Archives: forming an entity

A couple of years ago, we did a post on the difficulties in using “independent contractors” in China, entitled, Hiring A Chinese Employee Without A Chinese Entity. Good Luck With That. We wrote that post (and this post too) because forming a WFOE in China can be so difficult, expensive, and time-consuming, and because so many companies are looking for some way of hiring a Chinese employee without a China company.

This is our even grimmer follow-up.

In our first post, we listed out the following ways to “employ” someone in China without forming an entity there:

1.   A foreign 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 the foreign company 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 with an employee in China to be a legitimate Chinese entity (be it a WFOE/WOFE, a Joint Venture/JV, or a Representative Office).

And if the foreign company’s goal is to have its “own person” on the ground in China, how much of “its own person” is someone employed by and paid by another? And how this foreign company protect its trade secrets from the Chinese company? 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 as to why it is receiving monthly foreign currency payments.

UPDATE ON THIS OPTION:  Since writing the post, we have received calls from a foreign company that was caught doing this and then effectively kicked out of China and from a couple other foreign companies that were doing this whose Chinese company stopped going along with this program out of fear of getting caught.  This has led us to conclude that this is, at best, a very temporary remedy, if even that.

2. A foreign company 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 the foreign “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 his or her bank account and why no taxes are being paid on it.

In our last post, we noted the following big flaw with this sort of arrangement:  “We have received a number of calls in the last year from companies seeking our help in keeping their Chinese ’employee’ after they were told by their ’employee’ 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.”

UPDATE ON THIS OPTION. Since we did our last post, we have heard from many more foreign companies that have gotten into trouble with the Chinese authorities for having employed this option.  Perhaps more importantly, we are finding that the trend is for Chinese prospective employees (particularly those with a high level of experience or skill-set) to flat out refuse this sort of arrangement.

3. The third and maybe best option (at least from a legal standpoint) is for the foreign company to have its Chinese “employee” form his or her own domestic Chinese company and then simply contract with that Chinese company for the services it is 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.

UPDATE ON THIS OPTION.  We are unaware of anyone ever having tried this option as every foreign company has either deemed it too risky from the perspective of protecting its intellectual property or the prospective employee has simply been been unwilling to go through this convoluted process for the “job.”

4. Have your potential employee hired by a China-based staffing agency.  Under Chinese law, Representative Offices are not allowed to directly employ anyone; they must do so via a third party staffing agency.  Because of this, there are plenty of such staffing agencies in China and up to a few years ago, many of them were (for a somewhat reasonable fee) willing to hire someone for a company based overseas. Today, we know of only one such agency that will do that for  foreign companies without their own entity in China (be it a WFOE or a Rep Office) and that agency charges a 15% monthly commission on the salary to do so.  On top of that, come July 1, 2013, all of this will almost certainly be impossible as on that date, China’s labor law will be revised to make third party hiring for anything but “temporary, supplementary and backup jobs” illegal. For more on this, check out this article, entitled, “Newly amended PRC Labor Contract Law imposing stricter control over the use of seconded employees.”

At this point, I am not sure that the one remaining agency that will employ someone for a foreign company without an entity in China will remain willing to do so, but I doubt it.

For years, China has sought to force foreign companies seeking to hire in China to form a company in China. It appears that come July 1, it will have achieved this goal, which really is part of two much larger goals of increasing its tax revenues, particularly from foreign companies, and improving the lives of its working citizens. There is not going to be any going back on any of this. If you want someone working for you in China, you are going to need to form an entity — almost certainly a WFOE — to accomplish this.

What do you think?