1.  Introduction

Cross-employment between affiliated companies is quite common in practice, but such operations may lead to disputes in the determination of employee labour relationships and the calculation of seniority, etc. This article will summarize the key points of compliance for enterprises to manage the cross-employment, and provide operational suggestions for enterprises to comply with the employment management.

2. Common cross-employment patterns

There are three common modes of employment among affiliated enterprises: employee transfer, employee secondment and employee mixing.

a) Employee Transfer

The so-called transfer of employees refers to the transfer of employees between different units within the Group company by way of consensus or unilateral notification based on the needs of production and operation or other considerations of the enterprise, which is essentially a process of dissolution of the old labor relationship and establishment of a new labor relationship.

To avoid disputes, the company shall pay attention to the following points when transferring employees:

• The company needs to change the subject of the labour contract by consensus with the employee. The company shall keep evidence of the employee's consent to the transfer, such as the original and new employer and the employee's Tri -party signed transfer agreement;
  

• The original employer should handle the separation procedures for the employee and the new employer should handle the entry procedures for the employee in a timely manner;

• In case the employee terminates or ends the old labor relationship before joining the new company, the employee shall have the right to request that the seniority with the original employer be combined and counted with the new employer when calculating the financial compensation.

• If the employer is changed at the time of signing the contract with the employee, the number of times the employee has entered into a fixed-term labor contract and the seniority shall still be calculated cumulatively, which means that, when the employee has worked continuously for a period of ten years or has entered into two consecutive fixed-term labor contracts, and the employee proposes or agrees to renew or enter into a labor contract, except for the employee's own proposal to enter into a fixed-term labor contract, the company shall enter into a fixed-term labor contract with him. 

b) Secondment of Employees

The secondment relationship is a special form of employment in which the employer, the borrowing employer and the employee agree that the employer retains the labor relationship with the employee and the employee actually provides labor to the borrowing employer.

In order to avoid the establishment of a de facto labor contract relationship between the employee and the borrowing employer, it is recommended that the company pays attention to the following points during the secondment:

• Retain evidence of the employee's consent to the secondment;
  

• Relevant agreements should be signed between related enterprises to make clear agreements on secondment matters;
  

• It is not recommended that the seconding enterprise should directly pay wages and social insurance;

• The seconding enterprise shall not charge the employee for the secondment;

c) Mixed Employment

The main manifestation of "mixed employment" is that the shareholders, legal representatives, directors, supervisors, administrative, personnel and financial personnel of two or more companies have a high degree of overlap, and the employees provide labor for the above companies at the same time or alternately; or the employees work for different affiliates, or work in several positions, or change the main body of the labor contract constantly.

In order to avoid being recognized as "mixed employment", affiliates should pay attention to the following points:

• To maintain the independence of personnel, each employer should sign labor contracts with its own employees.

• The main body of the labor contract, social insurance payment and payroll, etc. should be consistent;

• If the employer needs to be changed for reasons of production and operation, each party shall sign an agreement on the transfer of labor relations;

• Where employees are seconded for management reasons, the parties shall sign an agreement to confirm the secondment relationship.

3. Common tax risks

Labor employment between related entities may present tax risks concerning payroll and social security payment, including obtaining pre-tax deduction vouchers for income tax. To mitigate such risks, we suggest following the guidance provided in the Circular on Issues Relating to the Treatment of Enterprise Income Tax on Payment of Expenses for the Provision of Services Between Parent and Subsidiary Companies (Guo Shui Fa [2008] No. 86) issued by the State Administration of Taxation (SAT):

a) Enterprise Income Tax Risks

Expenses incurred by a parent company for providing various services to its subsidiaries should be determined based on the arm's-length transactions principle between independent enterprises to determine the price of the services. For tax purposes, this price should be treated as normal labor expenses of the enterprise. In the event that the parent company does not charge the price in accordance with the business transaction between independent enterprises, the tax authorities have the right to adjust it.

