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Hiring “Independent Contractors” In China. Don’t Do It.

Posted in Basics of China Business Law, China Business, Legal News

We spoke with a software company the other day that has nearly fifteen “independent contractors” in China, who it views as “part of the corporate family.”  This company was contacting us to see about forming a WFOE in China.  They told me that they were not in any rush.

The first thing I did was to ask whether they knew that what they were doing in China is completely illegal. They did not.  I explained to them how there is almost no such thing in China as an independent contractor and that they essentially had nearly fifteen employees and because there was no company actually employing those fifteen people, what they are doing is illegal. I then told them of how China in the last year has stepped up even more its efforts to rid the country of foreigners there illegally and companies there illegally.  I also told them of how their existing structure puts all of their China assets at huge risk. Their China IP assets are at risk for the simple reason that they do not really own them.  A company operating illegally in China is just not positioned to be able to assert IP rights against anyone in China.  Their other China assets are at risk because the Chinese government will likely seize them if and when it cracks down on what they are doing.

They seemed very interested in going legal until I started laying out how doing so would greatly increase their China operating costs.  I told them how their forming a WFOE would necessitate their incurring the following additional costs/expenses:

  • WFOE formation fees and costs.  They expected this.
  • They would need to lease office space from an approved landlord.  This is a requirement for WFOE approval.  This would likely increase their office rent.
  • For every $1,000 in employee salaries, they would probably need to pay about $400 (40%) in employer taxes and benefits.  They were not expecting this at all.
  • In addition to the employer taxes, their employees will need to start paying income taxes. They seemed to think that their “independent contractors” are already paying all required taxes. I told them that I am virtually certain that they are not, and that their going legal will almost certainly lead to their “independent contractors” demanding higher salaries to make up for their take home pay being reduced by having to go onto the tax rolls.

I then talked of the advantages of having a WFOE, including the following:

  • You are operating legally.  Your risk of the government shutting you down tomorrow has essentially disappeared.
  • You are much better positioned to do real business in China, because you are legal.
  • You are much better positioned to protect your IP in China, because you are legal.
  • You are much better positioned to terminate employees because you do not need to keep them on forever for fear of their reporting you to the authorities.

After this phone call, I spoke with China-based co-blogger, Steve Dickinson, for the latest on how China’s government is treating foreign operations with multiple people working for them in China. Steve pointed out how the Chinese government is aggressively pursuing tax evasion claims against both the “independent contractors” and those connected to the illegal business. The government pursues the “independent contractors” for failing to pay their own taxes and it pursues the foreign business for Chinese income tax and related national and local business fees and taxes. Most importantly, the government also seeks to take action for back taxes against any representative (i.e., individuals) of the foreign company who happen to come to China. When the number of illegal employees is large, the claim for back taxes can be quite large. Often, the tax authorities time their raid on the illegal business to ensure that a representative of the foreign company is on site and, in many cities, they will not let the foreign representative leave China until after resolution/payment is achieved.

In other words, doing the “independent contractor thing” without having a registered business in China is asking for trouble.  Big trouble.

What are you seeing out there?

  • Robert

    Two things. First there is no one china. The big four BJ, SH etc are entirely different from the rest of china. Second even in bj and especially in IT bizz more and more companies lay of legal stuff and hire them back as contractors due to so many competitors never faced what U r talking about here.

    It does not mean I dont agree with U in terms of potential risks but the problem is chinese government is talking too much and doing to little. The trick is not to be caught and it still works for many… justmy2cents

    • ollumi

      It’s not that the government is talking too much and doing too little: a lot of the legal language here not only is, as per international status quo, intentionally nebulous to allow room for interpretation, but also sometimes intentionally complex and sometimes self-contradictory in order for the powers-that-be to do as they see fit depending on the situation that arises.

      I know a number of finance companies in SH which does the whole employee a works in location b but signs contract in locale c shtick – it’s not the government doesn’t know about it, they know about it and feel it gives them leverage when they have to talk to these said firms about regulations, “big direction”, and other issues so they let it play and in some cases even favor those companies they can get a handle on. So I don’t really believe this is the sort of thing that flies under the government’s radar, but more of a “gentleman’s agreement”, which is why you can see this can raise lawyers’ hackles, and rightly so.

  • No Name Given

    This happened to my company just this week and that is why I am on here now. We are trying to figure out what to do. Tax authorities shut us done and took all of our computers and they are now demanding that we pay $240,000 and if we don’t they are telling us that they will go after our people their for their taxes and that we will not be allowed in China again. Thankfully, this is happening with all of us here in the United States, but it is stressing out our Chinese manager so bad that he is demanding that someone come from the U.S. to deal with things. After reading this I don’t think we will be sending anyone. If we just pay the $240,000 will everything be okay or do we need to do something more? Can we get the tax authorities to sign a release for our payment? I don’t want to pay and still have problems.

  • D. Moyes

    I don’t get this article. Why exactly (and what laws say so) is hiring independent contractors and setting up a WFOE illegal? Please explain its really not clear other than you say so.

    • http://www.chinalawblog.com/ Dan Harris

      Two things make this illegal. First off, if you are permanently doing business in China, you are required to have a Chinese business entity of some kind. Second, if you have employees (and just about anyone who works for you is an employee), you are required to pay employer taxes/benefits and to withhold employee taxes and failing to do so is against the law.

  • BlueApple

    Consider the following situation:

    Company A is located in U outside China.

