lunes, 3 de octubre de 2016

China´s Tax authorities recoup IIT based on PE created by foreign employees

The Chinese tax authorities recently were reported to have successfully recovered substantial amounts of tax undercharges from foreign companies after the authorities determined that the companies had created permanent establishments (PEs) in China by sending employees to work in the country. While it may not be surprising that the Chinese tax authorities sought to recover enterprise income tax (EIT) from the foreign companies by identifying PE of the companies in China, the cases illustrate that Chinese individual income tax (IIT) liabilities also can arise for the
foreign employees working in the PE.

The cases demonstrate the consequences of creating (an unintended) PE: the income generated by the PE that is connected with the activities of the employees will be subject to EIT, and the expatriate assignees’ employment income earned from working in China will be subject to IIT. In this case, the PE generally will be deemed to bear the cost of the employee’s employment income and, therefore, the employee may not qualify for tax relief that otherwise would apply under an income tax treaty between China and the individual’s home country, regardless of how long he/she is physically present in China.

One of the published cases, which involved the Beijing local tax bureau, was posted on the State Administration of Taxation’s (SAT’s) social media site (WeChat) on 1 August 2016.

The case involved an investigation of a Sino-foreign joint venture manufacturer (Company A). During the period from 2009 to 2014, Company A received services (e.g. onsite technical support, post-sales assistance, etc.) from various groups of employees who were sent to China by Company A’s foreign parent (Company B). Company A took the position that the foreign employees were not liable for Chinese IIT because each individual had spent less than 183 days in China and the individuals’ remuneration was paid and borne by Company B. However, the Beijing tax bureau determined that the foreign employees rendered services for the same project and that the length of their cumulative stay in China reached the PE threshold (i.e. 183 days in any 12-month period) under the applicable tax treaty.

Therefore, Company B was deemed to have created a PE in China and the remuneration of the foreign employees working under the PE was considered a cost borne by the PE. As a result, the employees were not entitled to treaty relief, even though their actual physical stays in China were for less than 183 days.

The Beijing tax bureau’s final assessment indicated that the foreign employees’ activities had created 19 PEs of Company B in China, and a backlog of IIT and surcharges totalling RMB 23 million was collected.

Global mobility, which has become a norm in today’s global business economy, can have significant tax (as well as other) consequences for a company. Examples of global mobility range from seconding full-time employees to work in another country, to sending staff on a short-term basis to carry out or complete temporary projects (e.g. project management, quality control, training, provision of technical advice, etc.), to business travel. Any type of cross-border employment or recurring travel can give rise to myriad challenges, including, for example, challenges relating to
immigration, income tax and salary tax compliance, relocation, social security, etc.

Although many foreign companies are aware of the potential Chinese EIT risks arising from PEs, it seems that companies often have different levels of understanding of how the PE rules may affect the IIT liabilities of their expatriates working in China. Some companies may believe their expatriates can be exempt from Chinese IIT as long as each employee’s stay in China remains under the threshold in the relevant tax treaty (e.g. 183 days in a calendar year). It may be easy for companies to overlook the interaction between PE and IIT issues, and as demonstrated by the Beijing case, a PE of the employer could jeopardize employees’ entitlement to tax treaty protection. The consequences can be severe, ranging from financial penalties to reputational risks.

The dramatic increase in overseas companies sending employees to China to provide services has raised the awareness of the Chinese tax authorities about the potential creation of a PE and the need to intensify the scrutiny of foreign employers and their employees. The recently published cases signal that the tax authorities are looking closely at foreign companies and their expatriates working in China. The frequency and scope of inspections and tax audits carried out by the local tax authorities on PEs have grown exponentially, with the local bureaus conducting extensive investigations that include reviews of historical tax filings/submissions of documents, interviews of company personnel and onsite examinations. The local tax authorities also are working more closely with the SAT and the border authorities to expand the information channel for discovering PEs.
Foreign companies that frequently send employees to China should monitor developments and take appropriate actions to manage any potential tax risks. The following are some areas that should be considered when assessing PE and relevant EIT/IIT issues:

  • Nature of the activities carried out by expatriates and the duration of projects or services rendered in China;
  • Contractual documents and intercompany charges, e.g. salary reimbursements or service fees;
  • Assignment arrangements and a determination of the identity of the “economic employer”;
  • Physical presence of expatriates in China and possible IIT reporting obligations; and
  • Other factors, such as immigration formalities, etc. 
Source: Deloitte

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