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New Rules in the PRC Focus on Underreporting, Underpayment Regarding Social Insurance Fees

January 23, 2019

Under new rules effective January 1, 2019, Chinese tax authorities will now collect social insurance fees on the actual income paid to employees based on the monthly reporting of income for individual income tax filings. Sudden increases in collected amounts by the tax authorities are likely to trigger audits of employers by the authorities regarding underreporting of income and/or questions from employees regarding underpayment of social insurance obligations. Companies with operations in the People’s Republic of China are advised to self-audit their past social insurance fee payments in order to understand their past or current social insurance practices.

In the People’s Republic of China (PRC), employers are required to report their employees’ monthly base salary information to the government, and these figures are then used as the basis for calculating the respective contributions that the employer and employee are required to submit for the employee’s enrollment in state social insurance schemes. In some jurisdictions, these fees are assessed and collected by the local tax authorities, but in other jurisdictions, the fees are handled by the local labor authorities. In practice, and particularly in those jurisdictions where taxes and social insurance fees are assessed by separate agencies, employers frequently underreport employee salary information in order to reduce both their and the employees’ obligations for funding the social insurance contributions.

As part of the Reform Plan on the National and Local Taxation Collection and Management System, new rules mandate that the tax authorities in all jurisdictions across the PRC must collect the social insurance fees as of January 1, 2019. While the law does not explicitly provide for new enforcement measures, the new rules are part of a larger government effort to step up enforcement efforts around the collection of social insurance fees, with the goals of reducing individual social insurance contribution rates and increasing overall revenue. Therefore, the change is likely to trigger widespread audits of employers as tax authorities make use of accurate income information to tighten enforcement and reduce—and eventually eliminate—underreporting.

Multinational corporations doing business in the PRC or planning to do business in the PRC should take heed of this reform. Thanks to inconsistent enforcement and variation in common business practices across different regions, underreporting and underpayment are widespread and involve not only domestic Chinese firms, but many Chinese subsidiaries of foreign companies, without the parent companies’ knowledge. Underreporting and underpayment of social insurance contributions are also very common findings in mergers and acquisitions transactions.

Potential Impact

  • Audits of Companies’ Current and Past Payments: Under the new rules, the tax authorities will be able to audit current and past reporting of employees’ base income on the basis of employers’ tax reporting.
  • Repayment of Unpaid Fees: When instances of underreporting and underpayment are found, employers may be required to repay some or all of their unpaid social insurance fees. Companies with a history of underreporting may potentially face substantial financial liability, as it is not crystal clear under current laws whether the government is limited by any statute of limitations in collecting past unpaid fees.
  • Potential Increase in Social Insurance Fees: Those employers that have historically underpaid social insurance fees should expect to see a significant increase in their social insurance obligations going forward.
  • Potential Need to Increase Employee Salaries: Employers may also need to respond to employee concerns by increasing employee salaries to make up for decreases in the employees’ net income due to the employees’ increased social insurance contributions.
  • Social Credit System Implications: Any employer that is subject to a court order to repay any past or present unpaid social insurance fees and, despite having the financial ability to do so, fails to comply with the order may be listed as a “dishonest party” under the country’s new social credit system. The legal representative and senior managers of any company listed as a “dishonest party” may be stripped of certain rights, including traveling on airplanes or high-speed trains, purchasing apartments or villas in addition to their primary residences, and staying in luxury hotels.

Nonetheless, as with many written laws in the PRC, the degree of enforcement remains unclear. Many local government authorities are temporarily not actively enforcing the new rules against private and foreign-invested enterprises, particularly with respect to the retrospective collection of underpayments and penalties, due to the concern that active enforcement will further stifle the growth of the PRC’s already sluggish economy. That being said, the temporary stay on enforcement could change at any time; for example, if the government authorities decide to shift their policy priority from short-term GDP growth to the long-term funding of the social welfare system. Further, this deferred enforcement generally applies to government-initiated audits and may not apply to complaints lodged by employees for underpayments.

Steps for Companies to Take

  • Self-Audit: Companies with operations in the PRC are advised to audit their past social insurance fee payments in order to understand their past or current social insurance practices. If underpayments are found, companies should evaluate the extent of their potential financial liability in the event of a government audit and plan accordingly.
  • Training: Companies should train finance, human resources, and compliance staff on the new reporting regime.
  • Review of Social Insurance Practices: If underpayments are discovered, companies should comprehensively review and overhaul their practices in order to ensure accurate reporting.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Beijing/Shanghai
K. Lesli Ligorner
Todd Liao
Helen Tang