In business practice, some employees may reach informal agreements with companies to reduce taxable wages and convert them into reimbursement-type income to minimize personal income tax payments. While this behavior is relatively common in the business world, it can become a sensitive issue in labor disputes. Once a dispute arises, companies may face legal risks related to terminating the employment relationship based on employee tax evasion, while employees may leverage the company’s “collusion” to retaliate.

According to Chinese tax laws and regulations, companies, as withholding agents, are responsible for withholding and paying personal income tax on behalf of employees. If an employee is suspected of tax evasion, the company may face severe penalties for failing to fulfill its withholding obligations, with fines ranging from 50% to three times the amount of unpaid tax. In practice, tax authorities typically prefer to require companies to first pay the employee’s evaded taxes and then seek reimbursement from the employee, placing the company in a very passive legal position.

The key point is that an employee’s tax obligations are mandated by tax law and cannot be negotiated between the company and the employee. Any tax arrangement that violates laws and regulations is deemed legally invalid. In labor disputes, if an employee claims that the tax arrangement was a result of mutual agreement, the employee bears the burden of proof. In judicial practice, judges or arbitrators are usually not tax experts and find it difficult to make accurate judgments on whether an employee’s tax behavior constitutes tax evasion. Therefore, in most cases, courts or arbitration institutions will not consider an employee’s tax evasion as grounds for terminating the employment relationship.

Moreover, when evaluating whether a company can legally terminate an employment relationship due to employee tax evasion, courts or arbitration institutions will also consider whether the company has suffered significant losses as a result. Since the employee is evading personal income tax, the company has not incurred actual losses, which may turn out to be a disadvantage for the company. Some provinces have explicit regulations regarding the time limit for terminating employment relationships; for instance, Zhejiang Province requires companies to exercise their right to terminate within five months from the date they become aware or should have been aware of the situation, or they may face adverse consequences.

If a company chooses to report an employee to eliminate the risk of being a withholding agent, tax authorities will typically require the company to first pay the taxes owed, and then it may seek reimbursement independently. However, the tax bureau does not guarantee that the company will recover the taxes paid. After the termination of the employment relationship, the company may only demand the return of advanced tax payments from the employee on the grounds of unjust enrichment, and the level of court support for this varies by region.

In summary, the following recommendations are made:

Both companies and employees should strictly adhere to Chinese tax laws and regulations, ensuring compliance in tax reporting and payments. If a company needs to terminate its employment relationship with an employee, doing so solely based on the employee’s suspected tax evasion poses significant legal risks.