When the parent company provides various services to its subsidiaries, both parties should sign a service contract or agreement that clearly stipulates the contents, charges, amount of the services to be provided, and other relevant details. All service fees incurred in accordance with the provisions of the said contract or agreement shall be declared as business income by the parent company for tax purposes. The subsidiaries can deduct these fees as costs and expenses before tax.

The parent company can provide the same kind of services to several subsidiaries. The service fee charged by the parent company can be collected by signing contracts or agreements for each item. Alternatively, it can be collected by way of a service sharing agreement. This means the parent company signs service fee sharing contracts or agreements with each subsidiary. The total service fee charged by the parent company for the subsidiaries is based on the actual expenses incurred by the parent company for providing services to its subsidiaries plus a certain percentage of profit. This fee shall be deducted in the tax return of the beneficiary subsidiaries (including profit-making enterprises, subsidiaries, and subsidiaries). The total service fee charged to the subsidiaries is reasonably apportioned among the subsidiaries benefiting from the services (including profit-making enterprises, loss-making enterprises, and enterprises entitled to tax reductions or exemptions) in accordance with the provisions of Paragraph 2 of Article 41 of the Enterprise Income Tax Law of the PRC.

The parent company charges the subsidiary for management fees, which cannot be deducted before tax.

In the event that a subsidiary declares pre-tax deduction of service expenses paid to the parent company, the competent tax authorities must be provided with the necessary materials such as service contracts or agreements signed with the parent company. Failure to provide these materials will result in the service fees not being deducted before tax.

According to Document No. 86 of Guo Shui Fa [2008], the expenses incurred by the parent company for providing various services to its subsidiaries shall be determined based on the principle of arm's-length transactions between independent enterprises to determine the price of the services. These expenses shall be treated as normal labor expenses for tax purposes. Therefore, both parties must sign a service contract or agreement specifying the contents, charges, and amount of the services to be provided. Any service fees incurred in accordance with the provisions of the said contract or agreement shall be declared by the parent company for tax purposes as business income and deducted by the subsidiaries as costs and expenses before tax.

As per the Regulations for the Implementation of the Enterprise Income Tax Law of the People's Republic of China, certain deductions are not allowed for management fees paid between enterprises, rents and royalties paid between business organizations within an enterprise, and interest paid between business organizations within a non-banking enterprise. Hence, it is imperative to maintain strict distinction between service fees and management fees while signing contracts or agreements or issuing relevant invoices.

b) Value-Added Tax (VAT) Risks

According to the sales service annotation of Document No. 36, modern services refer to the business activities related to the manufacturing industry, cultural industry, modern logistics industry, etc., that provide technical and knowledge-based services. It encompasses research and development and technical services, information technology services, cultural and creative services, logistics auxiliary services, leasing services, forensic consulting services, broadcasting and film services, business auxiliary services, and other modern services. The Group companies and subsidiaries are generally the  taxpayers, and if VAT invoices for modern services are issued, there will be no overpayment of VAT as a whole, both as a seller and as a purchaser.

4. Conclusion

The situation of cross-employment of affiliated companies is quite common in practice, but this employment model not only brings convenience to the company, but also contains many legal and tax risks. Enhancing compliance awareness and making relevant preparations in advance can avoid facing legal and financial risks in the future and truly improve the efficiency of enterprise operations.

D'Andrea & Partners Legal Counsel and PHC Advisory Tax & Accounting (companies of DP Group) offer full-scale legal compliance, tax advisory support and consultancy to address any concerns related to this issue. If you have any inquiries, you are welcome to contact us: info@dpgroup.biz.

Disclaimer

The above content is provided for informational purposes only. The provision of this article does not create an attorney-client relationship between DP Group and the reader and does not constitute legal advice. Legal advice must be tailored to the specific circumstances of each case, and the contents of this article are not a substitute for legal counsel.