Hiring a Chinese Employee Without a Chinese Entity: Not Good at All

American companies are constantly asking us to draft employment contracts between their American company and their Chinese “employee.” One big problem: such contracts violate Chinese law.

Under Chinese law, only Chinese entities are allowed to have employees based in China. in addition, China does not generally allow for hiring independent contractors. If a person (as opposed to a legitimate registered business entity) is going to be performing employment-like services for you in China, that person is your employee you must comply with all Chinese laws that go along with that employment relationship. This means if you are an American company selling widgets you cannot hire someone in China as your employee to sell widgets for you. This means if you are a computer software company, you cannot hire someone in China to do coding for you.

We recently received a request from an American lawyer along the following lines:

We have a client that operates a Chinese language school in the United States. It wishes to hire native Chinese speakers in China to write and record dialogue in the Chinese language. The company would like to hire people living in China to do this work. However, the U.S. company does not want to form a company in China. Instead, they simply want to hire people to do the work.

This company has done this in various other countries in the world (with respect to other languages) and it has done so by entering into a contract with the foreign individual. The foreign individual agrees to do the work on a project basis for a fee. On completion of the project, our client wires the fee in U.S. dollars to the bank account of the individual. The individual is treated as an “independent contractor.” The individual is responsible for payment of all taxes on the income received and for arranging social welfare payments and pensions as appropriate.

I have been told this sort of arrangement is simply not possible under Chinese law and so my questions are:

1. Is this arrangement acceptable under Chinese law?

2. If yes, is there anything we should be particularly concerned with in terms of documentation?

3. If no, how should this work be done if the above will not work?

Our response was along the following lines:

1. The U.S. company could have its proposed employee hired by a Chinese company and then pay the Chinese company the equivalent of the Chinese employee’s wages and taxes, plus an administrative fee. The problem with this is that if the “employee” is not going to be doing at least some work for its Chinese employer, it is not legal and if your client gets caught, it may never be allowed to conduct real business in China again. If the “employee” does not actually do work for the Chinese company, it is nothing more than an attempt to get around China’s laws requiring foreign companies that do business at a level where they need an employee to have a legitimate Chinese entity — a WFOE, JV, or Rep. Office.

And if your client’s goal is to have its own person on the ground for it in China, how much of “its own person” is someone employed by and paid by another company? And how will your client protect its trade secrets from this Chinese company that employs its “employees”. There are situations where this can work, but not many.

Then there are all the issues for the Chinese company, which is likely going to have to lie to the Chinese government about the monthly foreign currency payments it receives from your client, if it is your client that is actually the one paying this employee.

2. Your client can hire the Chinese “employee” directly and just wire that “employee” his or her paycheck every month. Years ago, this sort of arrangement was pretty common, but it is becoming far less so as word is spreading that the Chinese government and tax authorities are on to this scheme and quashing it all the time. The problem with this set-up is that your client’s “employee” is at some point going to have to explain to the Chinese government why he or she monthly deposits foreign currency into their bank account and why they are not paying taxes on this.

We have received a number of calls in the last year from companies seeking our help in keeping their Chinese “employees” after they were told by their “employees” that the existing relationship must be discontinued. We told them that their best solution would be to form a China WFOE, but that we were very concerned about their WFOE application being rejected because of what they had already done. We also have seen a big uptick in foreign companies getting caught for these payments and then having to pay back taxes, plus interest, plus penalties. We are even hearing of arrests for this.

Your client should NOT risk this.

3. The third and maybe best option (at least from a legal standpoint) is to have your client’s Chinese “employee” form his or her own domestic Chinese company and then your client simply contracts with that Chinese company for the services you are seeking from this Chinese person. This is going to require a fair amount of initiative by the Chinese employee and the downside of this is that when all is said and done, your client has an independent Chinese company out there with which it is conducting business, and not an employee.

Maybe your client will need to reconsider a WFOE or a Rep Office.

What have you seen out there?