1. Legal Framework Differentiating Employees From Independent Contractors
a. Factors that Determine Who is an Employee and Who is an Independent Contractor
In practice, labor arbitration commissions and courts mainly refer to the Circular of the Ministry of Labor and Social Security on the Establishment of Employment Relationship (hereinafter referred to the “Circular”) to determine whether an employment relationship exists. According to the Circular, the basic characteristics of an employment relationship are: (1) both the employer and the employee are qualified to enter into an employment relationship according to law; (2) the employer’s various rules and regulations formulated in accordance with the law are applicable to the employee, and the employee is subject to the employer’s labor management and is engaged in certain paid work arranged by the employer; and (3) the employee’s work is part of the employer’s business. If the three factors above are satisfied simultaneously, an employment relationship shall be deemed to have been established, and the person involved should be an employee instead of an independent contractor.
Also, the Circular further provides that the following vouchers could be used as reference for confirmation of the employment relationship between two parties when there is no written employment contract: (1) wage payment voucher or record (employee payroll) and the record of various social insurance contributions; (2) the certificates such as the "Work Certificate" and the "Service Certificate" that can prove the identities issued by the employer to the employee; (3) the recruitment and employment records of the employer such as the "Registration Form" and the "Enrolment Form" that have been filled in by the employee; (4) attendance records; and (5) testimony of other employees. The employer shall be responsible for providing the vouchers as stipulated in item (1), (3) and (4) above.
In addition, some local courts provide more specific criteria for determining whether there is an employment relationship between two parties. For example, the opinions issued by Shanghai High People’s Court in 2002 emphasize that a person shall not be deemed as an employee if he/she is not subject to the management, constraint or control by the employer, takes the business risks with his/her own skills, facilities and knowledge, basically does not need to follow the work instructions of the employer and have no subordinate relationships with the employer. Such kind of person could be deemed as an independent contractor.
b. General Differences in Tax Treatment
According to the tax laws of China, employees shall pay individual income tax on the wage and salaries they receive from employers. The tax exemption amount is RMB 3,500 for Chinese employees and RMB 4,800 for foreigners, and then the progressive tax rate in excess of the said specific amount varying from 3% to 45% will apply. Employers should be responsible for withholding employees’ individual income tax from the wages and salaries, and then pay it to the tax authority for and on behalf of employees.
The tax treatment under other civil relationships is quite different from that stated above and depends on the specific situations. For example, if an independent contractor provides services to a company and receives remuneration for such personal services, the individual income tax on the remuneration would be paid at the rate of 20% of the balance after deduction of RMB 800 from each income not more than RMB 4,000 or the balance after deduction of 20% of the expenses of each income of more than RMB 4,000.
c. Differences in Benefit Entitlement
Under an employment relationship, employers shall contribute to employees’ social insurances (including pension insurance, medical insurance, work-related insurance, maternity insurance and unemployment insurance) and housing reserve fund in accordance with national laws and local regulations. Employees are also entitled to various statutory leaves including but not limited to paid annual leave, marriage leave, maternity leave, paternity leave, work-related injury leave and sick leave. Employers may grant more, but never less than the mandatory minimum level as provided by law. However, on the other hand, independent contractors are, in general, not granted the mandatory social insurances and housing reserve fund, or mandatory paid leaves described above.
d. Differences in Protection from Termination
PRC labor laws generally favor employees and therefore contain many statutory provisions on termination of employees. An employer is only permitted to immediately and unilaterally terminate an employee without severance pay in one of the following circumstances:
- the employee fails to satisfy the employment conditions during the probationary period;
- the employee seriously violates the labor disciplines or the employer's rules and regulations;
- the employee has established an additional employment relationship with another employer, which materially affects the completion of his/her tasks with the employer, or the employee refuses to rectify the matter per the employer's request;
- the employment contract is invalid because the employee used means such as deception or coercion, or took advantage of the employer's difficulties to cause the employer to conclude the contract or to make an amendment thereto, which is contrary to the employer's true intent; or
- the employee is criminaly prosecuted under the law.
Furthermore, the employer may terminate an employment contract under any of the following circumstances, but it must give the employee 30 days’ prior written notice or one month’s salary in lieu of notice, and also must pay severance in accordance with law:
- the employee, after undergoing a legally prescribed period of medical treatment and recuperation for an illness or non-work-related injury, remains unable to perform his/her original job duties, and is also unfit for another job assigned by the employer;
- the employee is incompetent in fulfilling his/her duties, and remains so after undergoing further training or an adjustment of his/her position;
- the employment contract cannot be performed due to any major changes of the objective circumtances under which the contract was originally conclued, and the employer and the employee fail to reach agreement on modification of the contract after mutual consultation.
If the employer intends to initiate a collective redundancy with at least 20 employees or 10% of the total staff being affected, it must satisfy certain conditions and complete the required procedures such as communicating with the trade union or all staff, seeking opinions from the trade union or employee representatives, and filing the redundancy report with the local labor administrative department.
Practitioners and courts in China interpret these statutory termination provisions as exhaustive. In other words, employers cannot add any additional conditions for early termination in its employment contract and use such additional conditions to unilaterally terminate their employees. The only way in which the termination provisions of an employment contract may differ from statutory termination conditions is by optional reference to an employee handbook (also known as a staff handbook) or other internal policies.
