China’s social security system requires five mandatory contributions made to the local provincial government. The reformed laws use the tax administration for the collection of all contributions to the following funds: retirement, health insurance, unemployment, maternity, and workman’s compensation. These costs can add about 30% to the cost of employing a person in China.
The Social Security Collection Temporary Regulations §6 provides that the province’s department of taxation shall collect social security contributions, but also authorizes the province’s labor department to designate an agency to process collections. Contributions in any particular locality can be collected by either the tax or social security administration. Liability for failure to comply with China’s social security laws can be severe, with major civil penalties and even criminal sentences handed out for non-compliance frequently as part of its recent crackdown on employers of record (EOR). We cover illegal EOR liability in an article here.
Therefore, businesses need to understand exactly how social security is calculated and the lawful way to process contributions.
Contents
How contributions are regulated
Determining the social security base
How the social security administration works
Circumvention of social security costs
How to Calculate Social Security in China
Social security in China is comprised of five benefits, which by law must be paid by an entity at the location where the employee works as part of payroll. Some sources refer to “social insurance,” which is the result of using machine translation; China’s policies define the program as mandatory social security. Overall, the individual contributes an additional 8% amount and the employer 25%, based on their pre-tax salary:
- Retirement benefits: 20% by the employer and 8% by the individual.
- Medical cover: 8% by the employer with 1.2% for supplemental medical cover which can total 9.2%, and 2% paid by the individual.
- Unemployment insurance: 2% by the employer and 1% by the individual.
- Workman’s compensation: 0.6% by the employer.
- Maternity: 0.9% by the employer.
Retirement fund contributions are the same across China, but each province sets a different rate for other funds based on local financial needs. The base uses all pre-tax earnings, which means all forms of income, including overtime and bonuses. Make sure to pay the amount required by the province’s social security department, otherwise, you may face huge penalties.
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The following textbook example is often given of how social security is calculated in China for a specific locality:
- Individual contribution: 2000 CNY Income x (8% + 2% + 1%) = 220 CNY
- Employer contribution: 2000 CNY Income x (20% + 8% + 2% + 0.6% + 0.9%) = 630 CNY
In this case, the employer is actually paying 31.5% and the individual 11%. This calculation reflects how certain provinces can have higher social security contribution requirements than elsewhere. Since collection is handled locally, local governments are often willing to impose extremely severe liability in order to protect local funds’ interests from underpayment or EOR-related non-compliance.
How China Regulates Social Security Contributions
China’s social security finance is primarily administrated by local governments according to local population needs, and much of the bureaucratic process for apportioning regional finances is outsourced to business human resource workers.
Employers are required to make monthly contributions with a full statement of calculation methods at the appropriate agency for collecting social security contributions (see generally, the Social Security Contribution Statement Administration Rules.) Employees’ social security contributions are made through the employer, and additional employer statements are not required for the remainder of a contribution year if no changes are made.
Periodic payments to the appropriate agency for social security collection are made after the employer has provided a statement of the social security base and contribution ratios to the collection agency and received approval. In practice, a common method for making contributions is to set up a trust account at your bank, into which social security contributions are made.
The collection agency will administrate the collection of social security contributions and is empowered to perform compliance inspections to identify potential misrepresentation or underpayment, in which case it has the authority to take enforcement action. A penalty will involve an order to make up the missing contribution within an appropriate time limit, and a late penalty equal to 0.5% of the shortfall per day. If contributions are not made within the specific deadline, the appropriate agency may impose a fine of up to three times the amount owed.
The China Tax Administration is the lead agency for the collection of social security. The tax administration does not make approvals as to social security contribution base and amounts. Instead, it will use a predictive risk assessment model to identify potential non-compliance among taxpayers for auditing.
The required amounts for contributions are provided in China Social Security Act §12, which requires using the employee’s salary total as the contribution base. The rate for contributions must be made based on contribution ratios announced in regulations. Local governments are also empowered to make their own rules, and those for Beijing are described as an example below.
Determining the Base for Social Security Contributions
In China, what kinds of payments and benefits are included in the social security base is a qualitative determination; below is an example of what Beijing’s local law requires.
Typical employees: The individual’s average monthly salary for the past year.
Atypical employment: For atypically low or high salaries, there is a floor of 60% of the jurisdiction’s average salary and a ceiling of 300%.
Freelancers and independent contractors: Apply the average monthly salary in the city as the contribution base. In atypical circumstances, the ceiling and floors also apply.
If you are using or planning to use independent contractors in China, note that regulators are only now just familiarizing themselves with this arrangement. If not using professional legal translators, you may hear about “flexible workers” which is what AI often recommends. While it could sometimes be used to refer to employees on a flexible schedule, “flexible workers” is often incorrectly used by unprofessional translators or AI to describe someone working as an independent contractor. Social security rules for freelancers and independent consultants are currently being reformed by regulators, but workers usually make their own contributions.
When calculating the social security base, use the gross salary as required by Labor & Social Security Letter No. 60 (2006). The Letter defines the base as including anything defined as “wages” by the China Bureau of Statistics, and Bureau of Statistics Order No.1 §4 defines “wages” as compensation for time worked, piecework rate, bonuses, overtime, and fringe benefit payments.
