Employer of record (EOR) services in China can create an unavoidable risk of civil, even criminal, liability. These services use local third-party entities as nominal employers to pay social security benefits for the person hired, and while the approach is widespread, it violates social security law and therefore raises a number of legal risks. In this article, we’ll go over the law and specific case studies of what caused other companies to be penalized, along with strategies for minimizing legal risks in situations where you might have a genuine need to use an EOR.

Contents

How EOR works in China

Civil liability for denial of coverage

Regulatory penalties for noncompliance

Criminal liability for major violations

Compliance Strategies to Minimize Social Security Risk

How employer of record services work in China

Operational challenges due to local entity requirements in China affect local companies as much as foreign ones, which has resulted in a robust EOR/PEO industry in China. Nonetheless, “employer of record” is an alien concept to Chinese law. Rather EOR/PEO is a solution developed by the private sector without legal sanction. Currently, EOR involves individuals with no genuine employment relationships with the entities that employ them, nonetheless having social security contributions made through them. Despite government crackdowns on EOR services, China’s market regulator still permits these services: even industry titans like Alibaba’s Ant Financial and 51.com launched EOR platforms.

EOR is often a practical necessity under Chinese law because its social security law often involves unmanageable red tape that makes it necessary to have a local entity, even if you are registered elsewhere in China. Many local government social security departments require a local entity to make contributions for anyone working “full-time” locally, which starts at 24 hours per week.

The increased popularity of remote workers following COVID has created a widespread situation where companies lacking a local entity have no way of making local social security payments for remote employees. Other companies attempt to reduce social security costs by paying in provinces with lower requirements. As a result, EOR is widespread despite lacking legal recognition.

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China EOR/PEO’s Confusing Terminology

Mandarin Chinese itself uses an informal metaphor to describe “employer of record” services, that being “hanging it on” (guakao) a third-party nominal employer. In this article, we refer to it as “EOR” without using the metaphor. In court cases, the EOR provider is usually referred to as an “HR Company,” which is a license type, with no mentions of the metaphor, and the courts provide a sentence-long description of how the HR company is a service that acts as the employer of record for social security. We abridge this to “HR Service” in the translation summaries below. When doing any type of business in China, it’s important to make sure that mistranslations don’t mislead you about what the law actually says.

EOR/PEO services originated outside China as a legitimate business service, but the circumvention strategies for Chinese companies to deal with the lack of local entities developed locally with their own parallel history. That means that using an EOR structure in China will likely be viewed by the courts as being the local circumvention method, guakao.

The government started cracking down on EOR/PEO in recent years because China’s birth rate decline and aging population have started to cause significant strain on local government social security departments. In turn, this has resulted in more vigorous social security compliance enforcement. The regulation Social Security Fund Administrative Oversight Procedures was therefore issued to solve these problems by encouraging more vigorous enforcement.

Recent local laws now provide enhanced enforcement directives to officers, the first of these being issued under the Guangdong Province Social Security Payment Violations Circular.

China EOR Business Models

Employer of record services in China use third-party entities as nominal employers to pay social security benefits for the person hired. EOR services in China are typically provided in one of two ways:

• The employer is located somewhere different from where the employment contract will be performed or where the worker lives, so they engage a third-party organization to make payments locally.
• Freelancers and temps use the non-employer organization to make social security payments.

Regardless, using an employer of record to circumvent local entity requirements is absolutely not permitted under Chinese law. The rationale for prohibiting EORs is that provinces and home rule cities’ social security departments rely on the cash flow provided through the Employment Contract Act framework for full-time workers (24+ hours/week). Under the China Social Security Act, contributions must satisfy two requirements:

• Social security payments must be made by the entity with the actual employment relationship.
• The employer must make social security contributions in their actual location.

(See generally Social Security Act §§4, 57, and 58, and Social Security Contribution Temporary Regulations)

The typical problem under social security law is that the employer is unable to make payments to the local social security office because they don’t have a local entity. In this respect, the need for a solution is similar to an international business that doesn’t have an entity in China. Freelancers also have problems with making social security payments locally on their own behalf because of hukou and other local administrative agency requirements, thus they look to using EOR/PEO.

While using a China EOR/PEO achieves social security payments in this case, it is not legally compliant and therefore creates significant legal risks. The most common risk of using EORs is civil liability, where an employee can claim constructive discharge and claim financial compensation on grounds that social security contributions were not made.

Legal authority for these claims is recognized by Chinese courts and derives from Employment Contract Act §§38 and 46 governing social security non-payments. No regulations further define whether the use of an EOR violates the statute, but judicial precedents reveal there is a risk of liability under the constructive discharge theory. Some local laws support claiming constructive discharge if a third-party organization is hired to make social security contributions for the employer.

