China’s Tough Times Encourage Tough Measures, But Be Careful: The Splitting Salary Edition

China’s economy is moribund and foreign businesses are paying the price. In an effort to minimize further losses, they are looking to cut costs. For many, this means reducing their workforce and reducing the hours of those who remain. But as Grace Yang, our lead China employment lawyer has written, the Chinese government is trying to prevent these things and so doing do will prove difficult. See e.g. Coronavirus and China Employee Layoffs? Think Again.

We have of late been seeing a big uptick in foreign companies seeking to reduce their spend by “splitting” their payments to their non-Chinese employees who work in China. Don’t do this!

China employer taxes and benefits are steep. For every 100 Yuan an employee in China gets paid, the employer pays out an additional 40 or so Yuan in employer taxes and benefits. In other words, about 40 percent. And for every 100 Yuan a China-based employee gets paid, the employer is supposed to withhold around 25 Yuan for employee taxes. In other words, about 25 percent. So imagine the savings if instead of paying an employee $100,000 on the China tax and benefit grid, you instead pay that employee just $30,000 in Mainland China and you pay the other $70,000 via Hong Kong or some other low tax country.

Ten years ago — before China became considerably more sophisticated with its tax system and its ability to root out tax cheats, foreign SMES with employees in China (especially expat employees) would routinely engage in this sort of salary splitting. You might have a company in Salt Lake City that would send an employee to China and have its WFOE in China pay that employee $30,000 in China while sending $70,000 each year from the SLC company to the employee’s US bank account. Back then, our China lawyers passingly (in a CYA way) point out “potential” problems with this and that was about it.

China now employs various techniques to crack down on this sort of thing. One of the Chinese tax authorities’ best and easiest techniques is to simply call bullshit on the idea of a foreign company being able to pay a top-tier expat software engineer or General Manager $30,000 a year. The other is to offer a tax amnesty (and/or financial incentives) to your just-terminated employee to get him or her to report your company for tax fraud. Armed with the information from your ex-employee, China’s tax authorities will not so politely demand you immediately pay all past employer taxes and benefits, plus interest, plus massive penalties. Those that do not pay get shut down and their key personnel get held in China until they do.

For many years it was the rare client that would even ask us about splitting salary payments and our response when they did would be to lay out the massive risks and emphatically (not passingly) tell them not to do that.

With the coronavirus and the economic desperation that has wrought, we are hearing anew from companies seeking to split their payments to their expat and higher paid Chinese employees alike. They are hearing of other companies doing this to save money and they want to do the same. Our advice is that this is simply too risky. Yes, the Chinese government is looking the other way right now at all sorts of employment law violations short of terminations, but that will eventually end and end big.

Fast forward a few months and things have stabilized a bit in China and its government is desperate for money. The Chinese government LOVES going after foreign companies when doing so leads to money. Imagine how easy and lucrative it will be to go after foreign companies that have greatly reduced salaries to its expat employees. There will be blood. Don’t do it.

On the flip side, our China employment lawyers have always counseled our expat employee clients about the dangers to them of split salary employment relationships with Chinese employers. Ten years ago, it was rare for an expat to work for a Chinese company in China, but today that is commonplace. It is also commonplace for Chinese companies to be unhappy/reluctant about high expat salaries and having to pay full taxes and benefits on that. They often try to get around having to pay these taxes and benefits by  offering a $100,000 salary with $70,000 paid to through Hong Kong. This is both illegal and really bad for expat employees and the full extent of how bad is coming to light with the coronavirus.

In China Expat Pay: Splitting with Hong Kong is 100% Illegal and 200% Dangerous, we wrote about how and why salary splitting is so bad for expats:

This has also led Chinese companies to come up with some very creative justifications for their illegal actions, in an attempt to quell any expat disquiet about participating in tax fraud. Their first “line of defense” is usually to say “everyone does this and your American lawyers simply don’t know China.” When this doesn’t work, they often propose the expat employee become a director or an officer of the Chinese company’s Hong Kong entity and get paid the $70,000 for doing that. Yeah right. Anyone who knows China law enforcement, especially China tax law enforcement, knows this is never going to fly. See this Forbes article, China’s Tax Authorities Want You.

What we are also seeing, most unfortunately, are a slew of expat employees accepting such split payment contracts to their massive detriment. We see this when the expat employee writes one of our China employment attorneys  for help against their China employer who just fired them or who is not actually sending any of the promised money via Hong Kong. These expat employees want to sue their China employer as though they have an employment contract for $100,000, when of course they don’t have such a contract because the Chinese employer is smart enough not to have put anything in writing about the $70,000 that was to have been sent from Hong Kong. Seriously, who is dumb enough to put their own tax fraud in writing?

