Labour contract issues when seeking local tax preferences

Alluring tax advantages in other cities may make a company move look attractive, but beware the pitfalls

When pursuing advantageous local tax preferences in another city, Chinese companies may be eager to relocate. But the matter is far from simple where employees are concerned. What happens to their existing contracts or their “geo-locked” social insurance? How these concerns are addressed can make or break company morale.

In the era of globalisation, taxation, labour costs, laws, regulations and policies are the new battlefields among both nations and corporations striving for the most attractive business climate.

In recent years, state and local governments have introduced numerous tax preference policies targeting a variety of enterprises with the aim of enhancing regional strengths and promoting industrial clusters.

Some local governments have formulated a series of policies to stimulate high-quality and rapid development of the local economy, particularly tax incentives benefitting specific industries or enterprises, which can be substantial. Many such policies are aimed at “newly established entities” or the “headquarter economy”, using bounteous cash incentives and other rewards to attract prominent enterprises.

While plans for these policies might manifest as alluring numbers on the accounting books, turning them into real funds and sustaining daily business operations and management requires careful planning and pragmatic implementation. It should be noted that if tax planning is done synchronously with the establishment of a new legal entity, the changes will test not only the company’s future operations, but also the faith of existing employees. Most notably, they may in no small way affect the staff’s core personal interests.

Under what circumstances will tax planning involve the personal interests of the employees? Decision makers are advised to ask the following questions when examining the requirements of tax preference policies:

• How significant are the changes for external business operations?
• Do these changes involve the employees?

In recent years, the author’s firm has helped many clients navigate organisational reforms and staff-related labour relation adjustments resulting from tax planning. From observation, companies generally set up new legal entities local to the policy, and generate operating revenue as required by the local policy.

In such cases, the new entities become responsible for paying employee salaries, and withholding and remitting their personal income taxes. However, the labour relations and legal issues involved in such an arrangement may be deceptively complex. Here’s why.

Employees have veto rights over whether to sign a labour contract with the new entity. When seeking to sign a certain number of employees for labour contracts, any plan to transfer some existing employees to the new entity falls under the circumstance of labour contract alteration. According to article 35 of the Labour Contract Law, the content of a labour contract can only be altered by consensus between employer and employee.

In other words, if an employee does not agree, the company cannot forcibly implement the unilateral transfer. If a large number of employees refuse to transfer, it will negatively affect the team and its normal operations.

Transfer of social insurance and personal income taxes strikes too close to home. To meet requirements of tax preference policies, in addition to the labour contracts, employees’ social insurance and personal income tax accounts must also be transferred to the new entity. If they are to be moved to another city, employees’ core interests will be affected.

As social insurance and personal income taxes are regulated by local authorities, many employee benefits are locked to their geographical location. For example, if an employee wishes to retire in a certain place, he/she is required to have recorded a certain number of years of local pension payment. If an employee wishes to obtain local hukou, China’s household registration, which makes it easier to later purchase a car or a house, it would also be based on his/her payment of local personal income tax and social insurance over a certain number of years.

So, when the city relevant to personal income tax and social insurance payment changes, the specifics of benefits and preferential treatments are also affected, inevitably cooling employees’ willingness to transfer their labour contract.

Paying social insurance remotely through agencies is coming to an end, according to policy trend. Before making decisions, companies should familiarise themselves with the local policies where employees are based. For instance, if an employee remains in city A, where the labour contract is performed, but the company needs to migrate to city B to accommodate tax preference policy, the company needs to decide whether to pay the employee’s social insurance in city A or B. This would depend on both requirements of the tax preference policy itself and the policy trend of paying social insurance remotely.

Take, for example, a company with no legal entity in Beijing, but that has employees working there, wishing to pay social insurance for its employees under Beijing’s local policy. In order to do so, in the past, the company had two options:

1. 1. Entrust an agency to pay their social insurance in Beijing under the name of the agency’s own employees; and
   2. Establish a branch in Beijing.

However, in July 2020, Beijing took the lead in halting the practice of paying social insurance remotely with a crackdown on social insurance agencies, followed by Hangzhou, Hohhot and a growing number of regions across the nation.

Uncertain job security. In addition to issues related to legal and personal interests, uncertainties in the situation will also lead to speculation and concern among employees. Is this a strategic business decision or one of financial consideration? Is the company planning even more drastic future changes, and how will that affect their own duties?

How then should corporate executives address these issues and challenges? The simplest answer lies in sound communication, legally, rationally and emotionally. Through effective and candid conversation, companies can direct employees’ views to the adjustment while building up a sense of crisis in operation, which requires both a strategic, higher-ground standpoint, and also the wisdom to not dismiss employees’ earnest concerns.

Wang Wenxu is a partner at Labours. She can be contacted on +86 135 2268 5822 or by email at wangwenxu@laibei.com