New tax policy could prove expensive for multinational companies

Expatriate workers are a valuable asset for many multinational companies in China. Those companies often assign specialists or senior executives to the country for one or two years. During that secondment period, few companies localise the workers, preferring instead to keep them on home contracts and benefits packages.

Companies do this for a variety of reasons – often it is simply a matter of convenience, but frequently the it is done to preserve the employees' social security benefits back home during the relatively short time that they are in China (this is particularly true in the case of US companies). It also keeps contract issues simple, and avoids the strongly employee-weighted provisions of the PRC Employment Contract Law (中华人民共和国劳动合同法).

According to Ernst & Young tax and business advisory services partner Henry Chan, if the expatriate employee's compensation during secondment is first paid by the home country entity and then subsequently reimbursed by the host country entity on a cost basis, this type of secondment has generally been regarded as reimbursement and would not create what is known as a permanent establishment (PE) for the home country entity in the PRC. (PE is a concept in international tax law by which a host country can establish tax jurisdiction over a foreign company's business activities in the host country.) This means no corporate income tax would be payable on the reimbursement of expatriate employees that is received by the home country entity from the host country entity.