Employees may initiate labor arbitrations in response to any unilateral termination by their employers. Either employee or employer may appeal a labor arbitration’s decision to the court when feeling dissatisfied with its decision. During the labor arbitration or litigation, the employer must provide solid evidence to support the termination and assume the burden of proof. If the unilateral termination by the employer is finally judged as illegal, the employer must either reinstate the employment with the employee and provide back pay, or pay double statutory severance as compensation for the wrongful termination.
However, termination of an independent contractor is much easier and more flexible. The company may terminate an independent contractor by serving a notification according to the conditions stipulated in the contract for service, or the Contract Law of the People’s Republic of China, but does not need to pay severance unless otherwise agreed by the parties. The company and the independent contractor may also agree on a termination at will without cause. Independent contractors are not protected by the provisions of the Labor Contract Law, but if they suffer losses from the company’s termination which breaches the contract or law, they may claim compensation for damages.
e. Local Limitations on Use of Independent Contractors
There are no specific limitations on the use of independent contractors in China. However, employers are not allowed to use nominal independent contractors to avoid their employer liabilities under PRC labor laws. Such relationship with the “nominal independent contractors who are de facto employees” will be penetrated by labor arbitration commissions and courts, and identified as an employment relationship according to the factors as stated above.
f. Other Ramifications of Classification
There are also other ramifications of difference between employees and independent contractors. For instance, employees shall work under one of the three working hours systems (i.e. standard working hours system, flexible working hours system and comprehensive working hours system) based on the nature of their work and positions. However, there are no specific working hour requirements for independent contractors.
In addition, the employer shall bear liability if any third party suffers loss or injury due to the employee’s performance of duties. However, based on different types of contractual relations, independent contractors’ liabilities for tort may be different. For example, according to Article 10 of Interpretation of the Supreme People's Court on Several Issues Concerning the Application of Law in Hearing Cases of Compensation for Personal Injury, where a contractor causes an injury to a third person when completing certain work, the contractor itself shall bear the liability unless the hirer has any negligence in respect of its order, or instruction or selection of contractors.
g. Leased or Seconded Employees
Under PRC labor laws, it is possible to lease employees to another employer, which could be called “labor dispatch”. Labor dispatch means the labor dispatch agency enters into a labor service contract with an accepting company and then dispatches its employees to the accepting company in exchange of service fees. The dispatched employees work under the instruction and management of the accepting company, but the labor dispatch agency is the legal employer of these employees and shall bear employer liabilities. The main advantage of labor dispatch is flexibility: dispatched employees are not considered regular employees of the accepting company. As a result, many companies used labor dispatch as their main or only method for hiring employees based on the belief that hiring through dispatch agencies could mitigate or avoid employer liability. Against this backdrop, the Labor Contract Law, which came into effect on January 1, 2008, attempted to address this practice by mandating equal rights for employees hired through labor dispatch agencies and “generally” restricting the use of labor dispatch only for “temporary, auxiliary and substitute” jobs. However, labor dispatch agencies have seized on the term “generally” in the law and the vagueness of the terms “temporary, auxiliary and substitute” to argue that there is no real restriction on the use of labor dispatch; as a result, the use of labor dispatch by companies increased rather than decreased. This is contrary to the legislative intent of the law.
In this situation, the Standing Committee promulgated the Decision on Revising the “Labor Contract Law of the People’s Republic of China” (the “Amendment”) on December 28, 2012, which came into effect on July 1, 2013. The Amendment focuses on labor dispatch issues by addressing the standards for labor dispatch agencies, discussing the general rule of equal pay for equal work, defining the scope of labor dispatch and setting forth the consequences for violating these regulations. To implement this Amendment, the Ministry of Human Resources and Social Security promulgated the Interim Provisions on Labor Dispatch (the “Interim Provisions”) on January 24, 2014, which became effective on March 1, 2014. The Interim Provisions describe the criteria for temporary, substitute and auxiliary positions, state the maximum proportion of dispatched employees an accepting company may have, establish the conditions for returning dispatched employees, and contain provisions on social insurance and work-related injury obligations. The Amendment and the Interim Provisions set strict limitations on labor dispatch, which has caused many companies to transfer dispatched employees to direct hire of employees or use labor outsourcing services as a substitute for labor dispatch to ensure full compliance with law.
On the other hand, there are no specific regulations on secondment of employees. In practice, secondment is used mainly by government agencies and public institutions to complete certain temporary work. Now some private companies may also second employees to other companies, mainly to their affiliated companies or business partners, with their employment relationships with the seconded persons remaining unchanged. Secondment and labor dispatch are very similar. The major difference is that secondment is not for the purpose of profit, and the seconding company shall not receive any remuneration from the accepting company except the reimbursement for the cost in relation to the employees’ salaries, social security contributions and other fees payable to the employees during the secondment period.
h. Regulations of the Different Categories of Contracts
In China, employment relationships are bound by various labor and social security laws, including but not limited to, Labor Law, Labor Contract Law, Social Insurance Law and Trade Union Law. The rights and obligations of employees and employers under these laws are quite different from those under general civil legal relationships. The contract for service with an independent contractor is subject to the Civil Law and the Contract Law, observing the principle of autonomy of will, and is more flexible in the conclusion and termination of contracts.