To describe employer and employee taxes in China as complicated is an understatement.  My law firm generally advices its clients to secure bookkeeping/accounting assistance for this, just as they generally use a payroll service back in their home country.  Because of this, we generally do not get much involved with calculating these figures.  However, a client of ours for whom we are handling a number of China employment law issues requested that we provide them with an overview of the employer taxes (broadly defined) and employee taxes (again, broadly defined) it could be expected to have to pay for the employees it would be hiring for its Chaoyang, Beijing, WFOE.  The below is a portion of the memorandum we provided to our client, setting out those required payments.

Have fun with this….

I. Introduction

In Beijing, the “Five Insurances” (specifically, pension insurance, on the job injury insurance, medical insurance, maternity insurance and unemployment insurance) and the “One Fund” (housing fund insurance), along with the individual income tax, constitute the deductions that must be made from the salary of Chinese employees employed in Chaoyang District.

II. Individual Income Tax 

Your employees’ individual income tax is withheld from their gross salary. In other words, you as the employer must pay to the government your employees’ income tax on behalf of your employees. After you pay your employees’ shares, your employees are not obligated to pay additional income tax to the Chinese government.

The amount of income tax depends on the employee’s gross salary and is determined using the following formula: Individual Income Tax = [Monthly Salary – Tax Threshold (3500 Yuan)] x applicable Tax Rate – Quick Deduction Amount. The table below provides 7 levels of Tax Rates. Note that the Taxable Income column below applies only where the employer pays the employee’s income tax on behalf of the employee.

Taxable Income(Yuan) Tax Rate (%) Quick DeductionAmounts (Yuan)
1 <1455 3 0
2 1455 ≤4155 10 105
3 4155 ≤7755 20 555
4 7755 ≤27255 25 1005
5 27255 ≤ 41255 30 2755
6 41255 ≤ 57505 35 5505
7 > 57505 45 13505

For example, suppose an employee’s gross salary is 10,000 Yuan per month, the amount of individual income tax that must be withheld from his or her salary is: (10,000 – 3500) x 20% – 555 = 745 Yuan.

III. Social Insurance Deductions and Employer’s Shares 

Base

Base is used to calculate the amount of Five Insurances and One Fund that the employer/employee must fund. Base is determined based on the employee’s monthly average salary in the previous calendar year (i.e., from Jan. 1 to Dec. 31) (“Employee Figure”), taking into consideration the city’s (here, Beijing) monthly average salary (“City Figure”).

If the Employee Figure is less than 60% of the City Figure, then Base shall be 60% of the City Figure. If the Employee Figure is more than 300% of the City Figure, then Base shall be 300% of the City Figure. If the Employee Figure cannot be determined, then the City Figure shall be used as Base.

Five Insurances

1.  Pension Insurance

The amount that must be deducted from the employee’s salary is Base x 8%.

Your WFOE’s share is Base x 20%.

2.  On the Job Injury Insurance

No amount is deducted from the employee’s salary for this type of insurance.

The employer’s share depends on the employer’s industry. In your case, because your WFOE is in an industry with a percentage of 0.5% your WFOE’s share is Base x 0.5%.

3.  Medical Insurance

The amount that must be deducted from the employee’s salary is Base x 2% + 3 Yuan.

Your WFOE’s share is Base x 10%.

4.  Maternity Insurance

No amount is deducted from the employee’s salary for this type of insurance.

Your WFOE’s share is Base x 0.8%.

5.  Unemployment Insurance

The amount that must be deducted from the employee’s salary is Base x 0.2%.

Your WFOE’s share is Base x 1%.

Housing Fund Insurance

The percentage for housing fund insurance for the period from July 1, 2013 to June 30, 2014 is 12%. Your WFOE may postpone funding or fund at a lower percentage (but generally no lower than 8%), upon approval by the Beijing Housing Fund Management Center (“BHFMC”).

Your WFOE’s maximum limit is 12% and the Chinese employee’s maximum limit is 12%. The BHFMC imposes a ceiling on the amount of the housing fund insurance that can be funded by the employer and by the employee, determined by the following formula: City Figure x 300% x 12% x 2. The 2012 City Figure is 5223 Yuan, so the ceiling for 2013 is 3760.56 Yuan.

VI. Illustration

By way of example, suppose a Chinese employee of your WFOE earned a monthly average salary of RMB 10,000 Yuan in the previous calendar year (2012) and her salary stays the same in 2013. The 2012 City Figure is 5223 Yuan. The employee’s salary is higher than 60% of the City Figure (3133.8 Yuan), but lower than 300% of the City Figure (15,669 Yuan). So her Base is 10,000 Yuan. As noted above, your WFOE’s industry percentage (for purposes of calculating on the job injury insurance) is 0.5%. Assume your WFOE funds the One Fund at 12%.

Applying the percentages above, her shares of the Five Insurances and One Fund are as follows:

  1. Pension insurance:                       800 Yuan
  2. On the job injury insurance:           0
  3. Medical insurance:                       203 Yuan
  4. Maternity insurance:                        0
  5. Unemployment insurance:            20 Yuan
  6. Housing fund insurance:            1200 Yuan

Total sum:                                           2223 Yuan

Your WFOE’s shares of the Five Insurances and One Fund with respect to this employee are as follows:

  1. Pension insurance:                     2000 Yuan
  2. On the job injury insurance:          50 Yuan
  3. Medical insurance:                       1000 Yuan
  4. Maternity insurance:                        80 Yuan
  5. Unemployment insurance:            100 Yuan
  6. Housing fund insurance:              1200 Yuan

Total sum:                                            4430 Yuan

As demonstrated in Section II above, the income tax for an employee with a gross salary of 10,000 Yuan/month is 745 Yuan. So after full deductions of income tax and the Five Insurances and One Fund, her net salary is 7032 Yuan (10,000 – 2223 – 745).

Are we having fun yet?

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?