July 2, 2009

Authorities Announce Investigation of Cross-Border Secondment Arrangements

On July 2, 2009, the International Tax Department of the State Administration of Taxation issued the Notice on Tax Investigations Regarding Payment of Enterprise Income Tax in Connection with the Provision of Services Through Cross-Border Secondment Arrangements (the “Notice”), which addresses secondment issues for multinationals. Multinationals commonly second personnel to their PRC entities. Under typical secondment arrangements, the overseas entity will pay the salaries of the seconded persons and the PRC entity will then reimburse such salaries. However, in practice, overseas entities often actually provide services in China themselves through seconded persons, under the guise of secondment arrangements, in order to avoid the tax and other implications of establishing an entity in China. According to the Notice, tax authorities are required to review cross-border secondment arrangements to ascertain the true nature of such arrangements in order to counteract tax avoidance. If an overseas entity is considered to be providing services in China and has a permanent establishment in China, it must carry out tax registration in China and pay tax on income attributable to its permanent establishment.

The Notice does not specify how to distinguish between genuine secondment arrangements and sham secondment arrangements. In practice, if reimbursed salaries are remitted out of the country with any additional profit added, it is likely that permanent establishment may be recognized by the tax authorities. It is also important to consider whether the seconded person has signed an employment agreement with the PRC entity, whether the salary of the seconded person is determined by the PRC entity, whether the seconded person reports his work to the PRC entity, and whether the PRC entity can remove the seconded person, etc. If the answers to the foregoing are negative, the seconded person may be regarded as working for the overseas entity. If so, tax authorities may believe that the secondment arrangements are not genuine and may determine that a permanent establishment has been set up by the overseas entity. Therefore, enterprises seconding personnel to China should review their existing secondment arrangements and maintain appropriate documentation to prove the genuineness of the secondment.

Copyright ©2009 by Kaye Scholer LLP. All Rights Reserved. This publication is intended as a general guide only. It does not contain a general legal analysis or constitute an opinion of Kaye Scholer LLP or any member of the firm on the legal issues described. It is recommended that readers not rely on this general guide but that professional advice be sought in connection with individual matters.References herein to "Kaye Scholer LLP & Affiliates," "Kaye Scholer," "Kaye Scholer LLP," "the firm" and terms of similar import refer to Kaye Scholer LLP and its affiliates operating in various jurisdictions.

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