Last week I wrote a post on how our China lawyers have been receiving a steady onslaught of calls from American companies with “employees” or “independent contractors” in China, but no China business entity. The onslaught has continued, and now I know more about why.
China banks (owned by the Chinese government) are providing information to China’s tax authorities regarding account-holders who consistently receive money from foreign companies. China’s tax authorities are apparently going to these individuals and pressuring them into spilling the beans on why they are receiving their funds from overseas. Upon learning of a foreign (usually American) company that has “employees” or “independent contractors” in China, the Chinese government pounces.
If you are a foreign company operating in China without a China WFOE and you are trying to figure out what to do, your choices are relatively simple and stark.
But before I talk about your limited choices, I feel compelled to explain again why it is that so many foreign companies are still operating illegally in China. Chinese law limits hiring China-based employees to only Chinese legal entities. This means that if you are an American software company, you cannot hire someone in China to do your coding or to provide your support services. This means that if you are a Australian company selling widgets, you cannot hire someone in China to sell widgets for you. This means that if you are a British company that has your products manufactured in China, you cannot hire someone in China to do your quality control for you.
Any person (as opposed to a registered China business entity) performing employment-like services for you in China is your employee because China does not recognize independent contractors in anything other than extremely limited circumstances (and your circumstances do not qualify!). And Chinese law requires you pay both employer taxes and benefits on that employee. These employer taxes and benefits vary from city to city, but they usually total around 40 percent of an employee’s salary. China also mandates employers withhold around 15 percent of their China-based employees’ wages for individual income taxes. But those companies that do not realize they have employees in China are not doing that withholding either. Then on top of the employer and employee taxes, the foreign companies with employees in China are almost always going to be viewed by the Chinese tax authorities as “doing business in China” and that is because they almost always are. The foreign company is now almost certainly liable for having failed to pay its corporate taxes as well.
So when all is said and done, the foreign company owes a heck of a lot of taxes to the Chinese government, plus steep penalties, plus interest. Needless to say, the Chinese tax authorities salivate over collecting these taxes and interest and penalties.
In my previous post, I noted two common ways companies operating in China without an entity get caught:
One, we are hearing of long loyal “contractors” going to their employers and saying that if their employer does not double or triple their pay, they will report the foreign company to the Chinese authorities because their doing so will get them a tax amnesty (and perhaps even a portion of the taxes collected?). We are also hearing of vendors with whom the foreign company has no beef making essentially similar threats. Two, and most importantly, we are hearing that the Chinese government is poring over bank records and questioning people (your “employees”) who regularly receive funds unreported funds from overseas.
It is the second way of getting caught that is steeply rising.
What then should you do if you are right now operating in China without a Chinese company. You have essentially the following three choices:
- You double-down in China by getting legal. Quickly, but very carefully. If you want to operate in China for the long term and you can afford to do so, you form a Chinese company, almost certainly a WFOE. For a flavor of what this involves, check out The NEW Steps for Forming a China WFOE. Note that it is not inexpensive to form a WFOE and if you do so you will need to start paying your employer taxes and you will need to start withholding your employee taxes and you will need to pay income taxes to the Chinese tax authorities on the income you earn in China. If you are going to choose this tact, you should do so immediately because in our experience, if you get caught before you even commence the process of forming your China WFOE, your chances of avoiding having to pay back taxes are slim to none. But if you can at least get going on forming your China WFOE, your chances of avoiding having to pay back taxes are shockingly good. But not only should you get legal fast, you should get legal in a way that neither tips off the Chinese government about your previous (illegal and untaxed) activities in China and in a way that works for both your vendors and your “employees.” If just one of your vendors or “employees” believes that your China changes will make things worse for them, you are at great risk of being ratted out to the Chinese tax authorities and seeing your China operations collapse.
- You ditch China entirely. If you either do not want to get legal in China or cannot afford to do so, your best course of action is to simply cease everything you are doing in China and leave. Doing this tends to anger vendors and “employees” and it certainly does not guarantee that you will always be safe from the Chinese tax authorities. So if you do this, we strongly recommend that neither you nor any of your foreign employees go to China for a long long time, preferably ever. For why this is so, check out How To Avoid Getting “Detained” in China and Why Your Odds are Worse than you Think. Both you and any of your foreign employees linked to your illegal operations in China are at risk both from your vendors/employees and from the Chinese government.
- You make your stand and you die a slow (or a quick) death in China. A third option is to just keep doing what you have been doing in China and do it until caught and closed down. Just as with ditching China entirely, if you do this you and your foreign employees should not go to China again. The added risks of doing this are that your China vendors and employees may seek to take advantage of your situation. Here are some of the examples of this that we have seen:
- A vendor learns from one of your “employees” that you are not operating legally in China and uses the threat of informing on you to the government to raise prices.
- Your employees use the threat of your illegal operations to get an increase in salary. I know you are