Structuring efficient compensation packages for employees can help a company to develop a stable workforce. However, it does make processing of payroll complex and risky to handle internally. The more a company differentiates compensation based on ability instead of seniority or length of tenure, the more it becomes important to ensure confidentiality.

Companies also face the risk that their internal human resource (HR) departments will interpret tax laws incorrectly; after all it is their own salaries that are affected as well. Potential consequences can be punitive fines from the tax office or even withdrawal of corporate income tax incentives provided by the local government. For these and other reasons, many companies are turning to professional third party outsourcers to handle their payroll in China.

Most foreign businesspeople will be familiar with the services provided by domestic organizations like Beijing Foreign Enterprise Human Resources Service Co. Ltd. (FESCO). While such companies are able to process payroll, make social welfare contributions on behalf of Chinese employees and handle individual income tax filings, organizations like these tend to be limited in two respects:

1. Their only line of communication is generally to the internal management team in China. It will be hard for the foreign investor to guarantee that the information provided by the local management team and the data that have been processed are accurate and in compliance with the law.

2. These organizations have a local presence in virtually every city in China. In addition to having direct contact with the local HR team they may also have direct contact with employees. This can affect confidentiality, especially in smaller cities with limited foreign investment. These companies also provide headhunting and other related HR services, which can lead to a major conflict of interest when processing payroll.

There are alternative options. Specialist payroll management providers now exist in China, providing professional, confidential services. Often they will base themselves in cities far from the location of their clients with the transmission of payroll-related data managed through secure servers.

Such providers can report directly to HR departments abroad and leave local HR to concentrate on hiring, termination and appraisal. The better ones will possess sophisticated systems capable of processing every aspect of payroll and providing comprehensive reports to headquarters on demand.

Individual income tax

After deduction of mandatory social security contributions from gross taxable income, Chinese nationals earning more than 2,000 yuan (about $290) per month are required to make monthly individual income tax (IIT) payments. The proportion of income payable to the tax authorities should increase gradually from 5 percent to 45 percent depending on income bracket. Wages on average are much lower in China than in most Western countries, correspondingly the top bracket of 45 percent is imposed on monthly taxable income exceeding 100, 000 yuan (about $14,500).

IIT is payable to the local tax bureau in the city where the company is registered. Companies are responsible for deducting the correct amount of IIT contribution from each employee's pay package before releasing the net take-home pay to staff. Consequently, companies can be held liable by the tax bureau for any underpayment made on behalf of employees.

Toward the end of each month, companies should calculate the amount of taxable income for their employees and the amount of tax payable. Then at the beginning of the following month a filing will be made with the local tax bureau for each employee. In most cities this filing is done online, although in certain locations a visit to the tax bureau is still required every month. Once the window for online tax filing closes the tax department will automatically take the amount of IIT filed by the company from the designated bank account. This is usually till the 10th of each month, although it still differs by city and exceptions can be made for months that start with long public holidays.

Companies that file less than the correct amount of tax on behalf of their employees can face punitive fines, while those that overcharge tax will have to go through a long process to recover the excess amount paid.

Even in cities that accept online filings of IIT, local tax bureaus around the country still require companies to make manual tax filings, although these are usually made quarterly or yearly instead of monthly. Beijing is an exception to this rule, where online filing is sufficient.

(This article will be continued in Issue No. 5, 2009)