    Company A sources products from China, pays the supplier directly.

    Company A hires an employee, the contract is signed at U according to the labour law in U, the employee is stationed at S in China.

    The employee pays personal income tax (income from abroad)

    Would that be legal? If not, why?

    In my understanding company a can’t do anything illegal, as they are not operating in China, they are not governed by Chinese law.

    Does the employee anything wrong?

    Should the employee pay social insurance fees? It would be in her/his interest to do so, but could/should he/she pay these insurance fees if working for a company not located in China?

    • http://www.chinalawblog.com/ Dan Harris

      To the extent I understand your question, it’s illegal. China’s labor laws apply to anyone working in China. If I, as an American company hire someone to work in New York and put in the contract that Chinese law applies, it won’t work. US law will still apply. The same would be true even if I were a French company in France. And on top of this, any company that has an employee in China not only must follow China’s llabor laws,abor laws, but they also need an entity in China.

  • http://www.chinalawblog.com/ Dan Harris

    That is something entirely different from the scenario I described above. In the case you set out, the company is not hiring an independent contractor. They are outsourcing their hiring to another company that in turns hires people as employees. What you have described is still possible in China, but it has gotten much more restricted and expensive.

  • Mike

    Where is the line drawn as to what constitutes “working for”? For example, if I get a back rub, the masseuse doesn’t work for me? Nor does my accountant (few hours a month at best, but for years on end)? The guys who come to renovate our office for a few weeks, couple months? No labour contracts, etc….
    They’d all be employed by xyz company, who then sells a service to me, right?

    So, what’s to stop somebody registering themselves as a company and sell me their consultancy services? I would think that as long as this chap runs his company more or less legally, get papers with red stamps, get a CPA, pay at least a pinch of tax (e.g. fapiao) every now and then, then nobody would object, would they? (at least as long as there’s no “100 days to kick out this or that” campain or olympics or expo or what not).

    Is there any legal cut-off point before a service provider actually becomes my employee?
    I would think that these type regulations are not meant to just annoy anybody (like some are), not even foreigners, but to ensure that (a) taxes get paid and (b) employees don’t get screwed out of benefits etc. So if (a) & (b) are the case, then all is well, not???

  • Allen

    All of you who are acting like what Dan says is not going to happen are living in a dream world. China wants to make it hard on foreign companies so as to make things better for its own companies. That is why it goes after big foreign companies for bribery as seen here: http://www.reuters.com/article/2013/07/15/us-gsk-china-idUSBRE96E02520130715 and it does the same thing against smaller companies that are not regisetred in China. We all know this is true even if some claim otherwise so as to protect your wallet.

  • mythotswithrespect

    Surely there is a provision for foreign parent companies to have a rep onsite at their WOFE factories that are NOT on the local company payroll but rather paid back in the home country. How does what you are saying apply to this rather common situation?

    Here is an example:
    We have a Mauritius GBC2 company “M” that is the sole owner of our China WOFE factory “F” . Our Mauritius company M wants to send a rep out for 6 mos to hang out at the factory, watch quality, and to insure that the interests of the parent company M are watched.

    Can that rep be stationed there indefinitely (going in and out every 6 mos to renew the new “M” visa I imagine)?

    We want someone NOT on local salary (loyalty follows who feeds them) but rather paid back home and looking out for the interests of the home company’s investment.

    • http://www.chinalawblog.com/ Dan Harris

      Generally, one can be in China in the situation you describe so long as it is for less than a year, total. This is generally and you should make sure that your specific situation qualifies.

  • Brian Mooney

    @mythotswithrespect:disqus He can’t be in China ‘for up to a year’ or ‘less than a year’ as Dan put it. That’s vague and incorrect. How long he can actually be in China depends upon his nationality and whether or not his nation of origin has a double tax treaty with China. If they do, he can be 183 days in any 365 day period. If not, its reduced to 90 days in any 365 days. You’ll need accounting/payroll advise on your specifics I think as you’ll need someone to look at any China-Mauritius agreement for you.

    • http://www.chinalawblog.com/ Dan Harris

      Please note that my comment was “generally” and specifically suggested that you make sure your specific situation applies. In other words, you should hire someone to do the research on your specific situation or do it yourself if you are comfortable with that.

      • Brian Mooney

        Dan there’s no ‘generalization’ in China concerning how long an employee can be in the country. Under DTA, it is 183 days in any 365 period, or income tax applies. That’s the law.

    • Tim

      Brian,
      There three aspects of this you need to look at it from:
      1) Service PE risk to the non-resident enterprise (home country of parent’s DTA with China)
      2) tax compliance for the individual (position held and DTA with China)
      3) compliance with China’s new entry-exit laws which limits a business visa cumulative stay to 90 days within a calendar year.

  • Kchu

    What if we used a dispatch agent who legally are the employers of these contractors who dispatches them to help us on projects? Who owns the intellectual property created by the contractors? I have read that there are specific exceptions that apply to software ownership as well as collective works but cannot find further information on contractor’s IP ownership whatsoever. help!

  • Brent McDowell

    I asked this question in a similar post, but what if the freelancer or independent contractor is paid via a 3rd party, such as Elance.com ? There are many Chinese “independent contractors” on this site which, going from what you’ve mentioned above means that the individuals, the clients and Elance themselves (although they’ve used some “creative” legal language on their site) are potentially liable..yes?