Secondment Arrangements & Permanent Establishment (PE)
Sep 27, 2013
The Chinese State Administration of Taxation (SAT) issued Bulletin 19 which went into effect June 1, 2013. The Bulletin provides guidance to companies who dispatch secondees to China by detailing which conditions will create a "Permanent Establishment," thus incurring a PRC corporate taxable presence. Note however that Bulletin 19 applies to all foreign companies that second employees to work at a host PRC company, but does not consider bilateral tax treaties between the company's home country and China.
Bulletin 19 presents a "fundamental criterion" and 5 additional reference factors which will be used by the SAT in considering whether a PE has been created. The "fundamental criterion", used to determine whether the employer-employee relationship exists between home entity and secondee, is triggered when the two following conditions are satisfied:
- The home entity assumes the responsibility & risk of work done by the secondee and
- The home entity examines and evaluates the work of the secondee.
When the "fundamental criterion" has been satisfied, then the SAT will determine to see if one of the following five additional reference factors is relevant. If so, then a secondee will be considered an employee of the home entity and a "taxable establishment or place of business in China" will be considered established by the home entity. The additional reference factors, used to determine if the home entity derives income from the secondment arrangement, are as follows:
- The PRC host entity pays a management/service fee to the home entity for the secondee's services;
- The payment made by the PRC host entity exceeds the expenses borne by the home entity;
- The home entity retains a portion of the payments made by the PRC host entity (i.e. the secondee does not receive the full amount of the payment);
- PRC Individual Income tax is not paid on the full amount of secondee's compensation paid or borne by the home entity;
- The home entity decides the number, qualifications, renumeration and working locations of the secondees in China.
One of the positive effects of Bulletin 19 is that it clarifies the documentation required to be reviewed by the taxing authorities in the determination of "PE." These include: the secondee agreement, management guidelines regarding the secondee's work responsibilities including who will evaluate performance, information on payments made from the home to PRC host entity, and any indication of disguised payments such as debt waivers and offsetting transactions between the home and PRC host entity.
It is important to note that the bilateral treaty (DTT) between China and the US can be an overriding factor in determining the establishment of "PE." Generally if the secondee meeting the criterion & factors above furnish services in China for more than 6 months in a 12 month period, a service "PE" will be considered established. In this case, the home entity will have to pay Corporate Income Tax (CIT) based on the profits (or "deemed profits") derived and will also be subject to CIT tax return compliance.
However, the DTT's Article 5 for determining PE will not apply if the services are considered to be carried on for "a preparatory or auxiliary character", as in the case of purchasing goods/merchandise or collecting information for the enterprise. It also appears that a simple dollar-for-dollar direct reimbursement by the PRC host entity to the home entity will not by itself create a PE, because no profit is being generated by the home entity for the secondee's services.
GMT recommends the following action:
- Revisit all secondment agreements with your legal department to make sure they do not meet the PE criteria detailed above. If these agreements are drafted to position the secondees as employees of the host PRC entity (even if the legal employment relationship with the home entity remains in effect), then the "fundamental criterion" will not be met and PE likely not established in China.
- Consider eliminating "extra service fees" paid from the host PRC entity to the home entity and only reimburse the actual compensation of the secondee borne by the home entity.
- Keep all relevant documentation on hand that demonstrates the nature and type of services provided by the secondee in addition to any employment contracts as the Chinese taxing authority is certain to step up efforts to scrutinize possible "PE" criterion.
GMT is able to provide immediate assistance in this area to review secondment agreements, provide revisionary language alternatives to help eliminate PE nexus, and analyze your secondee arrangement as it pertains to Bulletin 19 and the US/PRC DTT. Please do not hesitate to contact us. We are ready to help!