Typically, Chinese judges inquire into subjective bad faith and whether the employee gave informed consent to the payment arrangement; obtaining informed consent from the employee following fair negotiations can improve outcomes. Many courts bar an employee’s claims if the evidence establishes no employer bad faith, the employee gave informed consent, and no financial loss occurred.

The judicial precedents imply that you can at least mitigate or reduce the risks of using an EOR/PEO to hire in China without a legal entity. Below, we’ll go over a list of Chinese court cases that performed this analysis, illustrating what the actual legal risks are. Links are provided for cases that have sources outside paid legal databases.

In Beijing Appeal 02-cv-1006, the employee did not prove that the company evade social security payments in bad faith. The employee in this case, Ma, worked in Shenzhen, which prohibited out-of-province employers from making direct contributions, and thus the Company hired an HR Service to make local contributions for it. The court found that Ma provided insufficient proof of bad faith intent to circumvent making contributions.

Ma also claimed social security was underpaid, but the court held that Ma must first demand supplemental payments be made. Additionally, it denied their demand for financial compensation under the constructive discharge theory.

In Shanghai Appeal 02-cv-10102, the Company was not liable to pay financial compensation even though its decision to use an HR Service to make social security contributions was inappropriate.

In this case, the company used an HR Service to pay employee Nie’s social security contributions without his knowledge or consent, and there was no evidence of evasion. Nie also claimed underpayment due to using the wrong social security base, but Nie never made a demand to correct it. In the absence of other evidence, the court held the evidence presented was insufficient to show the company acted in bad faith.

In other courts across China, however, judges support employee claims under this theory solely for lack of strict Social Security Act compliance, which creates a significant risk for employees.

In Chongqing Appeal 01-cv-2386, failure to comply with the statute constituted failure to make required social security contributions. The Company made contributions for employee Lei using an EOR arrangement, which the court found resulted in material losses to Lei due to a lack of compliance with social security law. Lei terminated the employment contract by email as a result. The court held this to be a constructive discharge termination and ordered payment of financial compensation.

The social security administration may refuse to disburse payments to  the beneficiary.

The EOR approach can result in the Chinese government refusing to pay out social security benefits on the grounds that the social security premiums were paid by an entity having no genuine employment relationship with the employee in question.

This result often occurs in workplace injury claims made under China Social Security Act §41, because the employer of record’s qualifications are rejected. The actual employer may therefore be held liable for the cost of the social security owed, the workplace injury itself, and workman’s compensation.

If you don’t have an entity in China and hire using an EOR/PEO, the government may enforce the liability by freezing your payments into the country and imposing exit bans on your staff until the accounts are settled.

In Beijing Appeal 02-cv-1678, the employer did not lawfully contribute to an employee’s China social security, causing ineligibility for disbursement. A Company in Beijing outsourced social security payments to an HR Service and when an employee, Deng, suffered a severe work injury, the local social security department refused to pay his medical expenses. The court held the Company liable to indemnify Deng for all expenses in one lump sum payment.

In its opinion, the court cited the law that the employer must directly make social security contributions. The HR Service didn’t actually make the contributions for Deng’s social security, causing his ineligibility for receiving medical insurance and workman’s compensation coverage.

While not introduced into evidence in this court case, a common reason employers of migrant workers in Beijing have for outsourcing social security payments is that the worker’s hometown has a lower social security base than Beijing, which can cut social security costs in half. The Social Security Administration, however, is well aware of this potential loophole and may refuse coverage on grounds of underpayment noncompliance.

In the following cases, we will see that once an employer is found to have failed to lawfully contribute to an employee’s social security fund, they will be liable for payout amounts for health care, unemployment, and retirement payments.

In Hunan Appeal 01-cv-33, social security contribution noncompliance resulted in an order to pay maternity costs ordinarily covered by the government. Social security contributions were deemed non-compliant because the HR Service was not the genuine employer, and therefore the company was ordered to pay maternity costs.

Contractual provisions requiring the HR Service to bear the financial risk of noncompliance have been held unenforceable. In practice, an EOR/PEO Contract can include provisions requiring the HR Service to assume liability for the legal risks described in the above section. Nonetheless, some EOR services will often refuse to make the promised payments, and with good legal grounds, because Chinese contract law requires that unlawful contract provisions be unenforceable. Therefore, if taken to court, there is a major risk the judge will strike down the provision and deny relief.

In Beijing Appeal 03-cv-1281, such an EOR contract indemnity provision was held unenforceable. The judge in this case wrote that, as a matter of law, an agreement with an HR Service to cover liability for possible social security refusal is unlawful and harmful to the public interest.

