Independent Contractors in China: Worth the Risk?
As its economy has evolved China’s labor laws have also evolved. While independent contractors, an increasingly common trend in the United States and Japan, the world’s first and third largest economies, respectively, continue to embrace this model with increasing enthusiasm, this labor model has not taken off in the same way in China. This is due to Chinese labor laws, which strongly encourage direct employment by companies. Due to China’s strong preference for direct employment relationships that require contributions into the country’s social insurance program, hiring independent contractors is virtually impossible in China without hiring someone as an independent contractor and paying them under the table. This creates considerable legal and financial risks for companies choosing to use independent contractors instead of full time employees with proper registration to work in the country. For example, if an independent contractor hired by a construction company is killed on the job site, then the construction company will most likely be held liable by the Chinese government and will face not only a lawsuit from the independent contractor’s family but government audits, fines, and possible criminal penalties. Even discounting the risks faced if something untoward happens to an independent contractor, a company that chooses to use independent contractors also cannot deduct the expenses of their wages against its income, which will result in higher corporate taxes for the company. Using independent contractors in the PRC therefore is an approach that is fraught with risk for the employer and should not be employed for the sheer number of legal and other risks present when using independent contractors in China. Simply put, it creates substantial risks in return for minimal, if any, savings.
Independent Contractors in the United States and Japan
The laws of many countries, including the United States, allow for the job status of independent contractor. Under U.S. law, an independent contractor is someone who is not a formal employee and is not entitled to many of the perks that are traditionally offered by employers under United States custom, such as health insurance, retirement savings plans and other employer-sponsored benefits. More and more U.S. employers are starting to use independent contractors in lieu of hiring these individuals as full time employees in order to save money on benefits, payroll taxes, etc. A similar scenario is occurring in Japan, where the workplace tradition since the 1940’s has been a tradition of guaranteed lifetime employment by a single employer. This time-honored tradition has recently fallen by the wayside as many younger Japanese workers are hired on temporary contracts and serve as the functional equivalent of independent contractors.
Independent Contractors in China
Despite the increasing prevalence of the independent contractor labor model in Japan and the United States, this labor model has yet to take root in the world’s second largest economy and the rising economic superpower, the PRC. While some form of independent contractor status does exist under PRC law, it is an extremely uncommon, almost alien, concept in the Chinese labor market for both legal as well as business reasons.
Under Chinese labor and employment law, employers are required to offer each of their workers an employment contract. Failure to do so can result in the employer having to pay the employee double wages and can also land the employer in hot water with government authorities. If a company in China has employees, the company is required to pay employer taxes/benefits and to withhold employee taxes. Failing to do so is against the law. The Chinese government very strongly enforces these laws through routine audits and inspections in order to ensure that companies are maintaining compliance with China’s labor laws on this issue. This is motivated by a desire to ensure that employers are contributing to China’s social insurance program on behalf of all employees. 100% compliance is the PRC’s government’s goal and this is a goal the government aggressively pursues.
Nevertheless, for the employer who really would like to hire independent contractors, there are ways to hire independent contractors in China. An employer can go to a labor dispatch company in China who will in essence rent the labor dispatch company’s employees to the employer. In this scenario, the employer is not hiring an independent contractor. They are outsourcing hiring to another company that in turns hires people as employees. However, even the ability to utilize this type of arrangement has become much more restricted and expensive in the PRC with the 2013 implementation of the Decision on Revising the Labor Contract Law of the People’s Republic of China. Under this order, companies may only utilize independent contractors when the nature of the work that they will carry out is temporary, auxiliary or backup.
The Reality of Independent Contractors in China
The reality on the ground in China is that independent contractors nevertheless do exist. However, both the employee and employer often have a vested interest in keeping the arrangement secret where the company is using an independent contractor because in the vast majority of cases businesses will employ foreigners who may not possess the necessary work visas as, in essence, independent contractors. This allows the business to employ individuals who they may otherwise have difficulty recruiting and keeping due to their lack of proper documentation to work in the PRC; it also allows the business to save on the expenses of the paperwork associated with hiring the person(s) as full-time employees. In many cases businesses will often turn to these “independent contractors” because they can pay them less and they are easier to hire and fire. However, as explained below, this is not a good idea both for the legal risks it entails as well as the fact that it may not actually result in savings for the company.
Why Utilizing Independent Contractors is a Terrible Idea in China
Although it is not technically illegal to hire independent contractors in the PRC, this is not an attractive labor model for most companies for a variety of reasons, mainly having to do with the legal risks presented to the company. Even a company that does things “above board” and utilizes individuals who truly meet the definition of independent contractors under Chinese law, the limitations on doing so are so limited since the 2013 changes to China’s labor laws that the prices to hire independent contractors from a labor dispatch company have skyrocketed. In addition, the type of work for which independent contractors can be hired is extremely circumscribed, so much so that it can be a headache for an employer to even determine whether an independent contractor can be hired for a particular job or project.
However, hiring someone without the proper work authorization also exposes the company to significant legal risks and, contrary to what some executives might think, may actually not result in any cost savings to the employer. For instance, it also exposes any business that employs independent contractors without the proper work visas to serious legal issues if a government audit or an employee complaint ever turns up the fact that a firm is hiring employee “off the books.” Indeed, past enforcement actions by the PRC have included pursuing both the employer as well as the independent contractor for tax evasion, fraud and other serious charges under Chinese law. In addition, if an independent contractor is injured or even killed on the job, then the independent contractor, his or her family and the government will descend upon the company employing the independent contractor with lawsuits, audits, fines, and criminal charges. With respect to the financial aspect of hiring independent contractors, a company that chooses to hire someone off the books as an independent contractor cannot deduct the independent contractor’s wages against its gross income for purposes of calculating the net income upon which it is taxed by the Chinese government. Therefore, depending on the specific wages involved, an employer may actually end up not saving any money by directly hiring an independent contractor.
Although independent contractors, whether hired under the table or done properly can result in savings that translate directly to a company’s bottom line, these savings often are not the amount that a hopeful executive may wish and the risks of using independent contractors in China are simply too great to make this an attractive proposition for most employers.
About IPO Pang Xingpu:
IPO Pang Xingpu is a premier international law firm that has been representing clients in China since the early 1990s. We’ve been here longer than the vast majority of corporate law firms, and have helped hundreds of companies across a wide spectrum of industries securely and quickly establish operations in China, and then provide follow-on services for their ongoing legal needs.