How to Avoid Illegal Employment Relationships in China
September 22, 2020 | 5 minute read
Unfortunately, illegal employment relationships in China are all too common. A common mistake foreign companies make when hiring in China is assuming that the full range of employment relationships – formal employment, independent contracting, and freelancing – are operational in China just as in their own countries. This is not the case.
With independent contracting and freelancing not legally recognized in China, the only viable option is formal employment. To employ someone formally, however, a foreign company usually needs to have a local entity in the country. This can often be cost-prohibitive. As such, companies consider other more ‘clandestine’ tactics for hiring Chinese workers. These tactics can be extremely risky, and they are rarely – if ever – compliant. If the Chinese authorities discover foreign companies using illegal employment relationships in China, they can issue fines, ‘name and shame‘, and even blacklist. Knowing what these illegal arrangements are and how to avoid them is, therefore, imperative for foreign companies.
Illegal employment relationships in China
For the most part, illegal employment relationships in China manifest in one of three ways:
- Paying ’employees’ via a third party
- Making direct payments to ’employees’
- Paying the domestic company of the ’employee’
Paying ‘employees’ via a third party
Many foreign companies are told they can pay their ‘employees’ via a third party. Often, this third party is otherwise involved in the foreign company’s business activities in China. For example, a factory owner might offer to employ a foreign company’s staff member in exchange for a ‘management fee’. On the face of it, the setup sounds highly convenient, especially compared to other types of employment relationships in China. The reality, however, is that these arrangements are illegal under Chinese labor law. Some factory owners earn a significant additional income this way, so can be very persuasive in telling foreign companies otherwise.
In addition to the risks presented by that illegality (fines, naming and shaming, and so on), foreign companies are – unfortunately – subject to exploitation by third parties. Overcharging is common, especially in respect of:
- government taxes
- severance entitlements
- sign-on bonuses
- miscellaneous bank fees
- foreign exchange rates
Without engaging local lawyers and accountants to verify payments, foreign companies cannot detect these overcharges.
Making direct payments to ‘employees’
Making direct payments to ‘employees’ for their services is akin to independent contracting or freelancing. As such, there is considerable legal risk in taking this approach. Some individuals actively encourage their foreign ‘employers’ to take this route; in doing so, they request additional sums of money to cover so-called ‘employer taxes’.
In the vast majority of situations, it is impossible for employees themselves to pay an employer’s mandatory contributions to the social insurance and Housing Funds in China (as they, too, are not registered with the labor authorities as an employer). Accordingly, these additional sums usually serve as an additional cash bonus for the employee.
Paying the domestic company of the ‘employee’
Another highly problematic tactic used to avoid employer liabilities is where the individual (who would otherwise be hired directly by the company) sets up their own domestic company to receive payments. ‘Employees’ often incorporate in Hong Kong as opposed to mainland China as another attempt to bypass authorities.
In this case, ’employees’ accept direct payments to their company as a form of ‘consulting fee’ rather than salary. As the individuals would readily be classified as employees legally, the foreign company could face severe penalties for violating Chinese labor and tax laws.
How to avoid illegal employment relationships in China
Given that independent contracting and freelancing are illegal in China, companies without a local Chinese entity only really have one option when it comes to hiring in China: engaging a Professional Employer Organization (PEO).
A PEO is a service provider that can hire and administratively manage employees on behalf of foreign companies. Critically, foreign companies can use a PEO even if they do not have an entity in the country of operations. The PEO takes on the full legal responsibility as the individual’s Employer of Record (EOR), leaving the foreign company to manage only the employee’s day-to-day workload.
In partnering with a PEO, a foreign company can relieve itself of all legal, tax, and other administrative responsibilities in respect of an individual’s employment. This saves them time and money, thereby freeing them up to focus on the bigger picture of their operations in that country. What is more, with the PEO solution being so flexible, there is the option of later transferring employees to a local entity owned by the foreign company should they decide to establish one down the line. This is much safer for the foreign company, and considerably more favorable for employees.