Introduction
Potential legal exposures of third-party contribution arrangements
Adoption of strict measures against third-party contribution arrangements
Methods to rectify third-party contribution arrangements
Schedule for rectification
There is currently no nationally integrated social insurance system in China, meaning that social insurance schemes are still administrated by local governments at provincial level. Therefore, cross-city contributions are not feasible, and the Social Insurance Law explicitly provides that an employer is responsible for making social insurance registrations and contributing social insurance premium payments for all its employees in the city in which it is registered.
Employees are challenged by the fact that they are not allowed to enjoy social insurance benefits no matter where they work and live due to the lack of an integrated social insurance system. In other words, contributions may not be of much value to many employees if they work and live in another city. Therefore, employers in China often engage third-party local agencies to assist with social insurance contributions for employees based outside the company's registered location (ie, forming a third-party contribution arrangement).
A third-party contribution arrangement does not comply with the Social Insurance Law as there is no employment relationship between the concerned employees and the third-party agencies. The third-party agencies are not in a position to contribute social insurance for the concerned employees. Further, the legal employer of the concerned employees also will not satisfy the mandatory requirement of contributing social insurance for all its employees in the cities of the registered locations.
In short, third-party contribution arrangements are not in line with the legal requirements of the Social Insurance Law.
Potential legal exposures of third-party contribution arrangements
On this basis, there are certain legal exposures for employers to adopt such arrangement, several of which are summarised below.
Cessation and rectification of third-party contribution arrangements
Recently, third-party contribution arrangements were explicitly restricted by local regulations or practices in cities such as Beijing and Hangzhou. Therefore, the companies that adopted such arrangements in the past have had to rectify their contribution practice together with the third-party agency engaged within a given grace period. Specifically, companies are required to establish their local subsidiary or affiliate, as well as a local social insurance account, to make contributions for their employees in the area in question. The grace period normally varies from two to three months. If the company has no existing local entity, such grace period might be extended to around one year according to past practice in Hangzhou.
Making up under-paid social insurance premium and paying off fines
Employers may also face administrative penalties including orders to make up any social insurance contribution shortfalls and daily overdue fines of 0.05% of the under-paid social insurance premium. Such penalties could apply even if employers arranged and financed contributions at the concerned employees' request.
Claims on constructive termination and severance payment from concerned employees
It is possible that some employees may make a claim on constructive termination and demand statutory severance pay on the ground that their employers failed to contribute social insurance for them.
As a matter of practice, if an employer can evidence that it arranged and financed contributions at the employee's request (eg, showing the written application or consent signed by such employees), it will mitigate the legal risk of the constructive termination and severance payment. However, such risk can never be totally ruled out. A case in Guangdong Province saw a court supporting a similar claim, even though the special third-party contribution arrangement had been initiated based on the employee's own application.
Paying work-related injury benefits
Employee eligibility for work-related injury benefits may be restricted under a third-party contribution arrangement as the proof of a local labour relationship with the entity that contributes social insurance for the employee may be required when an employee applies for work-related injury benefits. Therefore, under a third-party contribution arrangement, if an employee suffered from a work-related injury, and if the relevant social insurance authorities strictly enforced the Social Insurance Law, they may not be eligible for the relevant work-related injury insurance benefits. This is because their employment contract will have been signed with their legal employer rather than the third-party agency that contributes their social insurance. If that is the case, the legal employer would be ultimately liable for paying all the work-related injury benefits that should otherwise be paid by the work-related injury fund.
Compensating other losses relating to third-party contribution arrangement
Apart from the work-related injury benefits, although not commonly seen, the concerned employees' eligibility to other social insurance benefits (eg, an unemployment subsidy) may also be impacted by the third-party contribution arrangement based on the different practices in different cities. Therefore, the employee's claim for compensation, which is equal to their actual social insurance losses, may be supported by a local court. Nevertheless, compared with the risk of paying the work-related injury benefit, this type of risk is relatively low.
Further, in some cities where the employee's right to acquire a hukou (a local household registration) and/or purchase real estate and a car is linked to their local social insurance contribution, it is theoretically possible that employees may bring cases against employers due to a third-party contribution arrangement and claim for compensation. However, such claims have rarely been supported by the courts (eg, in Shanghai). Therefore, risks in this regard are not considered to be high.
Criminal liability
Third-party contribution arrangements may expose the third-party agencies and the legal employer to potential criminal liability as fabricating documents and/or conditions to obtain social insurance benefits is also deemed to be a criminal offence if the situation is extremely serious. That said, there is no evidence that this has happened so far. Further, considering that the third-party agencies are to assume the main criminal liability in such cases, the risk for criminal liability is controllable overall.
Adoption of strict measures against third-party contribution arrangements
While third-party contribution arrangements have long been widely adopted among companies in China, employers have rarely been issued administrative penalties for establishing them. There is speculation that the Social Insurance Bureau tolerates these arrangements despite their illegality under the Social Insurance Law.
However, some cities have recently adopted strict measures and restrictions against third-party contribution arrangements and have requested local companies and third-party agencies to rectify any effective arrangements within a designated deadline.
Since June 2020, some provincial governments have begun to strengthen the enforcement of the statutory requirements relating to social insurance registration and contribution. For example, the labour authority in Beijing requires that all individuals who are enrolled to contribute social insurance in Beijing must be registered under a Beijing-registered legal entity in the social insurance system and have an employment relationship with that Beijing entity. Consequently, third-party contribution arrangements are no longer allowed in Beijing and payroll agencies and employers are currently provided with a grace period to make overall corrections and alternative arrangements. Similar requirements have also been seen in Hangzhou and Guangdong Province.
Finally, the revised Measure for Administrative Supervision of the Social Insurance Fund issued by the Ministry of Human Resources and Social Security, which took effect from 18 March 2022, further set out a restriction on fabricating documents for social insurance benefits. It is still a new measure and no related penalties have yet been imposed. It is widely interpreted that this might be a signal that third-party contribution arrangements may be restricted in a more severe manner in the near future.
Methods to rectify third-party contribution arrangements
The most common rectification methods for third-party contribution arrangements that are currently in use are:
- establishing local subsidiaries and branch offices or using existing local store branch offices for the concerned employees;
- contributing social insurance premium for the employees in the city in which they are located; and
- transferring the employment status of the employees from direct hires to dispatched employees or outsourcing labourers, and having their social insurance contributed by the labour dispatch companies or the outsourcing companies (which are their legal employers).
As the rectification measures consist of several steps, it will take time for employers to rectify third-party contribution arrangements. In light of this, employers should gradually rectify the practice based on the level of risk:
- For cities with strict standards, such as Beijing, Hangzhou and Guangdong Province, where the government does not accept third-party contribution arrangements, employers must set up a local legal entity (eg, a branch office) to comply with the law and the practical requirements.
- For cities where third-party contribution arrangements are still allowed, the current practice of paying through third-party agencies should be maintained. Employers could closely monitor the changes of practice in these cities and maintain close communication with local agencies. If there is any change to local practice, employers should promptly try to align themselves with the change.
For further information on this topic please contact Wei Hu or Tingting He at JunHe by email ([email protected] or [email protected]). The JunHe website can be accessed at www.junhe.com.