Source: China Tax Network

Author: Qin Yan

Labour dispatch refers to a service whereby a labour dispatch company assigns employees to an employer to meet the employer’s demand for various temporary, auxiliary or substitute flexible workforce. The dispatched employees are under the management of the employer and perform labour for it. The most distinctive feature of labour dispatch is the separation between the employment and utilisation of labour. Services rendered under an independent labour relationship fall within the scope of VAT taxable supplies, and their tax treatment differs from that of ordinary labour contracts under an employment relationship. This article conducts a detailed analysis of applicable VAT policies, relevant corporate income tax provisions, invoice issuance rules and accounting treatment for labour dispatch.

I. Applicable VAT Rates (Levy Rates) for Labour Dispatch

Labour dispatch service is a type of modern service. In accordance with the Notice of the Ministry of Finance and the State Taxation Administration on the Comprehensive Launch of the Pilot Programme for the Replacement of Business Tax with Value-Added Tax (Cai Shui〔2016〕No.36), it is classified as human resources service under business auxiliary services. The applicable VAT rate for general taxpayers is 6%, and the levy rate for small-scale taxpayers is 3%.

The Notice of the Ministry of Finance and the State Taxation Administration on Further Clarifying Policies Concerning Labour Dispatch Services, Toll Road Toll Deduction and Other Matters in the Comprehensive VAT Pilot Programme (Cai Shui〔2016〕No.47) sets out special provisions on VAT treatment for labour dispatch services under the difference-based taxation method. Where taxpayers elect difference-based taxation, the sales amount shall be the balance of total consideration and all price-related charges received, minus the wages, welfare benefits, social insurance contributions and housing provident fund paid on behalf of the employer to dispatched employees. VAT shall be calculated at a levy rate of 5% under the simplified tax calculation method.

Accordingly, when small-scale taxpayers provide labour dispatch services under the simplified tax calculation method, two levy rates (3% and 5%) apply depending on whether difference-based taxation is adopted.

II. Relevant Corporate Income Tax Provisions for Labour Dispatch

Income derived by enterprises from providing labour dispatch services is recorded in accounts such as 'Main Business Income' or 'Other Business Income', included in the total corporate income tax taxable income. After deducting all eligible deductions and allowable losses carried forward from previous years, corporate income tax is calculated and paid. The special provisions under the current corporate income tax policies governing labour dispatch mainly affect enterprises receiving dispatched labour.

Actual expenditures incurred by enterprises for accepting externally dispatched labour may be deducted when calculating corporate income tax taxable income under two scenarios:

1. 1.Expenses paid directly to the labour dispatch company under the agreement (contract) shall be treated as labour service expenses.
   
2. 2.Expenses paid directly to individual employees shall be treated as wages and salaries and staff welfare expenses. Among them, expenses classified as wages and salaries may be included in the base of the enterprise’s total wages and salaries, serving as the basis for calculating deductions of other relevant expenses. In other words, the portion of labour dispatch payments classified as wages and salaries by the employer may be included in the enterprise’s total wage base.
   

It is worth noting that payroll expenses for dispatched employees may also be included as personnel labour costs for the additional deduction of research and development (R&D) expenses. To further incentivise enterprises to increase R&D investment and support scientific and technological innovation, successive policies have been issued to raise the pre-tax additional deduction ratio for corporate R&D expenses. The Announcement of the Ministry of Finance and the State Taxation Administration on Further Improving the Pre-Tax Additional Deduction Policy for R&D Expenses (Announcement No.7 of 2023 of the Ministry of Finance and the State Taxation Administration) raised the pre-tax additional deduction ratio of all corporate R&D expenses previously eligible for a 75% additional deduction to 100%. The scope of R&D expenses eligible for pre-tax additional deduction includes personnel labour costs, direct input expenses, depreciation expenses and others. Personnel labour costs refer to wages and salaries, basic pension insurance premiums, basic medical insurance premiums, unemployment insurance premiums, work injury insurance premiums, maternity insurance premiums and housing provident fund contributions for personnel directly engaged in R&D activities, as well as labour service fees for externally hired R&D personnel. The Announcement of the State Taxation Administration on Issues Concerning the Scope of R&D Expenses Eligible for Pre-Tax Additional Deduction (Announcement No.40 of 2017 of the State Taxation Administration) clarifies that wages and salaries paid by an enterprise accepting dispatched labour to a labour dispatch company under an agreement (contract), and actually disbursed by the labour dispatch company to externally hired R&D personnel, qualify as labour service fees for externally hired R&D personnel.

