This post is by Grace Yang, one of our China lawyers resident in Beijing. Grace has her B.A. from Beijing University and her J.D. (law degree) from the University of Washington. Grace is licensed to practice law in Washington and New York States and she will be sitting for the China bar exam this fall. The below post stems from a recent project/memo Grace did for one of our American clients doing business in China.
We are often asked whether it is legal to pay a non-Chinese employee from both the China WFOE and from a company outside China (usually the US parent company). The answer to that question is an easy yes, but the tax issues that arise from that are where things get difficult.
It is perfectly legal for an American company to pay its American employees from both China and the United States. However if your American employees are resident in China for more than 183 days in any calendar year, you must pay taxes in China on the combined U.S.-China salary of your employees. This obligation to report and pay taxes is stipulated in the Circular of the State Administration of Taxation on Income Tax Paid by the Enterprises with Foreign Investment and Foreign Enterprises for Their Employees on Behalf of Their Enterprises Abroad (Guoshuifa  No. 241).
The Circular on Questions Concerning Tax Payments for Wage and Salary Income Gained by Individuals without Residence within the Territory of China (Guoshuifa  No. 148), mandates that if your employee works in China for less than 183 days in a calendar year, he or she is obligated to pay taxes only on that portion of salary received from the China WFOE when he or she was in China.
But if your employee works in China for more than 183 days but less than 365 days and so long as your employee did not live in China for a full year prior to this year, your employee must pay China taxes on the salary paid by the China WFOE and on the salary paid by your US entity during the period he or she is in China. In other words, your employee must pay taxes on whatever salary was earned in China, no matter who pays it.
If your employee works in China for over one year, but less than five years, your employee must pay China income taxes on the salary received from the China WFOE as well as on the salary received from your US entity during the time your employee is in China.
Don’t let the above throw you off, it is actually quite simple: if your employee works in China for 183 or more days in any calendar year, both you and your employee must pay tax on the combined U.S.-Chinese salary. There is no way around this obligation. We advise our clients to take this seriously, because failure to comply with this rule can result in penalties for both the WFOE and for the employee.
The problem is that foreign companies have customarily ignored this rule and while Chinese tax authorities have recently become much more aggressive in enforcing it. The issue normally arises when the employee applies to renew his or her visa. If the employee has resided in China for more than 183 days, the local tax authority will request a copy of the employee’s US tax return. If the employee fails to provide the US return, that employee’s visa gets denied. If the employee does provide the U.S. tax return, the tax authorities assess the tax, along with interest and penalties.
Our China attorneys are aware of several cases where foreign employees were denied entry into China after 183 days of residence for failing to report their combined salaries. We also are aware of multiple cases where the Chinese tax authorities took very aggressive penalty actions against WFOEs for failing to report and pay taxes on the combined salary of their high level China company managers. The risk of noncompliance is therefore significant.
So what should your WFOE do? Report the combined salary and pay the full tax, or ensure your employee resides in China no more than 182 days in any calendar year. In part II (coming tomorrow), we explain why you really do have no choice in this.