Evaluating Economic Employer Doctrine Principles under Chinese Secondment Rules
China reclassifies foreign secondment wage recharges as taxable service fees whenever the local entity operates as the true economic employer under Bulletin 19.
Intercompany Salary Recharge
Meaning
Cost recovery mechanisms for personnel expenses allow a group entity to bill another for the salary and benefits of an employee who has been assigned to work for the benefit of the recipient. The intercompany salary recharge is a common administrative practice in multinational organizations where talent is moved across borders to support specific projects or management needs. This process involves the direct reimbursement of costs without the addition of a profit markup if the activity is deemed a pass-through expense.
It is distinct from a service fee because the recharge covers only the actual employment costs such as wages, social security and insurance. The use of this mechanism is limited to situations where the employee remains under the employment of the home entity but performs duties exclusively for the host entity.
Operational Process
Documentation of the recharge begins with a formal agreement between the two entities that specifies the duration of the assignment and the breakdown of the costs to be recovered. The host company must track the time spent by the employee on local projects to justify the intercompany salary recharge during an audit. Monthly or quarterly invoices are issued by the home company to the host company to settle the outstanding amounts.
These invoices must be supported by payroll records and evidence of the actual payment of social security and taxes in the home jurisdiction. The host company then pays the invoice using its local currency or through a foreign exchange settlement if the entities are in different countries. This reimbursement ensures that the costs of the employee are correctly allocated to the business unit that derives the economic benefit from their labor.
Tax Treatment
Scrutiny from the tax authorities focuses on whether the intercompany salary recharge is a genuine cost reimbursement or a disguised service fee that should include a profit margin. The state taxation administration requires that the recharge be performed on a strict at-cost basis to avoid being reclassified as a commercial service. If a markup is added, the entire amount may be subject to value added tax and additional corporate income tax withholding.
Furthermore, the tax bureau checks if the employee has established a permanent establishment for the home company which could trigger additional corporate tax liabilities. The host company can only deduct the recharged salary for tax purposes if it can prove that the employee’s work was necessary for its local operations. Clear evidence of the employee’s role and the benefit they provided to the local entity is essential for a successful tax defense.
Compliance Risks
Risks associated with recharging salaries include the potential for double taxation if the home and host countries have different views on the nature of the expense. The host company might be denied a tax deduction while the home company is still required to report the recharge as income. Additionally, the foreign exchange authorities may question the intercompany salary recharge if the documentation does not clearly match the employment contract and the payroll data.
Large recharges attract the attention of the state administration of foreign exchange which monitors capital outflows closely. Errors in the calculation of the recharge can also lead to disputes with the employee regarding their social security entitlements and tax filings. Companies must maintain a rigorous control environment to ensure that all recharged costs are accurate and fully supported by documentary evidence.