This sort of non-payment has become so common I am now of the view that many (most?) China company employers that split salary payments do so not so much to engage in fraud as against the Chinese tax authorities, but rather to engage in fraud as against their expat employee. More than half the time when we get an email from an employee seeking our help in getting their $70,000 split fee payment, the employee has been working for her or his China employer for more than a year and that means their China employer saved about $100,000 over the last year (the $70,000 salary plus the approximately $28,000 in employer taxes and benefits it never had to pay) without violating a single law.

It’s like the perfect crime but it is not a crime at all. The employer simply managed to convince the expat to work at super low wages and there is no contractual record indicating otherwise. Sometimes there may be an email record, but the smart employer has made clear in its employment contract that the employment contract supersedes any prior written or oral promises or agreements. But even without that, Chinese law so favors the written and signed and chopped contract that not having such a provision likely won’t make any difference anyway. Many employers tell their employees they will make the $70,000 payment in one lump sum 6 or 12 months after the expat employee begins work, but then they never actually make the payment. Even without this promise, the expat employee does not want to quit because he or she believes doing so will mean they will never get the $70,000 — not realizing that continuing to work only puts them even deeper in the hole.

Then there are the instances where the employer does pay the employee out of country but stops for a while and then stops paying the out of China portion or fires the employee. The employee contacts our China employment lawyers believing he or she can sue his or her employer for damages based on a $100,000 salary. But how can they do this when their employment contract says their salary is $30,000? Are they going to stand up in a Chinese court and say, “excuse me, your honor, I know the contract says only $30,000 and I know my taxes show I have been paying income taxes on only $30,000” but this employer and I were together engaging in tax fraud against the Chinese government and so I just really feel like I am entitled to have this court enforce the oral agreement my employer and I used to defraud the Chinese government. Yeah, right.

All this very much reminds me of how in the old days when foreigners were not allowed to own real property in China they would buy real property in the name of their Chinese citizen girlfriends (it was pretty much always guys) to get around this prohibition. Then, once the girlfriend had the property, she would break up with her foreign boyfriend and keep the property, insisting that it was a gift. The foreigners would then contact my law firm wanting to sue their exes and we would have to tell them how we viewed that as folly because they would need to argue to the Chinese court that they had bought the real estate not as a gift to their girlfriends, but to have their girlfriends illegally hold the property in a sort of trust for them. Yeah, right.

Our Chinese employment lawyers frequently help expats with their China employment contracts. See China Expat Employment Contracts Because They Matter. A Lot. Even when we are not retained, we like to stay in touch with those who wrote us for employment contract help just so we can know what happens to expats who negotiate their own employment contracts. The below is an email we have used for those who admit to having entered into a split payment employment arrangement:

What your employer has done here is 100% illegal and it puts you at risk. Both you and them are engaging in tax fraud but all that should matter for you is that you are engaging in tax fraud — assuming your employer actually pays you outside China, which they often do not. Your employer may claim otherwise but there is no doubt about this. You are supposed to be paying China income taxes on all of your earnings attributable to your work as a China expat employee. Plain and simple. But under this arrangement (again, assuming you do actually get paid outside China what you have been promised) you will not be doing that. If I were you I would go to my employer and insist it change this payment plan and if it does not, I would consider getting a new job, and fast. Just this week I wrote here how China is — in response to the US-China trade war- – stepping up its hunt for Americans violating China’s law just as you are doing. Do you really believe China would not love to call out and penalize Americans right now for tax evasion? I am sorry I have to be such a downer, but if you were to end up in jail or deported I would not want it weighing on me that I did not at least warn you about your risks.

Fast forward to today. Nearly once a week our China lawyers get an email from an expat employee in China who havs been illegally terminated by her Chinese employer. Most of these terminations are happening in one of two ways. One, the expat is in China and fired in China. Two, the expat is ordered to return to China by an employer that knows this is impossible and then fired for not showing up for work (even if the workplace itself is closed and every single other employee is working remotely). These expats are reaching out to us, seeking to pursue lawsuits to recover some or all of their $100,000+ salary. But when one of our China employment attorneys looks at their China employment contract the salary is $30,000. And when we ask them why they told us their salary was $150,000, they tell us that the remaining $120,000 was always paid to them in Hong Kong.

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.