Any payment that falls under the “wages” definition must be added to the base for social security, which is calculated as the monthly average for all income earned over the prior year. For example, if hiring a translator to translate 10,000 words for $2,000, the per-word payment would fall under piecework and is therefore added to their base.
The tax administration now has jurisdiction to collect and administrate social security contributions in China, allowing them to review gross wage payments on business tax returns during audits to check whether social security is being withheld correctly. China’s tax administration has sophisticated data analytics and auditing techniques that it uses to detect social security contribution irregularities in tax filings.
If you have talked with local China managers about social security, you may have heard that business professionals developed a culture of evasion, and indeed a non-compliance mentality is still common among businesses. However, the previous auditing incompetence exhibited by China’s Social Security Administration has been supplanted with the audit expertise and forensic accounting capabilities of its tax administration.
How Social Security Collection is Administrated in China
China’s tax reporting system requires each organization to report taxable income for each taxpayer it makes payments to and prepare a combined tax statement each year. Taxable income categories include full-time employment income, independent contractor income, capital gains, and several other categories such as rental income. The tax administration has an Individual Income Tax App that automatically consolidates all data sources and prepares an annual tax filing for the taxpayer.
Tax regulations provide for and define a standard 60,000 Yuan deduction and additional itemized deductions. An employer must calculate the social security base using the average wage from the employee’s past year of income. Under China’s current tax policy, there is a major difference between the taxpayer’s combined individual income, tax gross income, and their social security base.
The differences are described below based on each common characteristic:
- Calculation Basis: The social security base uses wages and other compensation (for example, an expat housing rental stipend). Taxable income on top of this adds capital gains, rental, copyright royalties, and any other kinds of accession to wealth.
- Covered Persons: The social security base uses all the covered employee’s compensation within the context of an employment contract, whereas taxable income also includes income earned outside the employment relationship (rental income is especially common in today’s China).
- Administrative Filings: The social security filing only needs to be made once per year, whereas China requires a separate tax filing for each month wages are earned.
- Amounts: The social security base will be the same each month for the filing period, whereas the tax amount will vary from month to month. This can create some unexpected situations where the taxable income for a month is lower than the social security base due to issues like poor attendance or poor commission performance.
- Scope: The social security base is limited to the payroll, whereas a combined income list will be generated for a taxpayer, viewable in the China tax administration’s app.
- Annual Reconciliation: Annual reconciliation is typically not needed for social security, however, taxpayers with multiple income sources in China typically have underpayments, which would require an annual reconciliation.
- Timing Considerations: The social security base uses a consistent number over the prior 12-month period, whereas individual income tax amounts due are based on all sources of income during a single calendar year.
If you’re familiar with generally accepted accounting principles, you’ll notice that China’s tax is familiar, but its approach to social security deviates significantly. China’s current tax-based approach to social security is reflected in its recent commitment to pay benefits even if the funds have a financial deficit, which represents a transition from its earlier “insurance” model to a “security” model.
In addition, note that the Labor & Security Letter No. 60 (2006) excludes some fringe benefits from the China Bureau of Statistics definition of “wages,” including insurance, travel costs, and meal reimbursements.
Evading Social Security Costs
Just a few years ago, businesses simply refusing to pay social security contributions at all was very common, but the involvement of tax administration auditors makes evasion less viable today. Nevertheless, managers throughout China are still coming up with clever ways to reduce their social security costs, even in foreign subsidiaries that technically prohibit such unlawful cost-cutting measures.
A common evasion technique is to simply declare a lower social security base for the prior year than was actually earned by the employee. Another circumvention technique is to use an employer of record in a province with lower social security requirements than the employee’s own to make payments on their behalf. However, in China’s current climate of aggressive enforcement, managers using similar techniques to reduce social security costs are actually creating major legal risks for the business.
There are actually only a handful of lawful techniques for reducing social security costs in China:
- Reducing employee salaries.
- Terminating employees.
- Reducing social security rates.
China’s social security rates vary significantly among different regions: Beijing and Shanghai are expensive, whereas Shenzhen and Ningbo are cheaper. By basing offices in locales charging lower social security costs, an employer can save significantly on contributions. The government is aware of this, however, and requires strict legal compliance to enjoy reduced costs, which has resulted in a crackdown on illegal EOR services.
China is currently vigorously taking enforcement action against social security contribution non-compliance, therefore risks of violations are very high even if local business managers still think non-compliance is normal. The recent uptick in enforcement started in 2018 following the Chinese government’s issuance of its Social Security Violation Blacklist Temporary Procedures to deter non-compliance. Penalties can include loss of access to basic services, such as financial institutions. Blacklisting can be fatal for a business in China, therefore ensuring you understand and can comply with China’s social security rules is essential to maintaining ongoing qualification to do business there.
Conclusion
In this article, we’ve covered how to calculate social security in China and learned that it will add about an extra third to an employee’s salary in costs. The specific contribution rates are extremely local. Additionally, China now aggressively enforces compliance with its social security law; tax administration policies and audit processes now apply. For an international business, independent advice made clearly understandable through professional legal translation is essential.
FURTHER READING
Get authoritative insights about this topic from a official government guidance translated by CBL:
For a general overview of this topic, see also CBL’s China Employment Law FAQ.