract with a local company and have the local company do the hiring. However, it’s important to understand that you for this to work, it has to be a *real* situation in which you contract with a local company who then hires someone. One problem that you will run into is that the local company will *really* be the employer of the person being hired, and I can’t imagine why a local company would agree to a “fake employment” situation. One problem is that if you stop funding the employee, then the employee will still be on the payroll of the local company, and the local company will be responsible for social security payments. Alternatively, if the local company doesn’t like the employee and has to fire them, then there’s nothing the foreign company can do about it.
    Alternatively, you can try to go completely under the table, in which case everything happens by cash, and you don’t want any formal contracts at all. The problem that you will run into is that nothing is unenforceable, and you are going to expect very high staff turnover. I can imagine people making some extra spending money being paid like this, and just stopping once someone asks questions. What I can’t imagine is anyone depending on this sort of work as their primary source of income since the risks are much too high.

  • http://www.chinalawblog.com Dan

    @silva Good for you for getting legal. Makes life a lot easier.

  • http://www.chinalawblog.com Dan

    @ William,
    Not at all. Virtually every country (every country?) has pretty tight regulations regarding employees. The reasons for this are many, but primarily to protect workers and to collect taxes. If anything, the United States is the outlier on this.

  • http://www.chinalawblog.com Dan

    @ Jay in China,
    I think the explanation is simply that there are laws in place in the employment arena and China expects those laws to be followed, at least by foreigners. I don’t think that is so onerous or unusual.

  • http://www.chinalawblog.com Dan

    @ Douglas McCarroll
    It isn’t really a question of legal/illegal, it is a question as to whether the person you hire has become an employee or not and if they are an employee, then you must pay taxes and pensions, and you should have a written contract, etc.
    There are a few exceptions and maybe a one time dog walking is one of them.

  • http://www.chinalawblog.com Dan

    @ TwoFish,
    What you say is completely true and that is why these off the record type arrangements either never work at all or only work for a short time. You make a very good point though, which is that engaging in one of those has a good chance of ending in a lawsuit with the foreign company being sued for back wages, pensions, etc.

  • tonykan

    I am a chinese practising lawyer. it is true that offshore comany can not establish labor relations with chinese residents, according to chinese labor contract law, the basic requirement of an employer is that the employer shall registered in china, and foreign comany should employ through specific agencies, which can assist foreign company in signing contract, paying pension and other kinds of welfare. so, in my opinion, if you intend to market and develop in china, it is advisable to set up WOFE, the process and procedure of incorporate in China is not very burdensome.

  • Aemacst

    Can Hong Kong based companies employ mainland Chinese legally?

  • Jay in China

    Just the act of getting a simple business license can in fact be very burdensome under certain circumstances, for foreigners and Chinese nationals alike, and that is why you see lots of non-compliance.
    Many jurisdictions in China outside well-developed coastal cities will do things like only issue licenses to unemployed people (Shenyang did this for a very long time), stop issuing licenses for certain categories of businesses for months at a time, impose unreasonable capital requirements in certain industries in order to suppress competition, and even temporarily stop issuing new licenses for all businesses.
    Transparency International’s reports on how long it takes to form a business in China seem to confirm this.
    All of these inane requirements are bad public policy that make China poorer.

    • Xyz

      same thing in Us, certain industry is regulated, chinese company cannot enter. Do not make hateful comment disgrace china, that way, you are disgracing yourself

  • Roger Park

    I think one way to do this is hiring someone through a staffing company in China. More like #1 choice. Staffing company is the professional company who can handle the payroll and benefits for your employee. Try search ‘staffing china’ and you should be able to find some results.
    Otherwise, it’s illegal.

  • Wrong John

    I did this and got sued and then shut down. It was no fun. I got into it because my China consultant told me if I had a Hong Kong company I would be legal on the mainland. He was wrong. Very wrong.

  • http://www.computechmultimedia.ca Rick D

    I understand this is an old thread, but maybe someone can help me. I have been dealing with several Chinese companies for about two years, importing LED signs into Canada. Throughout this entire period, I have had the pleasure of working with one individual. She has become a dear friend, and been very helpful to me. She has worked for several different companies as a sales rep, and was even fired from one company as a result of standing up for my quality concerns.
    We are in contact nearly daily. And she has been relentless in finding me reputable manufacturers, and negotiating pricing and shipping logistics. Both inside, and outside of her employment perimeters. Her current place of employment has now reduced her wages by 25%, leaving her with only about 300.00 per month, and I know she works incredibly long hours.
    I would be more than happy to pay her even 300.00 per week to simply be my contact and liason in China, sourcing quality products and components, negotiating prices and arranging shipping.
    Reading the above, am I correct in the assumption that I can not simply tell her to quit her worthless job, work from her apartment or home, and I will just deposit her pay in the bank? And it also appears that I am not even permitted to send her money as a “gift”, for example as a token of my appreciation towards all she has done for me.
    Surely, there are many Chinese nationals having money deposited regularly into their bank accounts from relatives or friends living in North America. Why can I not do the same?

  • http://upcbusiness.org David Newingham

    The situation I have is this; I sell american goods in china. I have a 49 percent shareholder that is a chinese national living in china. This individual has set up a rep office for our company. We are paying him as an independent contractor. Is this legal??

  • Lee in the USA

    Hello.  I don’t see any mention of the FESCO option here.  Is that a workable option?

    • Lee in the USA

      Hello all… can someone please address my question about FESCO as an option?  Thanks!