With the Regulations on the Reform of National Tax and Local Tax (the "Reform") adopted on 20 July 2018 (to become effective on 1 January 2019), the responsibility to collect social insurance premiums (i.e. for basic pension insurance, basic medical insurance, unemployment insurance, work-related injury insurance, and maternity insurance) will be transferred from the local social insurance bureau to the local tax bureau. This means that from 2019 onwards, the same bureau will be in charge of the collection of both individual income tax and social insurance premiums.
This could have huge implications on companies in China, as the local tax bureau will have direct information on whether:
- Social insurance premiums are being contributed on the full salary of employees.
- Social insurance premiums are being contributed in the location where the employer is established.
- Under-Reporting of Social Insurance
The law (via the Circular on Relevant Matters concerning the Standardization of the Social Insurance Contribution Base ) establishes very clearly that social insurance should be declared and withheld by the employer and paid on the full monthly salary of the employee. The only exceptions are:
- If the monthly salary is higher than three times the average salary in such location, then this "cap" will be used as basis to calculate and pay premiums.
- The social insurance basis is normally adjusted once per year. Therefore an increase of wages will not immediately lead to an increase in social insurance obligations; instead adjustments should be made around February every year (referring to the average monthly salary in the previous calendar year).
Under current practice, social insurance bases are reported to and premiums are collected by the local social insurance bureau, which does not have direct access to information on an employee's actual salary; while the local tax bureau has the employee's salary (to calculate individual income tax) but is not involved in social insurance premium collection. As these authorities have separate systems and generally do not share information, some companies get away with under-contribution of social insurance premiums.
The main objective of the Reform is to put an end to this practice. Once local tax bureaus combine the two information systems into one, any incongruences will be found out immediately. Penalties for non-compliance remain unchanged, and include late fees (0.05% per day) and a penalty of up to three times the outstanding amount.
- Location of Social Insurance Declaration
The Administrative Provisions on Declaration and Payment of Social Insurance Premiums  (Article 4) provide that social insurance premiums should be paid in the location where the company is located. In practice however, it is very common for a company to hire people directly in other locations. Some examples of common situations:
- A retailer who is selling in another city through a join-sales agreement with a department store (so no branch is needed), and is using its own staff to operate the consignment store in the name of the landlord;
- A manufacturer has sales people in locations all over China to reach customers, but manages these people from HQ.
- A sourcing company hires local quality control people to manage production processes at various factory locations.
In all the above examples, the employee will want to benefit from social insurance premiums paid in the location where he/she works, but the employer is registered at a different location and prefers to avoid the set-up of a separate registered branch office in each location that it has staff. The normal way around the above restrictions is to hire a national-level, certified human resources agency (i.e. a staffing firm) such as FESCO or CIIC to assist: the employment relationship remains with the company and so individual income taxes are withheld and paid at the location where the company is registered; while the agency assists to pay social insurance premiums in the other location under a separate service agreement.
While we cannot stress enough how common this practice is, it is technically incompliant. And when the collection systems for IIT and social insurance premiums are combined, then any inconsistency will immediately become clear to the tax authorities.
The Reform does not seem to be primarily targeted at this practice, and it would be a huge effort on the part of tax bureaus to force companies to change their practices. It is also a main part of the business of State-owned staffing firms such as FESCO and CIIC which would lose much of their relevance if the practice is disallowed. At the same time, unless the current practice is somehow legalized, there remains a risk that a tax bureau will start addressing this issue sooner or later – for example by refusing payment of social insurance premiums if no IIT has been paid in the same location, or pursuing companies that try.
If a tax bureau raises concerns, and for companies that want to get ahead of the issue, we see the following options:
- Pay social insurance premiums in the location where the company is located, even if the employee is based elsewhere and cannot then fully benefit from the social insurance system. This would increase the challenge of competing for the best talent.
- Establish a branch in every city where fulltime employees are located, so that social insurance premiums and salary can be paid by the branch. This would significantly increase an employer's administration and costs.
- Have a staffing firm hire the employee directly and dispatch her to the company. However dispatch services are only permitted for temporary, auxiliary and alternative positions, and should represent no more than 10% of the total work service. Moreover, dispatch will reduce control over the employment relationship, and can increase costs.
Companies should review their practices to ensure that social insurance premiums are based on the full salary of their employees. While the risk of incompliances being discovered has been relatively low in the past, it will become very high starting 1 January 2019 and with high penalties, it is important to get ahead of the problem as soon as possible.
As regards the practice of paying social insurance premiums in a different location from where the employee is established, it remains to be seen how big this risk will be. Companies have a number of alternative approaches but none are ideal. Companies that wish to minimize risk should consider acting now; in any case, an affected business should be ready to take action immediately if its local tax bureau raises the issue.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.