The court noted how the facts of the case involved an HR Service that had actually contributed the costs to China’s social security administration, and therefore this part of the contract had been performed without any breach. The disputes arose because the required payments were miscalculated, resulting in a denial of coverage, but the obligation to pay is the company’s and not the HR Service’s.

The court also held that a provision requiring indemnity for the 600,000 CNY of workman’s compensation coverage is unenforceable, even though the contract included this in the provisions as a guarantee by the HR Service.

Using EOR/PEOs in China Could Result in Fines and Blacklisting.

Using an EOR/PEO to hire in China without a legal entity could subject you to major liability due to mistakes made by the service provider. The employer of record will often simply not make social security contributions for the employee locally as required by law, which can leave the actual employer open to claims by the employee. In the following cases, an EOR was used to avoid making social security payments at the employer’s place of business, Beijing, which has a very high social security base floor. These cases reveal the risk of using EOR services for employees located in high-cost-of-living cities as a cost-cutting strategy.

In Beijing Appeal 03-cv-368, an EOR could not substitute for an employer’s obligation to make social security contributions at their place of business. The court reiterated that China Social Security Act §57(a) and its regulations require making contributions to the local government social security department. A company located in Beijing’s high-cost Chaoyang district hired an HR Service to make social security contributions for its employee Hu, but instead of processing in Beijing, the contributions were made in Jinan City, Shandong Province. The court held that the company failed to lawfully make social security contributions.

In addition to the financial liability imposed in the above cases, the Chinese government may also place your company on a blacklist. A more recent Chinese regulation, the Social Security Fund Administrative Procedures (2022), now specifically imposes administrative penalties for engaging in the unlawful practice of using a sham employment relationship to make false claims for social security benefits.

The 2018 Social Security Dishonesty Memorandum provides 32 types of administrative penalties for failure to contribute or for making false statements to obtain social security coverage. The rules deem such practices as dishonest and non-compliant, and the Social Security Major Dishonesty List Temporary Procedures require listing persons who have committed fraud or falsification for participation in social security. Blacklisting in China can result in denials related to government contracting, financial services, or public securities trading.

Risk of criminal liability if you offer EOR/PEO in China.

International human resources companies operating in China risk criminal liability for offering EOR/PEO services. The risk of criminal liability mainly occurs in scenarios where your employees are noncompliant with social security rules in a way that causes excess payouts by the administration. Criminal culpability is provided under Social Security Funds Oversight Procedures §39. The procedures require construing fraud or falsification in social security enrollment as criminal fraud within the scope of the China Criminal Law Act §266.

Local governments throughout China have also clamped down on social security problems by issuing rules requiring their social security department to refer suspected fraud and falsification to the police department.

In Guangdong Case 0404-crm-40 (2018), company staff were held criminally liable for defrauding social security. Employee Gao was pregnant and unemployed in Zhuhai, where she lacked a local hukou and was therefore ineligible for individual enrollment in social security. Gao requested a company enroll her in their social security plan.

The company then falsified an employment contract and paystubs to file the enrollment application, which Gao used to pay maternity hospital expenses of 345,965.16 CNY in Zhuhai. Upon discovering the falsification, the China Social Security Administration ordered the company to pay back the ineligible costs. In the prosecution, the court held the company owners were personally guilty of criminal fraud for conspiring to defraud the Social Security Administration.

In Zhuhai Criminal Case 2422, an individual was found guilty of fraud for using an employer of record arrangement to obtain social security enrollment to pay medical expenses. Feng worked at a Zhuhai restaurant and was enrolled for minimum social security benefits, but became pregnant with twins and wanted higher coverage, so asked the employer to terminate her social security.

Feng instead used a barber shop as her employer of record, with a recorded salary of 11,800 CNY to obtain maternity care at a cost of 62,557.16 CNY. After receiving the medical care, Feng immediately terminated the EOR’s social security enrollment and transferred it to another restaurant. The court in this case found Feng guilty of criminal fraud, pointing to the large financial gain and falsification used.

Despite the vast case law showing that EOR/PEO services are likely to end in lawsuits or jail time, most foreigners in China seem to think they are legal. The underlying reason is largely systemic; translations of Chinese employment law can often make it seem that these kinds of services lack any legal risk. To protect yourself, make sure to have legal memoranda about your business model and compliance translated into English by professional translators. Don’t rely on poorly trained internal staff or LSP freelancers to work on legal content. Supervise China-based staff to ensure they aren’t adopting a strategy that could be illegal—even if there has been a recent history of limited enforcement, that can change as conditions in China evolve.