In addition, the number of dispatched employees accepted affects the calculation of the number of employees for small and low-profit enterprises, which enjoy preferential reduced corporate income tax rates. The Announcement of the Ministry of Finance and the State Taxation Administration on Corporate Income Tax Preferences for Small and Micro Enterprises and Individual Industrial and Commercial Households (Announcement No.6 of 2023 of the Ministry of Finance and the State Taxation Administration) reduced the effective corporate income tax burden for small and low-profit enterprises to 5% for the period from 1 January 2023 to 31 December 2024. A small and low-profit enterprise refers to an enterprise engaged in industries not restricted or prohibited by the state that meets all three conditions: annual taxable income not exceeding RMB 3 million, number of employees not exceeding 300, and total assets not exceeding RMB 50 million. The number of employees herein includes employees with labour relationships established with the enterprise and dispatched employees accepted by the enterprise. That is, dispatched employees shall be counted in the employer’s headcount. Based on the principle of reasonableness, labour dispatch companies may avoid double-counting dispatched personnel in their own employee headcount.

III. Tax Calculation Methods and Invoice Issuance for Labour Dispatch

Three tax calculation methods apply to labour dispatch services, depending on the type of VAT taxpayer and the adopted tax calculation method:

1. 1.General taxpayers providing labour dispatch services adopting the general tax calculation method calculate VAT at a rate of 6% based on total consideration and all price-related charges as sales amount. They may issue VAT special invoices for the full amount via the normal invoicing function in the VAT invoice management system. Employers receiving labour dispatch services may deduct input VAT according to the tax amount stated on the obtained VAT special invoices.
   
2. 2.Small-scale taxpayers providing labour dispatch services adopting the simplified tax calculation method calculate VAT at a levy rate of 3% based on total consideration and all price-related charges as sales amount. Taxpayers may issue VAT ordinary invoices for the full amount at the 3% levy rate for total consideration and all price-related charges via the system’s normal invoicing function; alternatively, they may elect to issue VAT special invoices at the 3% levy rate for the full consideration. Employers obtaining VAT special invoices issued by the dispatch entity may deduct input VAT based on the tax amount stated on the invoices.
   
3. 3.Special simplified tax calculation method for difference-based taxation. Both general taxpayers and small-scale taxpayers may elect difference-based taxation. The sales amount shall be the balance of total consideration and all price-related charges received, minus wages, welfare benefits, social insurance premiums and housing provident fund paid on behalf of the employer to dispatched employees. VAT is calculated at a 5% levy rate under the simplified method. Taxpayers electing difference-based taxation shall not issue VAT special invoices for the portion of fees collected from employers to cover wages, welfare benefits, social insurance and housing provident fund for dispatched employees; VAT ordinary invoices may be issued instead.
   

Where VAT is levied under the difference-based method and full-amount VAT special invoices cannot be issued (unless otherwise stipulated by the Ministry of Finance and the State Taxation Administration), in accordance with the Announcement of the State Taxation Administration on Tax Administration Matters Concerning the Comprehensive Launch of the VAT Pilot Programme (Announcement No.23 of 2016 of the State Taxation Administration), when taxpayers issue VAT special invoices themselves or apply for tax authorities to issue them on their behalf, they shall use the difference-based invoicing function in the VAT invoice management system. The system will automatically calculate the tax amount and tax-exclusive amount after entry of the tax-inclusive sales amount (total consideration and price-related charges) and deductible amount (wages, welfare, social insurance and housing fund paid to dispatched employees). The words 'Difference-Based Taxation' will be automatically printed in the remarks column.

It should be noted that VAT special invoices issued via the difference-based invoicing function calculate tax on the difference portion at the 5% levy rate and back-calculate the sales amount. Therefore, there is no direct proportional relationship between the tax amount and sales amount stated on the invoice. Invoices for difference-based taxation shall not be mixed with invoices for other taxable transactions.

Taxpayers providing labour dispatch services who elect difference-based taxation may also issue VAT ordinary invoices for the full consideration at the 5% levy rate. Another option is to issue partial VAT special invoices and partial ordinary invoices. Under this second option, the portion covering wages, welfare, social insurance and housing provident fund paid on behalf of the employer to dispatched employees shall be issued as VAT ordinary invoices at the 5% levy rate for both general and small-scale taxpayers. The remaining balance (total consideration minus the above deductible payments) shall be issued as VAT special invoices at the 5% levy rate. Employers may deduct input VAT for the tax amount stated on the VAT special invoices obtained.

