Every day for the last week — including the weekend — I have spoken with a Western company operating illegally in China that has decided to decide on what to do in China about that. I will not get into whether these companies knew they were operating illegally in China before they contacted my law firm, but I will briefly discuss what led to their picking up the phone or sending an email.
Roughly half of these companies are doing well in China and have resolved to get legal. The other half have a gun at their heads in the form of vendor or “employee” threats.
Back in May 2015, I wrote an article for Forbes Magazine, China’s Tax Authorities Want You, explaining how China’s slowing economy is causing the Chinese government to increase its tax collection efforts, “especially against foreign companies with off-the-grid ’employees’ in China. The article then explains why using “independent contractors” does not work in China.
Chinese law limits hiring China-based employees to only Chinese legal entities. This means if you are an Australian software company, you cannot hire someone in China to do your coding or to provide your support services. This means if you are a Canadian company selling widgets, you cannot hire someone in China to sell widgets for you. This means if you are an American 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 business entity) performing employment-like services for you in China is your employee because China essentially does not recognize independent contractors. 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. Many foreign companies do not realize they have employees and they fail to pay required employer taxes and benefits.
China also mandates employers withhold around 15 percent of their China-based employees’ wages for individual income taxes. But of course 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 company is failing to pay, the foreign companies with employees in China are almost always going to be viewed by Chinese tax authorities as “doing business in China” 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 lot of taxes to the Chinese government, plus steep penalties, plus interest.
In the Forbes article, I described how the Chinese government inevitably discovers the foreign company that is not paying the above taxes, usually stemming from one of the following:
- The tax authorities discover one of the foreign company’s China-based employees did not pay his or her income taxes, and they trace that back to the foreign company.
- The tax authorities discover the foreign company’s China presence from deductions taken by one of the foreign company’s China customers.
- The tax authorities discover the foreign company’s China presence when one of the foreign company’s customers seeks to wire funds to the foreign company.
- The tax authorities discover the foreign company’s China presence when the foreign company terminates one of its employees or has a dispute with one of its customers or vendors and that employee or customer or vendor reports the foreign company to the China tax authorities.
But things have in the last few weeks gotten much much worse. Call it the Trump effect.
Our China lawyers 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 a portion of the taxes collected?). We are also hearing of vendors with whom the foreign company has no beef making essentially similar threats. More importantly, we are also hearing that the Chinese government is poring over bank records and questioning people (your “employees”) who regularly receive funds unreported funds from overseas.
Our China lawyers have been working with China for a long long time and we have seen all sorts of ups and downs in US-China relations and right now is — let’s face it — a down period. More importantly, we have seen how China reacts during down periods and on this its record is clear. China does not go after law-abiding foreign companies doing business in China; China goes after law breaking foreign companies doing business in China. This is a rationale calculus as the law breakers are the low-hanging fruit and who can complain about China merely enforcing its laws?
So if you are operating illegally in China what should you do?
We are telling our clients they have one of three options, roughly divided between doubling-down, ditching China, or dying in China with your boots on (or off). In a follow-up post, I will explain in detail the various options, along with their pros and their cons.
SPECIAL UPDATE: One of our China attorneys insists I should not wait until Part 2 to point out that if you see yourself in this post, neither you nor anyone else who might be connected to China should go to China unless and until you are operating 100% legally in China. In other words, if you have China “employees” but no China company, do NOT go to China. For more on why this is so, check out How To Avoid Getting “Detained” in China and Why Your Odds are Worse than you Think.