Compliance strategies if you don’t have a local China entity

What are the options if you want to hire in China but don’t have an entity? Technically, Chinese law requires the social security payor to be the actual employer, and EORs are strictly not recognized. Nonetheless, companies will typically be considering a number of different options for dealing with social security:

1. Form a single entity for all employees nationwide

This is the strictly legally compliant method and employees also tend to be more satisfied with it. However, it can result in increased social security costs and inconvenience for remote employees who have more red tape when applying for reimbursements. Some employees also actually want to file for social security in certain regions in order to gain resident status.

2. Form a local entity wherever employees are hired

Forming a local entity is also strictly legally compliant, but operating each entity as a separate legal personality is expensive and difficult. China requires numerous costly compliance reports throughout the year for entities, and avoiding commingling problems under corporate law means setting up bank accounts and complex contracts.

3. Use a single nationwide entity with a staffing agency relationship

Using a staffing agency is much more cost-effective than other options and can achieve local compliance. However, employee staffing in China is highly regulated with “equal pay for equal work” mandates and a 10% cap on the total number of employees who are staffed. Employee morale also tends to suffer because they do not see themselves as belonging to the business.

4. Hire employees on your team through an outsourcer

A very common approach in China is to have an outsourcing company be the actual entity that hires the employees, while still managing them yourself. The approach circumvents the various restrictions imposed on employee staffing in China. However, it’s not legally compliant and the law may consider this “masked employment staffing” as merely a form of outsourcing.

5. Use an outsourcer that manages the employees

Hiring another company that does all of the management for the employees, and charges for service as an independent company, can solve compliance hurdles related to using employee staffing. However, hierarchy and proper communication channels must be observed to avoid allegations that you are masking an employment staffing setup. Note that decentralized, flat management structures are relatively uncommon in China, and team structures normal elsewhere could be seen as a way to mask employment staffing in China.

In this list, items 1, 2, and 3 are methods that involve the actual employer contributing to social security with no ambiguity about compliance. In China’s non-individualistic culture, employees in approaches A and B will feel a sense of belonging to the employer.

The higher costs of methods 1 and 2 are usually offset by improved recruiting performance and employee morale. Approach C, employment staffing, is still legally compliant and has a less severe employment morale effect in China, which is due to the equality provisions in the law. But ceilings on staffed employee headcount have made this otherwise legal approach relatively uncommon, and most companies are using approaches 1 or 2.

The very common but poorly compliant method 5, involving outsourcing, are very risky because there is always a possibility that a court or regulator will find your operation is masking employment staffing, and impose penalties for violating Chinese staffing law. Complying with employment law’s expectation that an outsourcer is exercising full management authority over employees also reduces employees’ sense of belonging, because they are made to feel like outsiders trapped in a soundproof silo.

Despite the serious compliance problems with these latter approaches, businesses often decide that this approach is in their best interest. When making a decision, ensure that you fully understand the pros and cons of each approach and are making an informed decision. Don’t take any EOR service’s promises at face value.

Outsourcing to HR Services nonetheless remains common and many companies may still want to consider it. The limitations placed on EOR arrangements have a major impact on HR Services that provide it as a primary service.

As described above, a contract for EOR services in China cannot transfer the risk of social security denial liability to the HR Service. Before these cases, an employer would usually expect liability for social security denials to be indemnified by the HR Service, reasoning that they have primary responsibility for ensuring contributions are compliant.

Local governments and the courts in China are becoming increasingly aggressive in enforcing social security compliance requirements. Nevertheless, HR Services often do pay these indemnities because of concerns that refusal to pay could damage their business reputation.

Conclusion

When working with an EOR service, there are always risks of legal liability no matter what the case is. Below is a summary of the main risk categories we’ve covered.

• If the social security process succeeds, there is a risk of it being later declared a fraudulent or false social security enrollment, which can be a crime in China.
• If the process fails, then the employer may be liable for the full balance of a claim that an employee would have otherwise received.
• A lawsuit filed against the HR Service for defects in its EOR services could be rejected because Chinese law does not allow claims against the non-employer.

However, problems with employers not being allowed to make social security enrollments in locales where they do not have an entity are still common. In such cases, using an HR Service may be a necessary risk, and regulators are encouraging HR Services to instead provide staffing or labor outsourcing services, which carry fewer compliance risks.

Government enforcement against social security noncompliance is only accelerating, therefore choosing a legally compliant strategy will always be the safest route in China’s current regulatory climate.

FURTHER READING

Get authoritative insights about this topic from a official government guidance translated by CBL:

• Hiring & Probation Period Law: the Official Guide

For a general overview of this topic, see also CBL’s China Employment Law FAQ.