IV. Accounting Treatment of Labour Dispatch

Accounting treatment for labour dispatch services varies under different VAT calculation methods. In accordance with the Notice of the Ministry of Finance on Issuing the Provisions on VAT Accounting Treatment (Cai Kuai〔2016〕No.22), three main approaches are as follows:

1. 1.General taxpayers providing labour dispatch services under the general tax calculation method shall debit accounts such as 'Accounts Receivable', 'Notes Receivable' and 'Bank Deposit' for the amount receivable or received, credit accounts such as 'Main Business Income' and 'Other Business Income' for the service income recognised, and credit 'Taxes Payable — VAT Payable (Output VAT)' for VAT calculated on total consideration at the 6% rate. If VAT is calculated under the simplified tax method, credit 'Taxes Payable — Simplified Tax Calculation'.
   
2. 2.Small-scale taxpayers providing labour dispatch services under the simplified tax method with VAT calculated at the 3% levy rate shall debit accounts such as 'Accounts Receivable', 'Notes Receivable' and 'Bank Deposit' for the amount receivable or received, credit accounts such as 'Main Business Income' and 'Other Business Income' for the service income recognised, and credit 'Taxes Payable — VAT Payable' for VAT calculated on total consideration at the 3% levy rate.
   

For the above two scenarios, if the VAT taxable obligation arises earlier than revenue recognition under accounting standards (e.g. invoices issued in advance), the corresponding VAT amount shall be debited to 'Accounts Receivable' and credited to 'Taxes Payable — VAT Payable (Output VAT)' or 'Taxes Payable — Simplified Tax Calculation'. When revenue recognition criteria are met under accounting rules, the service amount net of VAT shall be debited to 'Accounts Receivable', 'Notes Receivable', 'Bank Deposit', etc., and credited to 'Main Business Income' or 'Other Business Income'.

3. Accounting treatment for difference-based VAT taxation. Where a labour dispatch entity elects difference-based taxation, relevant costs and expenses (e.g. wages, welfare, social insurance and housing provident fund paid on behalf of the employer to dispatched employees) may be deducted from sales amount. When incurring such costs and expenses, debit 'Main Business Cost' and credit 'Accounts Payable', 'Bank Deposit', etc., for the amount payable or actually paid. Upon occurrence of taxable obligation, debit 'Taxes Payable — VAT Payable (Deduction of Output VAT)' or 'Taxes Payable — Simplified Tax Calculation' (small-scale taxpayers debit 'Taxes Payable — VAT Payable') for the deductible tax amount, and credit 'Main Business Cost'.
   

Case Study

Company A, a human resources firm and VAT general taxpayer, signs a labour dispatch contract with Company B. In February 2023, Company A receives RMB 1.38 million in labour dispatch fees from Company B. Out of this amount, RMB 900,000 is for the payroll of dispatched employees, RMB 60,000 for staff welfare, RMB 252,000 for social insurance and housing provident fund, and RMB 168,000 for administrative fees. Company A elects difference-based taxation.

For labour dispatch service income obtained in February 2023, Company A’s taxable sales amount is the balance of total consideration RMB 1.38 million minus RMB 1.212 million (900,000 + 60,000 + 252,000) paid for dispatched employees’ wages, welfare, social insurance and housing fund, equaling RMB 168,000. VAT payable calculated at the 5% levy rate is RMB 8,000 [(1,380,000 − 900,000 − 60,000 − 252,000) ÷ (1 + 5%) × 5%]. Key accounting entries are shown below:

Step 1: Recognise full labour dispatch revenue and output VAT

Dr: Bank Deposit  1,380,000.00

 Cr: Main Business Income  1,314,285.71

  Cr: Taxes Payable — VAT Payable (Output VAT)  65,714.29

Step 2: Recognise deductible costs and output VAT deduction

Dr: Main Business Cost  1,154,285.71

Dr: Taxes Payable — VAT Payable (Deduction of Output VAT)  57,714.29

 Cr: Employee Benefits Payable — Wages  900,000.00

  Cr: Employee Benefits Payable — Staff Welfare  60,000.00

  Cr: Employee Benefits Payable — Social Insurance and Housing Fund  252,000.00

Step 3: Carry over unpaid VAT at month-end

Dr: Taxes Payable — VAT Payable (Transfer of Unpaid VAT)  8,000.00

 Cr: Taxes Payable — Unpaid VAT  8,000.00